Iain Morse reviews Ireland’s custody market as it wakes up to fund rationalisation and thinner margins

Until the near collapse of the Irish private sector banks in 2008, custody in the Irish Republic was a game of two halves. Domestic pension funds, asset managers and stockbrokers used to use the custody services of one or another Irish bank. These banks also owned their own asset management companies, managing assets for domestic defined benefit pension schemes. Then there was a burgeoning cross-border, global asset management business, led by the UCITS brand, and catered to by global custodians, which set up outposts in Dublin when they recognised this market’s potential.

“Since the credit crunch, Irish banks have pretty much left the custody market,” notes Betty O’Reilly, a senior consultant at Aon Hewitt’s Dublin-based investment practice.
Government ownership, higher capital adequacy requirements, new priorities shaped by the collapse of property values have all played a role in bringing about this change. Ulster Bank sold its custody business to Northern Trust as long ago as 2000. Last year, Northern Trust purchased Bank of Ireland’s subsidiary Bank of Ireland Securities Services (BOISS) for a reported €60m.

Other changes include Bank of Ireland’s sale of its asset management business – Bank of Ireland Asset Management (BIAM) – to State Street in 2010, and Ulster Bank’s sale of its asset management operation to KBC. In November 2011, Allied Irish Bank announced it was selling its asset management business, with more than €8bn assets under management, to Prescient Holdings, a South Africa-domiciled financial services group. Prescient already owns an Irish-domiciled UCITs provider, Stadia Fund Management. No doubt, in time, the AIB brand will be folded away into that of Stadia.

Just as the indigenous, independent Irish asset management industry has largely disappeared, so once well-funded, domestic defined benefit pension schemes are rapidly closing to new members and, in more and more cases, to future accruals. “Meeting the funding standard has imposed a huge burden on trustees,” says O’Reilly.” They are focused on risk, and we are talking to them more frequently about liability-driven investing.” In 2009, there were 1,158 defined benefit schemes subject to the funding standard with private sector corporate sponsors. The number fell to 1,007 in 2010, and is now 993.

These figures mask a precipitous decline in the aggregate of active members in private sector defined benefit schemes – down more than 11.2% from 2010, to 197,177 in April 2012.

Over the same period, public sector schemes, not subject to the funding standard, have seen their active membership grow by 2.2% to 335,551. Under the so-called Croke Park Agreement (2010) between the government and the Irish Trades Union Congress, public sector jobs and pay have largely been preserved. But new members in public sector pension schemes are joining on a ‘career-average’ basis for pension calculation.

Meanwhile, the number of active members in private sector defined contribution pension schemes has also fallen almost 9% from 2010 levels to 239,150 in April this year. A focus on reducing counterparty risk and considering the wider use of LDI is making it more likely that defined benefit scheme trustees will opt for a global custodian. In the case of defined contribution schemes, this choice is typically with the underlying funds’ asset managers.

The real force driving the Irish custody market is the sheer volume of cross-border, regulated funds administered and custodied from Dublin. “By the end of this year we could see their value exceed €2trn in value,” says Rachel Turner, head of fund servicing at BNY Mellon in Ireland. Both the UCITS and non-UCITS guidance notes issued by the Irish Central Bank stipulate that the assets of a unit trust, investment company or investment limited partnership must be entrusted to an independent, regulated trustee bank for safekeeping.

Five global custodians dominate the Irish cross-border custody and administration markets.  By the end of June 2011, State Street Custodial Services serviced 25% of fund assets by value, closely followed by BNY Mellon Trust Company with 24%, then JP Morgan with 16%, Northern Trust with 14% and Brown Brothers Harriman with 10%, according to Lipper. Trailing the top five, RBC Dexia and HSBC Institutional Services at between 2-3%; Citi and Credit Suisse between 1-2%, with nine more custodians, each with less than 1% asset share. There are some big names lurking here, including BNP Paribas, UBS and Deutsche International Corporate Services, each with very small market shares.

Data on the numbers of funds serviced by each provider create a more complex picture. State Street Custodial Services might have a quarter of assets by value but these are concentrated in 768 funds, almost a fifth of the total. Much the same applies to BNY Mellon Trust Company, just behind State Street with 18% of funds.

The conclusions that can be drawn from this data are not particular to Dublin. The top five custodians service 88% of assets by value but only 70% of funds. “The trend to product rationalisation, to larger funds at the top of the market is likely to continue,” says Sean Pairceir, partner at Brown Brothers Harriman in Ireland. The firm’s market share is concentrated among the larger fund managers and big funds. The other custodians might be in market niches, but they also service a higher ratio of smaller ‘captive’ funds managed by asset managers with common corporate ownership.

Overall, equities and bonds account for around 25% of all assets, money market funds a little less, with hedge funds, property and others each at less than 10%. Non-domiciled funds account for just over 40% of assets but a far higher ratio, around 60%, of all funds.

Ahead of the global custodians in Dublin lies the impact UCITS V and the alternative investment funds management Directive (AIFMD). UCITS V will place an unprecedented level of potential liability on custodians. The AIFMD obliges non UCITS funds to use an independent custodian and source independent portfolio valuations for alternative investments such as private equity and hedge funds. “These new regulations are creating a new battle ground for custodians. Some will struggle to stay in the market,” says Shane Ralph, senior vice-president at State Street Global Services in Dublin. Paper-thin fees will need to rise for custody services but any increase is unlikely to meet increased costs in an ever more complex regulatory environment.

“Cost benefits lie increasingly with scale,” says Pairceir. “Taking advantage of these will require scale among custodians.’” Regulation and economies of scale are raising the barriers to entry both into the regulated fund market and the custodian sector servicing it. “But it would be a mistake to ignore the potential of the Cayman Islands as a fund domicile,” he adds. “This will suit investors who say they don’t need advice.”