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Comment and analysis

08

Banking

Custody services – inbound perspective

Custody services – Inbound perspective

The following article discusses the transfer pricing challenges faced by subsidiary custody operations. Understanding how the profile of the local subsidiaries may differ from the global footprint will provide direction for the transfer pricing methodology.

Market dynamics

For inbounds, it is relevant to understand the local market dynamics for custody services, particularly factors that may impact the pricing of local custody services, composition of the customer base, and regulatory requirements. In Canada, for example, the financial services industry and custody market is highly concentrated. The market is very competitive due both to the small number of global service providers, and the concentration of control over Canadian institutional assets by a small number of pension funds who are the custody banks’ largest clients. This places significant emphasis on client retention whilst exposing the banks to dictated terms and pricing.

Scale business

Significant investment is required to develop and maintain the information technology processes supporting the business. Subsidiary operations leverage global technology investments to provide local custody services as part of the global custodian network. Certain subsidiaries may have more significant roles and operate dedicated global services centres to take advantage of local cost advantages. The transfer pricing method selected should address the value contributed by technology.

Risk management

Global risk management processes and guidelines help shape local subsidiary requirements, however these subsidiaries are regulated in their local markets and must ensure they are managing their own risks. Operational risk (resulting from processing errors, miscalculation of asset values and trading settlement errors) in particular is important for both subsidiary and global operations and poor operational risk management could result in the loss of global customers. Who has the ability to control this risk and who will bear the risk of loss will be important considerations for transfer pricing.

Client relationships

A key role for local subsidiaries is to develop and maintain client relationships, either as primary relationship managers for locally domiciled global customers, or as the local sub-custodian for foreign based clients. The value of local subsidiary contribution to client relationship is not always clear. Institutional investors and asset managers perform substantial due diligence to identify potential custody service providers as “switching costs” are high. Local relationships help to identify opportunities, but the global brand, reputation and financial strength of the custody bank are also key selection criteria. Establishing the value of local relationship management and customer service will determine the level of compensation to the subsidiary beyond routine sales and customer support activities.

remuneration for subsidiary operations, local tax authorities will want to identify the services and intangibles provided to the local subsidiary and the related charges.

Understanding the margins associated with custody, which is provided by the subsidiaries, and the value added services, which may not be provided by the subsidiaries, is complicated by the pricing for “bundles” of services Verification of the margins attributed to subsidiary operations is a particular challenge for tax authorities.

Conclusion

Custody services are easily understood but not easily priced between global affiliates due to the global integration and interdependencies between the various service offerings.

Practical challenges for tax authority audits

For more information please contact:

Krishnan Chandrasekhar - krishnan.chandrasekhar@us.pwc.com

The extent of integration in the business will have consequences for the preferred transfer pricing method. Whether a transactional method or a profit split approach is used to reflect arm’s length

Emma Purdy - emma.j.purdy@ca.pwc.com

PricewaterhouseCoopers • A publication for financial services industry tax and transfer pricing professionals • February 2010

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