The “Aha moment”. That moment of total clarity and understanding. I am an Ops centric guy, so I think about controls over Nostro banks and custodians. A recent encounter, made me realise that banks have the same problems controlling IT vendors who are providing outsourced services.
This week’s thoughts build on a previous post about checking what you pay to your Network; the banks which provide correspondent banking services and custodian services. On the IT side of the house, banks have been busy outsourcing to offshore and nearshore locations. For each appointed vendor there will be an agreed rate card; that might involve either daily or hourly rates for given skill levels. My “Aha moment” was the result of a conversation with a friend in IT who is now struggling to check bills from outsourcing vendors. Rates charged seem to vary from what was contracted for and then there is quite some variation with hours charged.
My sense is that a sizeable amount of pain is caused by the disconnect between the purchasing decision, the review of the charge and the accounting.
Nostros & Custodians
|Who agrees terms?||
|Who checks the bill?||
|How are costs allocated to businesses?||
Actual amounts charged divided by trade count, asset values
There are too many different departments involved in these processes and nobody has both responsibility and oversight. From various exercises over the years, I have a view on good and bad practice.
The following notes apply to Operations; they could easily apply to IT for vendor management. The key is to make sure that the person responsible for negotiating rates is then on the hook to check that what is being charged is what was agreed to.
- Every debit from a Nostro or a Depot is charged to the underlying business as an expense soon as the debit appears on the bank statement. NetMan is not involved; this is between the Reconciliation team and the Expense Management team.
- An allocation key is used to allocate all the way down to the trader’s book.
- The basis is the number of trades actually booked.
- If there were anything to recommend this at all, it would be the allocation down to the trader’s book. The other two considerations are really unhelpful. The first means that all sums, great or small are divided up into potentially very small bits. Some less active trading books will get a charge for $20 and the owners will not have time to understand the charge. Secondly, there is no certainty that there is even a sanity check on the number each month.
- The STP vs. Exception distinction is a good one, however it is beyond the capability of every bank I have ever worked at to carry that cost distinction all the way back to the actual user. But, that distinction is one that should drive discipline in the Network Management (NetMan) team to understand the exceptions and try to fix their root cause. If there is a really widespread case where one desk or unit either cannot or will not adjust to the required standard, then that area should bear the extra costs.
- “Trades booked” is not necessarily a good measure. Some of those trades may be netted, or if they are CLS eligible, settled there.
- Set a flat rate normal ticket price: based on the volume budget and the external cost budget, a ticket price is set for the year. This will be a blended rate from all the costs. So the costs of non-STP and normal overdraft costs are factored into a single “all in” cost. A few things to be aware of here; if you have multiple providers, for example in the USD, you might consider having a single blended rate across all of them. This is because it is unlikely that you can be that specific in the allocation method and also, that level of precision would require very high tech systems where the marginal benefit of absolute precision would be outweighed by the cost. You may want to add in a margin of 10% to allow for any errors.
- I would also include the regular, normal debit & credit interest at the Nostro in the base ticket charge. In the ideal world, the cash account connected to a depot would be flat, exactly zero, every day. Life does not work out that way. Some deviation is simply part of normal everyday business.
- Determine a sensible allocation key: sensible means that it is one for which you have enough detail when the trade is booked to determine the fee to charge the trading book with the ticket fee at the point of trade. So for an equity, you might have a charge based on the currency rather than where the trade settles, as that might not be on every trade. Where a transaction results in a payment, some care is needed. For example, in FX, there must be distinction between CLS settlement and non-settlement. That latter group needs to be further divided: gross or net.
- Adjust for actual vs. budget: Ops is not a profit centre, so it should not have P&L. It may also be the case that the charges on a ticket level are too high or too low. The NetMan team need to do their review of monthly charges from the Nostro or Custodian. Exceptional items, such as massive overdrafts, need to be dealt with separately. Then the adjusted costs need to be compared to the monthly charges to the trading books. The difference, and there is bound to be one, then needs to be dealt with. One method is to adjust the trading books; another is to do a single adjustment at a business or division level across all products. If the differences are less than +/- 10%, a summary method would recommend itself.
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