Financial Journalist

FT Mandate March 2006

The latest research from FT Mandate reveals a more mature securities services industry, with a discerning outlook for deals. Gerry O’Kane examines the winners and the trends of 2005.

It has been all change in the world of securities servicing over the past 12 months. Players have veered away from outsourcing being their seemingly sole preoccupation and some are even touting the hitherto reluctant ‘c’ - word – custody – as being a healthy market in which to be.

“Anybody who discounts the value of custody which creates the platform into which you can sell other services is crazy,” says Tim Keaney, head of the Bank of New York (BNY) in Europe. He estimates that basic custody in Europe added $500bn (€420bn) to the bank’s assets under custody over the past year.

Now the talk is of selling new services to existing clients, an expansion of business in continental Europe and the increasing growth in alternative fund administration. There even seems to be an agreement that the industry as a whole, clients and suppliers, has matured.

“Clients are becoming more realistic,” points out Nadine Chakar, chief executive of ABN Amro Mellon. “Everyone wanted that landmark deal and promised the stars and moon but now people are taking a sceptical look at what’s on offer and are more realistic.”

“There’s a more mature understanding among clients as to what is custody and administration,” agrees Penny Biggs, head of corporate and institutional services and global sales at Northern Trust. “In the past when margins needed to be clipped, they focused on services like custody.”

The industry itself seems to have taken a step back to consider deal implications. F&C Asset Management walked away from a potential new outsourcing contract with Mellon because it was no longer attractive and while State Street flaunted its renewal of outsourcing to Scottish Widows Investment Partnership (Swip), there was little competition for the contract.

The Bank of New York retained the custody and administration business of Merrill Lynch Investment Managers but walked away from a full outsourcing deal because of Merrill’s refusal to move to its SmartSource platform.

For the first time since FT Mandate has been casting its eye over the performance of players in the custody market, JP Morgan has moved to the top of the pile with $11,200bn under custody. It leap-frogged both the Bank of New York and State Street to pole position, in spite of both banks boosting their assets over the year by $1200bn and $600bn, respectively.

“Firstly we must say that it’s not our aim to be the biggest in the business but it’s a consequence of our success with clients,” says Richard Warne, head of relationship management for Europe, the Middle East and Africa at JP Morgan Worldwide Securities Services. More modestly, he also points out that most of the firm’s clients had a good 2005, helping to boost asset figures.

Pinning the group down on what accounts for its sudden emergence as leader is more difficult. It did witness the exit of some well-known personnel in the past year and has been seen as taking a more focused approach to the business by creating the Worldwide Securities Services arm.

However, the bank has done more than simply create a new department, it is also pulling in newly created business arms to provide a full service such as provision of fund administration services to private equity firms. It had already been performing these services for its own various private equity businesses worth over $11bn under management.

Like others in the sector, JPMorgan is taking a closer interest in servicing the buy-side of the industry. “An area of keen focus for us is the recently launched Alternative Investment Services Group,” explains Mr Warne. This is founded on the acquisition of the middle and back office operations of hedge fund Paloma Partners Management, which has been in the hedge fund business for 25 years and its JP Morgan’s existing Tranaut hedge fund administration unit.

“Servicing alternative assets is an absolute trend in the industry, especially in Europe with asset managers and pension funds seeking alpha while having an eye on asset liability matching,” says Mr Warne. And there is little doubt it ought to have the expertise having spent $60m on new technologies.

Certainly, having a close eye on the alternatives market has been the continuing trend throughout 2005 and a bigger headache for all those involved in securities servicing.

“The year 2005 was a slightly different one for us,” explains Ms Biggs. “We knew we had to do something pretty significant in the alternative asset group.”

Northern Trust bought Barings financial services group from ING and has been busily integrating the entity into its own custody unit. From Northern Trust’s point of view the acquisition gives the bank an easily exportable solution in the alternative investment fund administration world and it intends to concentrate initially on Europe.

Similarly, BNP Paribas Securities Services (BNPPSS) says it intends to beef up its handling of alternative assets. “Because of the French usage of over-the-counter (OTC) products we’ve brought in people with dedicated experience in leveraging the market,” says Margaret Harwood-Jones, head of client segment, institutional investors at BNPPSS. “We’re also looking at a range of instruments for reporting and will offer independent valuation services.”

However, things have not all gone BNPPSS’s way. It remains in sixth place in the FT Mandate table, but dropped nearly $400bn in assets.

Even so, it is one custodian to have profited from buy-side business. Its outsourcing mandate with Aberdeen Asset Management was renewed in 2004 and now includes Edinburgh Fund Managers. It also won parts of Deutsche Asset Management and it is leveraging all these contracts for alternative investment expertise.

One contract it must have been bitterly disappointed to lose out on was the outsourced business of Axa Investment Managers in France, which was secured by State Street.

Muted but successful

“It was a great year for us,” says Alisdair Reid, head of the asset owner group EMEA with State Street, pointing to the Axa deal, retaining the Swip business and winning an outsourcing contract from ABN Amro Asset Management in the Netherlands.

But apart from these hefty contracts, business at State Street could be considered muted and reflected in its third place standing in our table. The disappearance of the well-respected Jeff Conway back to the US at the end of 2005 would have had little effect and the bank seemed to concentrate more on sorting out loose ties. “We’ve just marked the end of our major integration efforts bringing legacy clients to the State Street platform,” says Mr Reid. This includes the Deutsche business of which it retained 88 per cent.

He also said that tough decisions, especially in outsourcing, had to be made in 2005. “We have to deliver value to shareholders and had to walk away from deals because they weren’t financially viable.” He warns that any company thinking about gaining market entry to the business by cost cutting would now be playing a very dangerous game.

Like Mr Keaney, he sees growing business based on good relationships as vital for the company and straight-forward custodial services are the base for that. “There is an increasing demand for bundling – companies are finding they don’t have the time or resources for certain elements and come looking for extra services,” explains Mr Reid.

“Bundling is a continuing trend,” agrees Mr Keaney. Transition management has been one area where Bank of New York has built business with 25 per cent of its clients now using that service. “It’s been a matter of making an effort in education.” All the players seem to have picked up business in transition management or securities lending, as part of this trend.

He also identifies the middle-market players as those most likely to take standardised products and services. “We’re keen on the $5bn-$50bn-sized firms who are most likely to go that route,” he says.

Nadine Chakar, who has long argued the benefits of buying components based on strong relationships with clients, says this sector is benefiting from price transparency and adds that ABN Amro Mellon is aiming to be the Dell of the asset management
servicing industry, providing whatever bells and whistles are required. “Rightly there is an expectation [from clients] that their provider can take off-the-shelf products and customise them to achieve a solution to their unique requirements,” she says.

“There’s a greater requirement for price transparency and asking ‘Am I getting the best execution on FX?’ and they’re smart enough to know they can’t get everything for nothing,” summarises Ms Biggs.

The view that the ‘black-box’ solution is no longer good enough is supported by Mr Reid. “You have to be able to customise, whatever the statement of recommended practice.”

But there are warnings. Ms Biggs says that component business is developing but it must be built from a position of holding the custody mandate. “We’ve had to be quite discriminatory about that,” she says. And Mr Keaney adds that there are very few operational one-off components in the market: “About 99 per cent are bundled.”

Although it is refreshing to hear so many securities services providers cite good relationships and basic custody as being the stepping stones to other service provision, it would be foolish to think that beady financial eyes were not on the look-out for new forms of business.

Nevertheless maintaining their technology and meeting the new challenges of the alternative investment market and coping with the differing regulations abundant in Europe is taking some effort. State Street boasts that 20-25 per cent of its operating budget goes on information technology. On top of that is staffing, finding the expertise and knowledge.

The Bank of New York had a tough year with many of its senior staff being poached. “It’s a knowledge worker business, experience is the key,” accepts Mr Keaney. He admits it has been a bit of a struggle to keep staff, exacerbated by a planned move of staff from London to Manchester. However, he adds that BNY has brought in people from the US and has led the way in hiring from the big consultancy firms.

Mr Warne at JP Morgan agrees that keeping staff is crucial but made easier if you’re a global organisation offering a full career structure. “It’s a challenge to the smaller players in the market,” he says.

And all these pressures are both creating more difficulties while opening new markets, especially in continental Europe. (State Street aims to boost revenues outside the US from 38 per cent to 50 per cent, mainly in Europe.)

One new area of business is pooled funds with a number of multi-national companies sponsoring pension schemes in Europe attempting to pool their pensions, such as Unilever and IBM.

There are certain tax advantages to some pooling vehicles. “Multi-nationals can invest their pension assets through funds set up in Dublin or Luxembourg and these fonds communs de placements or common contractual funds do not have to pay withholding tax on investments,” explains Mr Reid.

And everyone is talking the talk about capability but in reality there have been few deals.

In the more mundane world of outsourcing and securities services, continental Europe has differed from the UK and US in its approach. There has been a slower take-up of outsourcing because of a model in which all operations are done in-house from custody to asset management. But banks are being pressured to change and the global custodians are looking expectantly on.

“In Italy and France local guys are approaching a decision on whether to remain local or go global or partner – the underlying clients are international themselves and are outgrowing their custodian,” says Mr Keaney.

Merger moves on up

Société Générale, which moved from eleventh to ninth and boosted its assets under custody by a 42 per cent to $2000bn in the FT Mandate survey, acquired the custody arm of Italy’s UniCredit Group for $690m including custody, clearing and settlement, depository bank, fund administration and transfer agency for clients in Italy, Luxembourg and Dublin.

BNP Paribas has also announced its intention to buy Banca Nazionale del Lavoro in Italy, including its fund management business and private bank. In addition to expected benefits in retail and corporate banking, there is the theory that Italy’s pension market was due for a shake-up and a developing asset management industry would boost
custody returns. Already Italy spends one of the highest levels on pensions in Europe.

In Germany, BNPPSS took over the Invesco Depotbank operations starting with fiduciary and custody and moving towards full administration outsourcing. Ms Harwood-Jones says that winning this sort of business depends both on technological capability and experience. Even the announcement of State Street winning the Axa deal in France had the benefit of acting as a catalyst on the rest of the European market, in her opinion.

Others have been more proactive in gaining European business. Northern Trust,which fell one place to eighth in the survey, managed to crack the lucrative Nordic market. It was selected by Swedish insurance company Folksam as sole global custodian for all its $17bn investment portfolio through a new agreement with Swedish trustee Svenska Handelsbanken. “This is a sophisticated market, the institutions have been globalising and we’re hoping to pick up some of that business,” admits Ms Biggs.

Everyone expects some form of continued consolidation. Mergers in the industry were few and far between in 2005 and the closest came with the announcement that Royal Bank of Canada and Dexia would form a 50/50 joint venture to create RBC Dexia Investor Services. The only surprise was that both parties committed all their securities servicing arms to the business.

The deal also kicked RBC from 12th place in the league table to ninth with assets under custody totaling $1993bn.

Hedge fund administrators, technology providers and domestic European providers have just seen the start of a predatory environment which leaves them at the lower end of the food chain. No-one, however, will name a big cat that might be too old in the tooth.

securities services, servicing, custody, asset management, alternative fund administration,outsourcing