What is a custody certificate?
In finance, the term “custody certificate” refers to a legal document indicating the beneficial ownership securities held by an institution on behalf of their owner.
In modern financial markets, these types of custodial relationships are commonly used by investors, who rely on brokerage firms and other intermediaries to buy, sell and securely store assets on their behalf.
Key points to remember
- A custody certificate is a legal document that clarifies ownership of a title.
- Although their format has evolved over time, they remain an essential means of maintaining the chain of custody of financial assets.
- Most retail investors rely on brokerage firms to hold their assets in their name, registering those assets “in street name” and listing the investor as the beneficial owner.
How custody certificates work
In the past, investors who stored their securities with a trusted financial company obtained physical certificates describing the nature of the assets stored and their beneficial ownership status. Today, that same legal relationship still holds, except that certificates are now kept in digital form rather than physical copies.
Specifically, the modern equivalent of the custody certificate is the contract between a brokerage client and the brokerage firm that is established prior to the creation of the investor’s account. Through this agreement, it is clarified that all securities purchased and stored by the broker on behalf of the investor are the legal property of that investor.
Like investors, brokerage firms also get their own version of custody certificates, often relying on third-party financial institutions for their own asset storage needs. These kinds of child care are commonly offered by major banks such as JPMorgan Chase (JPM),Citigroup (VS), and Bank of New York Mellon (BK).
While some investors might derive satisfaction from holding physical share certificates rather than holding them through a brokerage firm, this would involve additional holding costs due to additional bank deposits and insurance premiums. . For most investors, the convenience and security of custody through brokerage firms makes in the name of the street system the preferred mode of ownership today.
Concrete example of a custody certificate
One of the most common examples of custody certificates used in modern finance is that used by retail investors and discount brokerage firms. Today, stocks purchased through a brokerage firm are technically registered “by street name”, which involves using the name of the brokerage firm itself. Nevertheless, the legal ownership of these shares remains in the hands of the investor, as the brokerage firm will always list the investor as the beneficial owner of the shares.
Proper management of custody certificates is essential to maintain a chain of custody for global financial assets. Without these processes, it would be impossible to enable the near-instantaneous transaction speeds we currently enjoy, along with historically low brokerage fees. For these reasons, the procedures used by financial companies to store and transfer these certificates are closely monitored by regulatory and government agencies.