June 29, 2022

UMB: What does a custodian do for alternative investment managers?

June 29, 2022 | Amy Small | UMB

Legacy mutual fund managers are likely accustomed to hearing about custody requirements driven by regulation. But what does a custodian do for alternative asset managers who are not experienced in hiring a qualified custodian?

The primary duty of a third-party custodian is loss prevention by safeguarding assets. All registered funds, even those with alternative strategies, are required by law to use a custodian, who “sit between” the investment manager and the assets themselves, for everyone’s protection.

Many unregistered alternative funds—such as hedge funds and limited partnerships—also use a custodian, often at the request of one or more large investors who want the strong controls provided by third-party oversight such as compliance with anti-money laundering (AML) requirements. Or, because the ancillary services provided by a custodian support efficiency in their cash management and investor onboarding efforts.

The word “custodian” can be a bit confusing, especially in the context of alternative asset classes. The role I’m addressing here is different from the services a manager’s prime broker may provide. Private fund custody, in this case, refers to third-party oversight and processing services sometimes known as “bank custody” or “institutional custody.”

That said, like prime brokers, private fund custodians can provide a suite of services that complement the primary function. For prime brokers, sales and trading is the primary function, complemented by ancillary services such as financing.

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