Sponsored: What Does a Custodian Do for Private Funds?

By Amy Small, Executive Vice President, Executive Director of Institutional Custody, UMB Bank

Traditional fund managers are likely accustomed to hearing about custody requirements driven by the 1940 Act, designed to protect investors. But what does a custodian do for alternative asset managers who are not experienced in hiring a qualified custodian?

The primary duty of a third-party custodian is safeguarding assets by sitting between the investment manager and the assets themselves, protecting investors and mitigating conflicts of interest. Though there are very few physical certificates to safekeep anymore, custodians safeguard all assets, including cash, domestic and foreign marketable securities, private partnerships, digital assets, and other securities-related or loan documents.

While registered funds have a federal regulatory requirement to use a qualified custodian, many unregistered or private funds – such as hedge funds and limited partnerships – also hire a custodian. While some use a custodian to complete middle office duties, often the driving force is a request of one or more large investors who want the stability provided by third parties, along with independent oversight of money movement controls and compliance with anti-money laundering, or AML, requirements. Unregistered funds also use a custodian to take advantage of ancillary services that support efficiency in their cash management, document management, and investor onboarding efforts.

What Exactly Is “Custody” in the Context of Alternative and Private Assets?

The word “custodian” can mean different things to different people, especially in the context of alternative asset classes. The role I’m addressing here is different from the services a manager’s prime broker may provide. Private fund custody, in this case, refers to third-party oversight of cash and securities, and processing services sometimes known as “bank custody” or “institutional custody.”

That said, like prime brokers, private fund custodians can provide a suite of services that complement the primary function. For prime brokers, sales and trading is the primary function, complemented by supplementary services such as financing.

For institutional custodians, exercising control of assets and therefore providing risk reduction is the primary function, complemented by services such as:

• Servicing and settling trades;
• Managing overnight cash;
• Providing liquidity options such as lines of credit (LOCs) or reverse repos;
• Providing real-time data and reporting;
• Enabling straight-through processing to other counterparties;
• Tax reporting;
• Managing proxy and corporate actions; Handling foreign exchange, i.e., FX, needs;
• Collateral management;
• Registering and opening foreign accounts; and
• Loan document custody.

Not surprisingly, these private fund custody services relate to either or both securities themselves, or the cash transacted for them. That intersection of securities and cash is precisely a custodian’s domain – and where it applies rigorous controls to avoid mistakes and fraud.

Investor-Related Services

But private fund custody services can extend even further to areas relating closely to the investor base of an alternative fund. These investor-related services can end up making a huge difference in managers’ operational efficiency. One such area is online reporting and statements, via an investor portal that allows investors self-service access to account information.

Another investor-related area – one which we’ve seen significant interest – is help completing alternative investment subscription documents on a manager’s behalf. This can include completing the core offering documents as well as AML and know-your-customer, or KYC, requirements for each investor.

Financing Arrangements and More

Although prime brokers are more associated with financing than custodians, managers should know the role private fund custodians play in supporting their financing strategy. At UMB, for example, we work strategically with both our customers and their existing lenders to enter into tri-party collateral agreements and to offer lending solutions such as credit facilities and reverse repurchase agreements.

Bank custodians like UMB may also be able to support alternative managers even further throughout the investment lifecycle with traditional banking and escrow services, liquidity needs, investor servicing, fund accounting, and fund administration.

Ultimately, the work of a custodian is to keep all parties secure and provide the client service that helps managers run their businesses as efficiently as possible.

Amy Small is executive vice president, executive director of institutional custody at UMB Bank. UMB has more than 70 years of custody servicing experience with domestic and global transaction processing with straight-through processing, a robust security master that can accommodate data requirements of complex holdings, integration with large accounting providers, corporate actions processing, and securities lending partnerships, as well as cash management services.

UMB is a sponsor of AltsWire, and the article was published as part of their standard directory sponsorship package.

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