Along with the untimely, if unlamented, demise of the global Straight Through Processing Association, the acquisition by State Street of Deutsche Bank Global Securities Services was undoubtedly one of the more notable developments in the industry during 2002. The transaction put State Street at the very top of the custody tree in terms of assets held – around $8trn (e7trn), comfortably ahead of rivals The Bank of New York at $6.6trn and JPMorgan at $6.5trn. Just as important, it gave the Boston-based financial services firm a critical foothold in a range of key and second-tier markets in Continental Europe.
Having carved itself a lucrative niche within the securities financing arena and in State Street Global Advisers (SSGA) built up a formidable fund management operation, State Street can lay claim to the titles of largest offshore service provider and largest mutual fund service provider globally. In the US, it is the largest pension plan service provider and administers 43% of all US mutual funds, holding a 45% market share by assets. The challenge was to replicate this level of success on the continent.
The commitment was certainly there, and at the highest level. When he took over as State Street CEO and chairman in May 2000, following the retirement of Marsh Carter, David Spina made plain his goal over the next five years: “To win in Europe”. Furthermore, senior management were confident that State Street’s strengths were in line with prevailing regional trends – pension reform, the increase in individual savings, the drive towards member choice and the shift to a defined contributions (DC) model, the movement within pension funds towards daily valuation, evolving distribution and pricing patterns and an overarching shift towards regional solutions. However, there was no escaping the fact that, when it came to the ratio of cross-border assets it serviced, State Street – with just 19% – conspicuously lagged rivals BNY and JPMorgan.
All of which clearly made the GSS business too tempting to resist. “These types of opportunities only come around once in a lifetime,” noted State Street president and chief operating officer Ron Logue. “It is the composition of the assets… that is very attractive.” So what has State Street got for its $1.4bn ($1.1bn already handed over, to be followed next February by a further payment of up to $360m, depending on how much business is retained)?
At the end of last summer, when it first emerged that State Street was in ‘exclusive discussions’ with Deutsche to purchase the business, GSS boasted some $2.2bn in assets under custody. In addition to the global custody operations, State Street has taken on fund administration and depot bank services, securities lending capabilities, performance measurement services – via the WM Company – and benefit payment services, as well as UK and US-based domestic custody and securities clearing operations.
Jeff Conway, head of State Street’s investment services business in the UK, northern Europe and the Middle East, argues that the GSS transaction brings clear benefits in three areas. “It reinforces and expands our market share, and in particular pushes that share above 25% in key markets such as the UK, Germany, Luxembourg and Dublin,” he says.
“In addition to those core markets, the deal allows us to enter new markets with critical mass already in place. To do that on our own would have been quite difficult, Italy and Austria being two good examples of that. It also allows us to meld our equity-based, custody-aligned product offering with the fixed income and third-party businesses of Deutsche and, of course, to extend existing relationships and in many instances establish new relationships.”
Indeed, the importance to the GSS deal of those Italian and Austrian fund administration operations, in terms of bolstering State Street’s Luxembourg operations, should not be underestimated. London, meanwhile, will remain the primary investment management, investment servicing and securities lending centre for State Street in Europe.
It has been suggested in some quarters that the Edinburgh and Dublin businesses – the former offering fund administration, performance measurement and securities operations, the latter a broad array of investment fund services – may be subject to similar rationalisation programmes as that recently announced for the US. (The Deutsche GSS operations centres in Jersey City and Nashville will be closed by the third quarter of 2004, generating projected pre-tax cost savings of $90m–110m.)
Certainly both operations have grown exponentially: Edinburgh from 140 to 700 staff and Dublin, from 300 (250 acquired only last year with State Street’s acquisition of hedge fund administrator International Fund Services) to 650. Furthermore, the Dublin workforce is about to be swelled by 100 as State Street takes full control of its successful alliance with Bank of Ireland Securities Services.
Conway concedes that some “periodic and nominal reductions” may be inevitable as State Street looks to align people and resources. “The European part of this transaction is the most important part,” he says. “Ireland and Scotland are key operating centres, indeed we have quadrupled our staff size there over the past couple of years. Overall, in the longer term we would expect to continue to hire in those markets as we grow our alternative investment business and wealth services management services.”
Changes will be afoot, however, at Edinburgh-based WM Company, as State Street clearly believes much of that franchise’s true potential remains untapped. “We see a great opportunity to refresh the WM strategy and achieve what was originally intended – that is, building off of performance reporting whilst not getting boxed into that,” says Conway.
“Over time, custodians have become very adept at accounting and performance recordkeeping, and over time WM finds itself competing with them, and it is not equipped to do so. Instead, it should be looking to differentiate itself and work up the value curve to get into compliance and risk analysis and research and consultancy – when you start bundling all that in with trade cost analysis for pension funds or asset managers, then you have a compelling proposition.”
The jewel in the crown, however, must of course be Germany, not least because it remains the lynchpin European market where the US banks – JPMorgan excepted – have failed to make significant headway. Although it will continue to employ Dresdner Bank in Frankfurt in a traditional agent capacity – that is, for safekeeping, settlement, corporate actions processing, tax reclamation and so forth – it will now be looking to leverage its newly inherited depot bank operation at Eschborn to capitalise on a relaxation of Germany’s regulatory environment and the concomitant shift on the part of clients towards a greater acceptance of third-party fund administration solutions.
State Street’s appointment in February to provide fund administration and accounting, compliance, securities processing, safekeeping, recording and reporting services to several billion euros in assets held by German insurance company Deutscher Ring Versicherungen was, Conway notes, “a big win psychologically”.
Given the uncertainty amongst its clients engendered by the sale of GSS, Conway acknowledges it is imperative that State Street restores a sense of stability and, just as important, commitment to proceedings. “In Germany we are more seen as a German organisation than as a US organisation because we are building on the Deutsche infrastructure – the people running the depot bank yesterday and the ones running it today,” he stresses. “As for commitment, this is all we do – it is a business we understand and to some degree have helped define, we can bring new solutions, and we are investing for the long term to meet tomorrow’s needs.”
Indeed, perhaps mindful of the senior management bloodletting that crippled Deutsche’s earlier ill-starred merger with Bankers Trust (see IPE July/August 2001), Conway is anxious to cast the GSS acquisition more in the light of a ‘partnership’. “I use the word complement quite often when I speak about this transaction because it is not all about State Street,” he says.
“There is tremendous knowledge and expertise on the GSS side, and we want to leverage that to create broader and deeper leadership. It is not a one-sided approach.” Numerous GSS executives have taken up key roles within State Street – Peter Adams, managing director at WM Company; Richard Fodder, head of sales for UK investor services; in Ireland, Willie Slattery, managing director of investor services; and Yoram Matalon, managing director of investor services in Germany.
Whether this will mean State Street meeting its informal target of retaining 90% of client revenue remains to be seen, of course, although thanks to GSS’ 10-year contract to supply custody, securities lending and fund administration services to Deutsche Asset Management, it had a cool £350bn (e500bn) – or 25% of total revenue – in the bag from the word go. The £600m Tate & Lyle pension fund is another client that is definitely staying put; all the more heartening given it already had an RFP out when the acquisition was announced.
As has been widely remarked, however, T&L is a relatively small fund. The real test will be whether big institutions such as BP and British Airways – both former Bankers Trust clients that stuck with Deutsche through thick and thin – remain aboard. Conway is confident: “70% of the revenue in the transaction comes from the top 100 clients, so we feel comfortable with that goal.” He would not be drawn on just how many of the top100 have so far converted.
There are, of course, those who argue that State Street has bought a pup. “We made a bid, but that bid reflected our view that there were some seriously underperforming areas within that business,” BNY’s Jeff Tessler told IPE at the end of last year – although those assets were clearly not underperforming to such a degree that BNY’s interest was wholly snuffed out. ABN Amro Mellon, which along with BNY went through the due diligence process but ultimately did not make a bid, declined to comment.
It is true that, as of August 2002, the acquired business represented some $700m in annualised revenue. Based on the first two months of operations, the business as acquired is generating approximately $576m in annualised revenue. “However, given the timeframe it is clear we are not comparing apples with apples,” says Conway. “GSS is not immune to what is going on in a wider sense, and that lower annualised revenue rate reflects the same environmental factors affecting State Street as a whole, not least the decline in worldwide equity values between August 2002 and end of the first quarter of 2003.” The delayed acquisition closings for the GSS businesses in Italy and Austria and expected client attrition must also be factored in, he adds.
More pertinent, perhaps, are suggestions that State Street lacks the experience to handle the massive integration task GSS presents – after all, the firm is unique amongst its peers in that it has until now grown its securities services business almost wholly organically. Certainly, the sheer scope of GSS business was cited by Tessler as another factor behind BNY’s low bid – given its own travails following its acquisition of the RBS Trust Bank business in the late 1990s, BNY felt there existed “a significant reputational risk” given the detrimental effect such integration projects can have on service delivery.
Conway fiercely refutes any inference that State Street has bitten off more than it can chew. “Our competitors have made a lot of noise about this, and no doubt will continue to do so,” he says. “Certainly, this transaction may have been too difficult and too big for them. Given the way we have structured our corporate organisation, however, we are in a better position to integrate this business – on the custody and accounting side we have one global platform, so there is no need to develop new systems for the new markets, plus we have the tools and experience in integrating large businesses, notably Scottish Widows, so this is not new to us.”
So will the GSS deal trigger a radical redrawing of the European securities services landscape? Certainly, it catapults State Street into the continental big-time, endowing the firm with the sort of presence within the region that it could only dream of a year ago. Assuming it can successfully negotiate the tricky integration programme that lies ahead and meet its self-imposed targets in respect of client retention, the other global custodians will find themselves going head-to-head in the key continental markets with a well- equipped, resourceful and, crucially, committed competitor blessed with significant critical mass.
Does the deal represent a decisive step towards the establishment of a US hegemony in the region? It’s too early to say. Both BNP Paribas Securities Services and ABN Amro Mellon Global Securities Services – the two key ‘Euroland’ providers – entered 2003 with renewed vigour. The former was buoyed by its acquisition of dedicated outsourcing and fund administration firm Cogent, while the latter is basking in the afterglow of its formal incorporation last autumn following a highly successful few years in the guise of a ‘joint marketing alliance’.
In the longer term the real losers look to be smaller domestic custodians, an increasingly beleaguered bunch who must already contend with the likes of Euroclear and Clearstream casting covetous – and increasingly less covert –glances in the direction of their franchises. With markets across Europe moving to embrace ever more complex products – albeit at different speeds – the sophistication and investment required to meet clients’ evolving demands is immense.
Borderless product distribution may still be some way off, but more and more European clients are looking right now at regional, even global, solutions. With multiple providers it is difficult to achieve consistent levels of data and service delivery across markets. A lack of consistency leads to inefficiency, something no client can afford to countenance in the current business environment. This recognition that Europe is slowly but surely becoming a regional play is what is driving the expansionist strategies adopted by State Street and its ilk, and purely domestic players simply do not have the resources to compete, and will accordingly find themselves pushed to the peripheries. One, perhaps two, larger domestic players in each market will be able to stay the course by dint of their importance to the pan-regional players as local agents, but for the rest the prognosis looks grim indeed.