Pooling is now on the agenda
The UK custody and securities services market continues to be one of the most competitive in Europe and can still attract new players. BNP Paribas Securities Services and KAS Bank are the latest European players to take on the dominance of the big US banks.
These relative newcomers are not only entering a crowded market, they are also entering a market that is undergoing significant change.
Nigel Taylorson, head of relationship management, UK and Ireland at ABN Amro Mellon Global Securities Services, says: “The Myners Report has had a real impact on pension funds and their asset managers. At the same time, there is an increasing move to multi-manager strategies where pension funds are selecting specialist managers. Fund managers have also got out of doing their own custody. In general, I would say the market is more mature and there is an awareness of the risks in the market.”
Such a period of change is providing rich pickings for custodians, although not everyone is piling into the market. In July 2004, National Australia Bank closed its UK operations, National Custodian Services, transferring clients to Bank of New York (BNY).
Most of the large US custodians regularly predict a further consolidation of suppliers in the market (which they will survive, of course). However, Benjie Fraser, managing director at BNY in London, says although the environment is similar to that of five years ago when Deutsche Bank withdrew from global custody, he hasn’t heard “any serious talk about anyone leaving the business. Returns are low and it is a very competitive market, but there are no indications there will be a shake-out. People are looking to grow their business and to try to do that in a unique way.”
Differentiation is difficult when today’s value added service becomes core in a matter of only a few years. Alasdair Reid, head of asset owner group for northern Europe at State Street says the difference between core and value added services is now quite blurred.
“Years ago clients would start out with basic custody and then add on modules. Now the decisions for which modules they will use are usually made up front,” he says. An overriding trend is that pension fund clients are trying to bundle as many services as possible in order to make operations easier and get a good financial deal. “However, clients want transparency of pricing, so they know the fee of each service.”
Activities such as custody, accounting and securities lending are now considered as core offerings, says Robert Binney, managing director, Citigroup Global Transaction Services, EMEA. “The value added is in performance measurement, risk analytics, transfer agency, share record-keeping and pooling. For pension funds, investment managers and others pooling is definitely flavour of the month.”
A pooled pension fund enables multi-national corporations to combine all of their worldwide, or European, pension schemes into a single fund. Most corporates believe this will deliver better performance and lower costs.
Ann Doherty, regional head of client management, Emea, at JPMorgan Worldwide Securities Services in London says pooling is attracting an “enormous amount of interest” from clients, although very few are doing it. “Pooling is fraught with legal, regulatory and tax problems, which go across jurisdictions. Despite these problems, the savings that can be made are driving interest in it.”
JPMorgan plans to have one of the first virtual pooling clients in the UK in place by the fourth quarter of 2005. Virtual pooling, which is allowed in Ireland and Luxembourg, enables assets with the same investment management mandate to be combined, while they are legally and beneficially owned by the pension fund participants in the asset pool.
ABN Amro Mellon’s Taylorson says the bank provides multinational pooling capabilities for clients by tying together all of the information to provide a consolidated overall position to the pension fund. “The next phase will be a single pension fund for all of the different country branches to dip into. This is a service that all custodians will have to develop further. The custody and accounting functions can be done, the trick will be to get the tax treatment right as well as individual legal and regulatory country requirements.”
Tony Solway, head of BNP Paribas Securities Services in the UK says the bank can deliver solutions to clients on a structure that will enable them to continue to run individual national pension schemes but manage them as a single unit. “BNP PSS has offices in 13 European countries and we use the same infrastructure across those locations and in other markets besides. We can provide a single point for managing all custody assets, as well as using our accounting and performance systems to deliver reports on both an aggregated and separate basis.”
Solway says such a solution gives asset managers the effect of managing assets in one large pool without the upheaval of moving to a pan-European pension vehicle, which can be extremely difficult to do. He is also sceptical about the uptake of pan-European pension funds: “Some of the pooling structures are well conceived, but when it comes to the practical implementation, it will be a tough sell to scheme members. In the context of the current debate on the European constitution, for example, I wonder how easy it will be for pension funds to tell their members they are moving their funds to a pooled vehicle outside the home country. While the securities services industry can deliver these solutions, I am not sure the social side will be as straightforward.”
The perennial favourite of custodians, outsourcing, is also an area of focus. Citigroup’s takeover of £60bn (e90bn) of assets under custody at UK life company Standard Life has provided a boost for Citigroup and the industry as a whole, says Binney. “Custody is a goldfish bowl and all players look very carefully at what works and what doesn’t. There are certainly some big fund managers that haven’t had happy experiences with outsourcing.”
JPMorgan’s Doherty says outsourcing investment administration will help support pension funds as they increase their exposure into more complex instruments. “Pension funds need independent reporting and more information about risk. As a custodian, we have had to develop our traditional services, which provide performance measurement, to provide more sophisticated analysis around fixed income instruments and value at risk analysis in terms of the portfolios in which our clients are investing.”
Binney says outsourcing is not driven only by cost reduction and efficiency, but also by the fact that a number of clients have legacy systems that have come to the end of their useful life. Taylorson agrees, saying many pension funds don’t have the capabilities and resources inhouse to do functions such as fund accounting, which is very time consuming.
Chris Fisher, head of UK client relationship management at Brown Brothers Harriman says the myriad changes asset managers face is forcing smaller and mid-range managers to restructure their operational and systems models. “These institutions are outsourcing in a big way. Some of the larger managers have operating systems that are still relevant but perhaps there are specific modules they need to look at. BBH has developed a modular approach to outsourcing, which is really paying off now. As managers move into new markets or products, they can pick off discrete modules where they need access to new and relevant technology.”
Fisher says the price wars of a few years ago are over in the custody market. “Clients are now looking for good quality in the core services, something that quite often gets forgotten in the discussions about value-add. Good quality core services and strong risk control have become the focus of attention. Institutional asset managers are trying to differentiate themselves in their market and are looking for flexibility of services from their custodians now, not the ‘pile it high and sell it cheap’ approach.”