Regulatory Changes Driving Changes in Custodial Preferences for Affluent Families and Institutions

By Mark Barnicutt on August 6, 2015

Affluent FamiliesIn our previous article, ‘Keeping Investor Assets Safe: The Custodians Role’, we outlined the importance of having an independent custodian take safekeeping of clients’ investable assets where their portfolios are being managed by advisors. The logic for this statement is what we refer to as the ‘professional division of duties’; in other words, we believe that for affluent families and institutions such as foundations and endowments, the organizations that are ‘managing’ your assets should not be the same organization/legal entities that are ‘safekeeping’ your assets.

Separating the two eliminates a conflict of interest and helps to protect clients against fraud.

Public and Private Securities

Within client portfolios, there are generally up to two types of security types, as it relates to the pricing/valuation of those securities: Public and Private.

While Public Securities are generally considered to be prospectused based stocks and bonds that trade on a regular basis through established markets as well as mutual funds, Private Securities are considered to be everything else; effectively stocks and bonds that are not prospectused and don’t trade on a regular basis through established markets as well as non-prospectused investment funds.

Historically, the two types of custodians (Investment Brokerage and Trust Company) have been able to hold assets within clients’ portfolios that are both publicly and privately traded. With pending securities regulatory changes in Canada, we believe that it will become extremely challenging for the Investment Brokerage Custodians to custody private securities.

Although there are various factors contributing to this change, one of the dominant factors is how securities are priced, or valued. Specifically, for publicly traded securities, ‘the price’ is determined by ‘the market’, and so this provides regulators with the perceived comfort of established value for those publicly traded securities.

The challenge for privately traded securities (i.e. stock or bond investments in private companies) is that there isn’t a ‘market’ to establish a price; instead, the price of the securities is determined by other valuation techniques, which may or may not align with brokerage custodian regulatory requirements.

Implications for Affluent Families and Foundations

For the average Canadian investor who is saving their hard-earned income for retirement purposes, they typically have no need to invest in private securities but instead concentrate the wealth accumulation with publicly traded securities.

But for affluent families and institutions, who often invest in both publicly and privately traded securities, we believe it will be increasingly challenging for these investors to employ an Investment Brokerage Custodian for the safekeeping of their privately held investments.

As a result, we believe that these affluent family and institutional investors will increasingly be forced to custody their privately held securities with Trust Company custodians (and potentially for convenience and simplicity, their publicly traded securities as well). While Investment Brokerage Custodians will soon be having regulatory issues with such privately traded securities that can potentially impact their firm capital requirements, Trust Company Custodians are not impacted by these regulatory and capital changes as they are not brokerage firms but financial institutions whose sole purpose is to safekeep client securities, for a fee.

Given these pending regulatory changes, we believe that we’ll soon begin to witness a ‘dividing line’ being drawn in the Canadian custodial industry. For retail investors who seek primarily publicly traded securities, Investment Brokerage Custodians will service their needs well; but, for affluent families and institutions with assets who seek both public and private securities in their portfolios, Trust Company Custodians will increasingly become their preferred type of custodian, as they already are for extremely affluent families and large institutions.

>> HighView Financial Group is an investment counselling firm for affluent families and foundations. Schedule a complimentary discovery session to see if we’re the right investment stewardship counsellors for you.

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Mark Barnicutt
See Beyond

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