A year to...?
U2 frontman Bono famously burbled “Nothing changes, on New Year’s Day”, and certainly any review of the past 12 months in global custody will typically conjure a sense of déjà vu. Year in, year out, the same themes recur: the implacable broadening of the product set as custodians push deeper and deeper into their clients’ middle and front offices; the need to seek out new revenue streams to counter the ongoing commoditision; the potential disintermediation of smaller players who lack the deep pockets required to remain in the club; the circling, non-custodial predators waiting to pounce.
However, if 2004 did not produce any real shocks, it was nonetheless a year that saw global custodians continuing their expansion of the already multi-faceted asset servicing model into a number of key areas. Risk management solutions, for example, while not exactly new, have certainly moved centre stage given the renewed focus on regulation and compliance in light of recent corporate scandals such as Enron and the kerfuffle over late day trading and the like. Accordingly, in September The Bank of New York (BNY) followed in the footsteps of Mellon, JPMorgan and RBC Global Services when it hooked up with an independent specialist, in this case Wilshire Analytics.
A number of providers - State Street, Northern Trust, BNY, JPMorgan - have also been exploring the concept of pooling as an extension of their existing administration offerings. By combining the assets of funds drawn from multiple domiciles within a single ‘pool’ which is then administered as if it were a segregated portfolio, significant gains in efficiency, control and cost can be derived, it is argued. If a number of nagging regulatory and tax obstacles can be successfully negotiated, expect more providers to jump on the bandwagon.
Hedge fund administration remains another fecund area. As alternative investments continue their transformation from the esoteric to the mainstream, more and more institutional clients are looking to allocate capital to strategies uncorrelated to the major markets. JPMorgan became the latest custodian to buy its very own hedge fund administrator when it snaffled up Tranaut Fund Administration in July – having preferred to pursue the partnership route while State Street, BNY, HSBC and Citigroup went ahead and made acquisitions which it argued were exorbitantly priced, it is clear that the bank got tired of waiting for that partner.
Of course, asset manager outsourcing continued to loom large during 2004. With 10 new deals announced since the beginning of the year to complement the eight struck in the second half of 2003, the business model has clearly now gained traction in the marketplace after a series of false dawns stretching back to the late 1990s. Notably, HSBC lost its outsourcing cherry to Gartmore in January, leaving BBH - which has in any case never had much truck with the total outsource concept - as the only ‘big ten’ custodian not to have a lift-out on its books.
That said, it is expected that the big ‘lift-out’ deals - involving the wholesale transfer of the manager’s back and/or middle office operations - that dominated the headlines in the early days will become rarer over the next couple of years. Given that custodians needed the technology and infrastructure they lifted out from their early clients to provide the foundations for their outsourcing models going forward, this tapering off was to be expected now that the business is on a sounder footing.
Component or modular solutions, where managers outsource operational functionality in ‘small steps’ rather than in one ‘giant leap’, is now seen as the way forward by all players, even those that a few scant years ago dismissed the model - championed by BBH - as uneconomic and pointless. Outsourcing providers can also be expected to start targeting private wealth managers over the next 12-18 months. As SEI Investments noted earlier in the year, private banks now find themselves in much the same position as fund managers were two or three years ago, all parts of their business under pressure as they grapple with issues such as market performance, investor caution and regulation.
There has been the usual idle (and inconclusive) speculation about which global custodian might be next to quit the business. ABN AMRO’s decision in October to sell its domestic custody business, which took in eight markets including its home market of the Netherlands, to Citigroup dark mutterings about the future of ABN AMRO Mellon Global Securities Services. However, as ABN AMRO Mellon swiftly pointed out, subcustody is not its prime focus, and it hence saw no strategic justification in taking on ABN AMRO’s network.
More significant was the exit during the summer of National Custodian Services UK (NCS), whose parent National Australia Bank (NAB) pulled the plug in the face of declining volumes and fees, in that it underlined once again how only the most committed and innovative providers will survive in the longer term. Geographic reach, diversity and depth of product offering, the financial resources to keep pushing the technology envelope: these are all prerequisites to meet the needs of increasingly sophisticated and diversified clients in what is a fiercely competitive marketplace. It seems that, as long predicted, scale will win - indeed is winning - the day.
Europe continues to be central to the plans of the big global players. Partnership with small, single-market banks looks to be a (mutually beneficial) solution. That said, BNY’s recent appointment of former Capco consultant Tom Casteleyn to manage its relationship with ING Bank, with whom it forged a pioneering alliance two years ago, has been interpreted as a sign that all is not well in the state of Holland. Other custodians will no doubt keep a close eye on how the relationship plays out – it is not, after all, in their interest to see it founder and in the process poisoning the pool from which they themselves may soon be drinking.