Much has changed since the invention of the mutual fund in 1924 – the MFS Massachusetts Investors’ Trust fund. The first index fund was conjured up in 1971. The world’s first hedge fund designed to hedge risks was created in 1949, with the first market-neutral hedge fund crafted in 1952.
A lot has changes since those early innovations of pooled investment portfolios owned by multiple investors across a range of ever-evolving investment strategies. Risk appetite has fluctuated. Specialized investment sectors have emerged. Oil/gas and commodity sectors have come to the forefront, and specialized funds focused on the IT sector have flourished. At the end of the third quarter of 2022, the most recent numbers available, total worldwide mutual fund assets stood at a notable $56.19 trillion, according to data from the Investment Company Institute.
Trend to watch: Sub-custodians
Global custodian banks or trust companies manage those investor portfolios, including handling record-keeping, purchase and redemptions, reconciliation, and managing cash positions. The Investment Company Act of 1940 strictly regulates the custody of mutual fund assets. Custodians hold securities, maintain assets and safeguard them for mutual fund managers who make investment decisions. They provide an end-to-end solution as they handle a range of vital behind-the-scenes services, including fund administration, fund accounting, legal compliance, transfer agency services and tax support for individual parts of the collective global mutual fund industry.
However, outsourcing some functions to a third-party sub-custodian can allow the mutual fund company’s global custodian to focus on performing those tasks that produce the most value. The use of a sub-custodian can also increase Straight Through Processing (STP) rates and make monthly reconciliations easier. If, for example, funds aren’t received by a designated cut-off time, the sub-custodian can notify the various fund managers. The sub-custodian can also request for the various fund managers additional time in case the custodian cannot meet the designated fund’s cut-off, or accommodate the payment receipt deadline to achieve the desired trade date for the client on an exception basis — such as due to technical or workflow issues. This can all free up the global custodian to focus on more critical and often time-sensitive tasks.
Sub-custodians can provide a range of comprehensive transaction settlement and custody services that include swiftly acting on transfers, such as from one portfolio to another where no actual cash is involved. They can also span the regional differentials and complexities that mutual funds can bring, for instance where a US investor wishes to invest in an India-based fund or execute an internal fund trade order for an Australian client. Sub-custodians can be given vital tasks to handle that mutual fund custodians themselves may not have the staff to accommodate, such as needing to look into specific transactions.
But precise and proper onboarding of a sub-custodian is crucially important as every client is different and custodians and their choice of sub-custodian must be negotiated and fee structures carefully devised to benefit each.
On the horizon
The entire ecosystem that custodians and sub-custodians are an important part, must adapt to the shifting landscape. On the horizon is ISO 20022, the new international financial messaging standards that allow for data exchanges – including payments – between financial institutions across the world. Technological advancements and rapid digitalization have enabled faster, easier payments within standardized messaging schema, and allow for additional and enhanced interoperability across the financial services industry. Streamlining of financial messaging enables faster, secured payments and facilitate a real-time payments network with an enhanced data format. ISO 20022 also enables STP (for some securities) for more efficient clearing and settlement.
In addition, Blockchain technology — which relies on secure distributed ledger technology – remains on the horizon for use by financial institutions of all types, including mutual fund global custodians and sub-custodians. Although Blockchain technology has been around for several years, the true Blockchain revolution is still on the horizon but decidedly on its way.
(The author is Santosh Kumar Malla, Senior Business Analyst, Synechron, and the views expressed in this article are his own)