Contact: David Wilson, ext 7407

1 Introduction

1.1 Custody of the Fund's assets is currently arranged by the three investment managers, who use their own appointed custodians as follows:

Deutsche State Street Trust and Bank

Schroders SIM Global Custody

SGAM Bank of New York Europe

1.2 Many pension funds now use their own global custodian, who act as custodian to all of those funds' investment assets (excluding property). The forthcoming review of the Fund's investment management arrangements provides a good opportunity to re-consider whether the Fund should directly select and appoint its own global custodian.

1.3 This report outlines the arguments both for and against the Fund appointing its own global custodian, and recommends that tenders be sought as soon as possible with a view to having a global custodian in place at the end of May 2006.

1 Functions of a global custodian

1.1 Custodians perform a number of essential functions including:

· The settlement of transactions as instructed by the Fund's managers.

· The collection of income on the Fund's investments.

· Processing corporate actions eg bonus issues, rights issues, and mergers.

· Implementation of voting decisions made by the managers on the Fund's behalf.

1.2 In recent years custodians have sought to expand their services to cover:

· Performance measurement services.

· Commission recapture schemes - where custodians offer market brokers minimum levels of business in exchange for rebates of commission which are shared with clients, subject to those clients' approval.

· Monitoring of individual managers' trade execution costs.

· Pension Fund accounting services.

· Stocklending (already carried out on the Fund's behalf by both State Street and SIM Global Custody).

2 Advantages and disadvantages of using a single custodian

2.1 The advantages of having a single custodian independent of the managers can be summarised as follows:

· Responsibility for the custody of all the Fund's investments (excluding property) would be with a single provider, standardising and consolidating our arrangements for accounting and reporting.

· It would be much easier to `move' assets between managers - in Hampshire's case having a single custodian in place when we implement the management changes in 2006 would make the transition much easier as there would be no transfers between separate custodians. This would reduce delays, costs and risks.

· A single custodian may be able to offer more advantageous terms for the provision of the optional extra services as listed above in paragraph 2.2.

· A direct contractual relationship between the Hampshire Fund and its custodian would make it much easier to ensure that the service provided is tailored to the Fund's specific needs. Currently the Fund's managers decide the level and nature of the service provided.

· There may be a reduced risk of loss to the Fund because of a clearer separation of duties between manager and custodian.

· Many investment managers do not offer a custody service. This marginally restricted the Fund's choice during the last tender exercise in 2001, and it would be likely to be a more significant restriction this time if the Fund adopted a more specialist management structure next year, using some smaller `boutique' managers.

2.2 The major disadvantage of using a single global custodian is that the fees and other direct costs of using a custodian may not be offset by lower investment management fees. However, this can be partially offset by using opportunities to increase income from stocklending, and other `value-added' services available from custodians listed in paragraph 2.2 above.

3 Selecting a single global custodian

3.1 If the Panel opted to appoint an independent single global custodian it would be necessary to undertake a full tender process compliant with European procurement procedures. Such a process could take up to eight months to complete, and would enable the Fund to have a custodian in place by May 2006 to assist with the restructuring of the Fund's management arrangements.

3.2 It is essential that any custody arrangements should:

· Maximise the security of the Fund's investment assets, many of which our held in electronic form rather than as paper certificates.

· Minimise overall costs, including hidden costs such as foreign exchange dealing costs, which can be significant.

· Comply with best practice, taking full account of legal and regulatory requirements.

3.3 The Fund has had no previous experience of selecting a global custodian. The majority of other local authority funds who have undertaken the process have sought the assistance of consultants who have that experience, and hence a deeper knowledge of the possible pitfalls - in particular the need to ensure that all costs, including hidden costs that could result from an inefficient custody service, are as explicit as possible and under the Fund's control.

3.4 The Fund's actuaries, Hewitt Bacon & Woodrow, have offered to help in such a process at a cost to the Fund of £25,000. They would provide:

· Training to County Treasurer's staff on the role of a custodian and how they charge for their services (including hidden costs).

· Advice on selection criteria.

· A comprehensive draft tender questionnaire tailor-made for the Hampshire Fund.

· Analysis of the responses.

· Advice on shortlisting.

· Attendance at and advice for selection interviews.

3.5 It is suggested, as this is the first custody selection process the Hampshire Fund has undertaken, that it would be appropriate to accept Hewitt Bacon & Woodrow's offer.

Recommendation

1 That the County Treasurer undertake a tender exercise for the appointment of a global custodian, with a view to making a final recommendation to the Pension Fund Panel at its business meeting on 26 May 2006.

2 That Hewitt Bacon & Woodrow be commissioned to provide assistance with the process as necessary at a cost of £25,000.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

1. Published works.

2. Documents which disclose exempt or confidential information as defined in the Act.

TITLE FILE

None.