Withers Worldwide

Are you worried about the robustness of your custody arrangements?

Have you assessed and reviewed your counterparty risk?

Is it time to review or renegotiate your banking facilities?

Current market conditions dictate that very close scrutiny will need to be paid to counterparty risk. Custody agreements can be an overlooked area: it may be surprising to know that in some instances documentation and the relevant clearing rules provide for an outright transfer of title in the securities placed with the custodian, exchange or clearing house, thereby exposing the true owner to the insolvency risk of the custodian, broker or counterparty.

In the wake of the collapse of Lehmans in particular, there is increased focus on counterparty risk in respect of monies and securities held by a custodian. What is often easily overlooked is that similar risks can arise even where assets are held by financial institutions acting as custodians.

Where a bank acts as a custodian, credit balances on custody cash accounts may not represent cash deposits. Whilst custody clients may be willing to take custodian credit risk in respect of their cash accounts it is imperative to ensure that assets credited to client securities accounts are not at risk in the custodian's insolvency, or otherwise available to its creditors.

The traditional view of the custody relationship has been challenged by computerisation, such that the assets in the hands of the custodian in general comprise not physical instruments, but intangibles, which raises significant issues as to the nature of the relationship: ie, is such relationship one of bailor and bailee, or (the more favoured view) is the contemporary custody relationship one of trust?

While it may be entirely appropriate to take the view that certain types of investment remain desirable notwithstanding potential risk exposure, these decisions are best taken on an informed basis.

Our team is well versed in this area and can assist family office clients by conducting a thorough legal due diligence review, thereby identifying areas of operational, counterparty, credit and systemic risk and risk in cross-border trades. Such review will also extend to contractual and legal risk, departures from good market practice, and recommended risk management tools.