Who will compete?
“Size is important in this business to cover the substantial ongoing investment needed in systems development,” said Ken Farquhar, managing director of Lloyds TSB Securities Services (LTSS), as he announced the withdrawal of the bank from the custody business. With a mere £140bn (E213bn) in assets, LTSS just wasn’t big enough to compete with the global players, and couldn’t survive on the business they didn’t win or didn’t want.
No one was surprised by this admission of defeat, but many were shocked to learn that Lloyds TSB had not managed to sell any of the custody or trustee business lines. In March this year, The Bank of New York agreed to pay over £400m for RBS Trust Bank, the custody and administration arm of The Royal Bank of Scotland which has assets of about £400bn. This deal excluded the Royal Bank’s unit trust trustee operation, which competes head-on with the LTSS trustee business.
But LTSS is in a very different condition to Trust Bank. The Bank of New York (BoNY) was keen to acquire Trust Bank’s people, systems and clients, all of which offered additional competencies that BoNY didn’t have. LTSS, on the other hand, was beginning to wither on the vine: it had dug itself a huge black hole with its failed operating system, Laser, to such an extent that it was unable to take on new UK clients and was largely running on ancient systems inherited from its acquisition of NatWest Investment Services in 1995. When its last IT director, Chris Baldwin, suddenly left earlier this year, he was not replaced. The systems strategy was out of control and even an army of consultants - firstly from Oracle, then from Cap Gemini – couldn’t fix it.
The saleability of the LTSS business was also damaged by the shape of its client list. It has a high proportion of very small UK pension funds on its books, as well as a substantial portfolio of overseas banks that use it for UK agency services. Neither of these client groups is particularly attractive to the big global custodians, as there is limited scope to earn higher margins from value-added services like securities lending and treasury management. According to industry rumour, the one part of the LTSS business that is attractive – the unit trust trustee – has some skeletons in its closet, including regulatory compliance issues.
Add all these factors together and one gets a better idea of why the Lloyds TSB directors decided to withdraw rather than sell. But the loss of LTSS throws the UK market into turmoil, and intensifies the debate about whether European custodians can ever compete with the big Americans. For those LTSS clients – like local authorities and overseas banks – which have a preference to work with a British bank, the only choice is HSBC. All the other British-owned banks – NatWest, Barclays, Bank of Scotland, The Royal Bank of Scotland, and now Lloyds TSB – have pulled out. For a market that prides itself on being one of the world’s major financial centres, this is an astonishing state of affairs.
There now exists a very real danger that the smaller UK pension funds will find it almost impossible to appoint a custodian of any description, let alone a British one. Most of the major custodians are not interested in anything with assets of less than £250m, and several won’t get out of bed for less than double that. LTSS was a safe home for some of the small fry: when Chase started purging its client list after the acquisition of Morgan Stanley’s custody business, for example, LTSS happily picked up a lot of the mandates.
There is little chance that custodians from other European countries will step in to fill the gap. Even after its acquisition of Bankers Trust, Deutsche has signalled its intention to concentrate much of its sales activity on the continent; Paribas has no custody franchise in the UK and is likely to be highly distracted by its merger with Société Générale; and ABN AMRO’s alliance with Mellon Trust doesn’t stretch to the UK’s middle market.
All of this leaves the UK market in considerable disarray. It would be unwise and unfair to assume that HSBC will step in to rescue those LTSS clients left high and dry, and State Street – the officially recommended alternative provider – will be very selective about which portfolios it wishes to take on. The market may only just be realising the true price of American domination of the global custody business, and whether that price is worth paying. Unless the domestic banks and central depositories pull themselves together soon, what has happened in the UK will also happen in every other European financial centre.
It is highly debatable whether that will be good for the global investment industry.