Sub-Custodian Risk

John M. Cotter

Vice President & Global Network Manager

March 31, 2010

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Role of the Sub-Custodian

• Sub-Custodians: contracted by Global Custodians to provide the following services in local securities markets:

• Custody services• Trade settlement• Income processing• Corporate event processing• Asset servicing

Sub-Custodian Risk vs. Market Risk

• What are Sub-Custodian Risks?• The risk of using or not using a sub-custodian in a local market.

• What are Market Risks?• The risks faced by investors and interested parties when trading

and investing in a local market.

What are Sub-Custodian Risks?

• Operational Risks• Credit Risks• Legal and Contractual Risks• Systems and Communications Risks• Physical Infrastructure Risks • Regulatory Risks• Settlement Risks

Operational Risks

• English language ability• Staff levels/experience• Management structure (union vs. non-union)• Regional service centers vs. local offices• Types of clients serviced (custodian vs. broker/dealer)• Account structure• Holiday differences

Credit Risks

• Financial soundness and creditworthiness of a local sub-custodian• Review of financial statements and credit ratings for sub-custodians • Insurance coverage• Examples of credit risks: Barings and Fortis Bank• Reduce risk through due diligence reviews and contractual

obligations

Legal and Contractual Risks

• Local laws and regulations• Disclosure requirements (UK, India)• Investor approval requirements (India, Taiwan)• Taxation (Indonesia)• Settlement practices (i.e. irrevocable DVP)• Foreign exchange controls (Argentina, Venezuela)

• Local laws vs. U.S. law• Impact on service level agreements and custody agreements

Systems and Communications Risks

• Sub-custodians disaster recovery plans including testing• Off site back up facilities• Use of communication standards (i.e. SWIFT)• Examples/Issues: SWIFT developments, use of email and

internet• Communication outages: India• SWIFT outages: Pakistan• System failure between local custodian and depository: Poland,

Germany

Physical Infrastructure Risks

• Communication facilities• Computer facilities• Physical security

• Information access• Vault• Safety

• Back up power

Regulatory Risks

• Changes in securities/custody laws• Changes in investment/foreign exchange laws• Changes in taxation• Regulatory oversight• Audit requirements

Settlement Risks

• Failure to delivery of securities by counterparty/depository• Failure to delivery of cash by counterparty• Buy ins (Singapore, Malaysia)• Trade fail penalties (Taiwan)• Trade matching (system, fax, telephone, none)• Settlement Practices (Russia, India, Israel, Taiwan)

What are Market Risks?

• Counterparty Risks• Foreign Exchange Risks• Depository Risks• Regulatory (including Taxation) Risks

Counterparty Risks

• Counterparty risks:• Broker/dealer risk on non-delivery of securities or cash• Risk of counterparty bankruptcy (Lehman Brothers)• Settlement practices (Russia, India, Israel, Taiwan)

Foreign Exchange Risks

• Risks associated with currency exchange rate volatility• Foreign exchange control risks

Depository Risks

• Rating of depositories (Thomas Murray)• Association of Global Custodians• Transparency of depository• Depository risks

• Risk of depository bankruptcy• Risk of system failure• Risk of depository errors or omissions• Risk of legal action against securities/accounts• Insurance coverage

Regulatory Risks

• Exchange controls• Currency redenomination/conversion (Turkey/EURO)• Market restrictions • Account reporting (Thailand, Malaysia)• Change in tax regulations (Turkey, Peru) • Account approval process • Government restrictions/takeovers (Ireland/Venezuela)• Political Risks (South Africa)

Contact Details

John M. Cotter

Vice President & Global Network Manager

john.cotter@unionbank.com

(415) 273-2427