Hi,
As far as I understand a malicious custodian might create a fake Holding of an Instrument X.
exercise accountRefCid Account.Credit with quantity
How could we detect a fake Holding like that?
Thanks!
Jose
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The legitimacy of creating a holding depends on what X represents.
If X is a Cash IOU (or other instrument) issued by the custodian itself, then it is usually considered legitimate for the custodian to create a holding (similar to how a promise to pay on a piece of paper can be legally binding). Of course you need to trust that the custodian will provide the promised payment when demanded or that it can be enforced by legal means, and a custodian would never credit you with something without getting something in return.
If X represents an intermediated security, such as a security in book-entry form, the parties involved are regulated entities. A holding of an equity, for instance, is typically represented by a chain of bilateral holding instances from the Depository where the security has been deposited, through intermediaries, to you. It is important to note that if an intermediary creates a holding out of thin air, it is considered fake and has no backing, and regulated entities would lose their license if caught doing so.
If X is a DLT security, where an issuer has issued a bearer token on-ledger, then a malicious custodian cannot create such a token out of thin air as the issuer is a signatory on the contract. However, the custodian might keep such a token in custody on behalf of its clients thereby spawning an intermediated security or depository receipt for the client. In such a case, typically nothing prevents a malicious custodian from spending the bearer token (unless some extra workflows are put on top such as also locking the asset to the owner or so).
In conclusion, unless you keep the security in custody yourself (or put some extra customized workflows in place for locking), it is typically necessary to trust that your custodian (and all other intermediaries for that matter) will act properly and segregate your assets from theirs. Failure to do so could have significant consequences for both you and your custodian.
I hope this clarifies the matter.
Johan
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