Ultra-low and zero-fee bids have become common in the scramble for the global custody accounts of large pension funds.
While these types of bids may be good news for the favored few pension funds that are offered them, they may not be good news for the great mass of global custody clients in the long run.
The most publicized recent near-zero-fee bid was that by Bankers Trust Co. for the Los Angeles County Retirement System's $14 billion fund.
But Bankers Trust has not been alone in making very low bids for global custody accounts. The number seems to be growing as the global custody world becomes ever more competitive.
Of course, Bankers Trust and other near-zero-fee bidders are not volunteering to give away their global custody services.
They calculate they can enhance returns from securities lending and currency transactions sufficiently to give the client a competitive return from those activities and still make up for the low or non-existent global custody fee.
Nevertheless, the trend toward ultra-low and zero fees is troubling for a number of reasons.
First, global custodians offer valuable services for which an overt fee is deserved.
The custodian keeps the assets safe and keeps records of transactions involving the assets, a difficult service when it involves foreign markets and transactions.
In addition, among many other custody services, the custodian executes foreign exchange conversions, tracks down failed trades, collects dividends and reclaims taxes when they have been incorrectly imposed and paid.
The customer should not expect to receive these services "free."
Second, even if the client fully understands that the services are not free - that he or she is paying for them through excess return the custodian earns on securities lending or currency transactions - the amount of that fee will probably not be fully understood.
Fees should be overt, not covert.
Third, a near-zero fee might misalign the interests of the global custody client and the provider.
The primary role of the custodian is to keep the assets safe and to keep a record of transactions affecting those assets.
If the custodian must make its fees from excess return generated from securities lending or currency transactions, both of which should be virtually risk-free to custody clients, the custodian may be tempted to take more risk than clients expect or want.
The dangers were shown earlier this year when a major custodian, Harris Trust & Savings Bank, suffered major losses in securities lending because of attempts to enhance returns through securities lending. Harris fully covered the losses for its clients.
Global custody services must command reasonable fees to be a viable long-term business for the global custodian banks if the banks are to continue investing in the computer systems and programs needed for an ever broader and more complex investment world.
Clients do not have to select the global custodian offering the lowest fees.
They should select the global custodian that best fits their needs and selection criteria - then negotiate reasonable fees. Such fees must be not only acceptable to the fund, but also must allow the global custodian to continue to invest in the business.