As investors increasingly diversify into global assets and derivatives, their demands for information increase.
"In fact, we now live in a world that wants super-information," said Marshall Carter, chairman of State Street Boston Corp., a leading global custodian. By "super" he meant superior in size, quality, number, or degree.
The challenge for all financial service providers, and especially global custodians, is to organize their clients' data so that they have the information they need to make intelligent, timely investment decisions. What everybody wants is a perfect securities movement and control system.
Almost everyone with a computer has a securities movement and control system. Quicken or and Managing Your Money, the personal computer programs that keep track of personal finances, are microcosmic examples. Until recently, institutional movement and control systems were well suited to domestic custody and trust needs.
"Now, however, we need a whole new generation of (them)," said Borys Harmaty, a vice president with the Bank of New York who designs financial software. One reason is to handle currencies. Another is to control the vastly increased variety of securities, many of which do not have standard identification numbers normally assigned to U.S. securities.
There is a third reason. "As reporting needs get more complex, (securities movement and control systems) must be able to report exposures the new instruments create," Mr. Harmaty contends. As long ago as March 1989, the state of Kentucky issued $78 million worth of municipal bonds denominated in Japanese yen. To report exposure properly, a movement and control system now has to mark this security to two markets (yen and municipal bonds) daily, and then combine the values. If an investor hedges this bond, two more marks-to-market in municipal futures and yen forwards or futures will be needed.
Over-the-counter derivatives add yet another dimension because they often include options whose values can be determined only by using the binomial distributions or Monte Carlo simulations, mathematical exercises that describe how options will probably behave. There is no complete agreement on how to value options.
How to value assets brings up an interesting question for custodians. Philosophically, custodians - to spare themselves liability - prefer that the value of customers' securities come from outside sources.
"But, banks are willing to interpolate a forward (foreign exchange) rate to give a market value to a future currency position," Mr. Harmaty said. "Here, you are simply disclosing to your customer that this was the value yesterday at the close of business, making no claim about what it might be in the future." He notes that willy-nilly, custodians are being pushed deeper and deeper into the valuation game.
Mr. Harmaty knows of no securities movement and control system that's perfect - not even Bank of New York's. But pressure from customers for better reporting is increasing. This is one reason banks have been getting out of global custody.
What do clients or customers really want? "My goal is access to all data from my desk at any point in time," said Philip Halpern, chief investment officer of the Washington State Investment Board in Olympia, a Bank of New York customer with a $28 billion portfolio. He has three needs. First is accounting information - today's asset values and distribution by asset class, by fund, by geographic location. "Being able to access that basic information is critical because the other two needs can only fall out from the first need," he said.
Assuming the pricing is correct, Mr. Halpern's second need is performance reports which also must be sorted by fund, by manager, by sectors, and so on. This leads to the third need: to measure exposures if certain events occur. The first two parts are records of the past and the present which no one can do anything about. The third has tools to determine risks versus potential returns. "That's really where we should be spending our time," Mr. Halpern explained.
So the ideal securities movement and control system should report correct prices easily and quickly on traditional assets as well as futures, options, and swaps. It should show options, futures, and swaps either separately or cross-encumbered with the instruments they are hedging. It should net all of the margins and collateral involved with these instruments. It must distinguish between countries of issue, countries of exposure, and currencies of exposure. It should provide cash management reports that show the effects on cash, forwards, options, futures, and swaps. Finally, it should be able to "talk to" the securities movement and control systems of clients' international brokers - especially when managing cash internationally.
Sometimes third, fourth, or fifth parties are also in the loop. One common example is calculating and presenting portfolios' net asset values. Securities prices for marking-to-market may come from one outside source; futures and option prices from another; and swap prices from yet another.
"You look for the best capabilities of each party to the process," said Bank of New York's Mr. Harmaty, "Then, you link them in the most efficient way." True efficiency in software means creating information programs for clients that are transparent, accessible, flexible, and task-oriented.
What happens if custodians don't update their securities movement and control systems? "People not planning to change their (systems) to do these things now," Mr. Harmaty said, "are dead in this business."
How much will this cost? The hardware expense is no more than $10 million, according to Mr. Harmaty, but there are additional cash and psychological costs. "You have to teach staff. You have to add a wealth of reporting detail over and above what it now being done for customers. You have to persuade your senior management to bear this cost now so that it will cost less later, and so that your institution can keep its competitive edge," Mr. Harmaty explained.
A securities movement and control system, no matter how good it is, will not be effective unless it is fronted with a good interface. Anyone who has ever learned a personal computer program will remember the initial frustrations that came with not being able to find commands to perform common tasks. A good interface - the presentation of a program's information and commands - can reduce this frustration to almost nil. But for all too many of today's computer programs, levels of frustration are directly related to the complexities of the tasks. What good is superinformation if a customer can't get to it?
Good interface design should produce standard and ad hoc reports of portfolio activities that can be charted, graphed, printed, or exported in any form. When financial crises occur, everyone needs fast, accurate reports, so good designs should have powerful and accessible ad hoc query tools that can create reports on, say, holdings in equities in Mexico or futures in Singapore. No one tells a human assistant every step to take. No one should have to tell a computer either.
In 1993, Mr. Harmaty set to work on an interface that incorporated these features. It was based on Microsoft Corp.'s Excel spreadsheet software and had an existent user file menu structure. It had all the needed tools. It could call out data and graph them. The bank's senior management liked it.
"But we didn't really know how clients could use it efficiently because we didn't really know how they worked," Mr. Harmaty recalled. So in late 1993, the bank hired Unified Field, a New York computer firm that specializes in interface design and multi-media software, to recreate the interface.
Unified's tasks were: To make sure the mechanics to use the system were clear; to have everything on one system; to make sure clients could retrieve information and chart, graph, print, or export it immediately without needing multiple sign-ons or having to navigate different systems; and, most importantly, to have everything task-oriented. This meant that only the information and tools needed to do a specific task came on the screen. There were to be no complex menus, no indecipherable icons, and no extraneous tools or information.
Watching how clients worked together, Mr. Harmaty and Eli Kuslansky, one of Unified's managing partners, developed a list of questions whose answers showed that people wanted a simple, direct way of getting a set of securities holdings. They wanted it recorded, graphed, or charted automatically, and sometimes exported. Then, they wanted to get back to the top of the main menu to begin the next job. By early 1994, a prototype interface was ready.
Dubbed "Custody Workstation," the prototype won first prize in the finance category of the 1994 Windows World Open contest. Sponsored by Microsoft Corp., the contest is an annual competition held each May that selects the best custom applications using Microsoft's "Windows" software in eight institutional categories such as finance, public administration, health care, and insurance.
Late in 1994, it was put to work for the Washington State Investment Board, with which the final bugs are now being worked out. Mr. Kuslansky and Mr. Harmaty have some simple advice for plan sponsors who are want good interface designs (See related story).
Is Mr. Halpern pleased with "Custody Workstation?" "It takes time to move from the test stage to the live stage," he said. "But I do anticipate this interface will be very, very successful, and that it is going to add a lot of value to our funds."
Good interface design cannot fix an inferior securities movement and control system; a good interface depends on a really good system. For custodians, future success in customer satisfaction and profits will come from having the best of both.
Desmond MacRae is a freelance business writer based in New York.