The effects of the Pensions Act are still reverberating through the whole investment industry. Custodians working for UK pension fund clients are taking a lot of the impact, and say new demands from the funds are changing their marketplace.
Changes triggered by the legislation have made funds keener to choose one single custodian. Practical implications of the act have coincided with a growing consensus among consultants that the balanced approach to investment is no longer appropriate.
As pension fund trustees move more towards specialist fund management mandates, we are experiencing a great deal of portfolio re-structuring," John Stubbs, senior global business development manager at Midland Securities Services (MSS) in London says.
Using a single custodian is a way of getting a consistency in reporting, says Mark Thatcher, senior manager, marketing and business development at Lloyds Bank Securities Services. "Rather than getting, say, four different reports, a single custodian can put them side by side and then give a consolidated report as well," he says.
There is a general push by parents of multinationals to have common reporting. This can often only be achieved by having the subsidiaries use the same custodian in different jurisdictions, says Jeremy Hester of Northern Trust in London.
Demand for new services from custodians continues. In the last 12 months, pension fund clients have shown more of an interest in the corporate governance side of share ownership. "There is so much encouragement now for pension funds to vote the shares," says David Batten of RBS Trust Bank in London.
This new stance makes more work for pension funds, who often pass this on to their custodian. Typically, where a client shows an interest, the custodian will let him or her know which shareholder meetings are coming up and say what the issues are, says Batten. Some custodians may even advise how to vote according to the pension scheme's own guidelines while others actually do the voting as well.
Any bank appointed as master custodian needs to provide a comprehensive range of services to fund managers. Although there is a client group which only buys core custody services - typically local authorities - there is a second group of pension fund clients which have moved away from the traditional balanced approach. For them, information collation and monitoring has become more complex.
This latter group is becoming more important within the market, and makes more use of the value-added services provided by custodians, says David Bilbé, head of global investment services in the UK at State Street. He sees in-vestment compliance monitoring becoming a more popular service from custodians. And State Street has seen an interest from clients in more frequent net asset value calculation, as a measure of absolute performance.
"Clients are more aware today that custodians hold so much information and can therefore provide a range of additional services such as performance analysis, investment policy monitoring and, on the investment side, transition management and equitisation products that are a complimentary fit to custody services," says Hester.
But are some extra services mere gimmicks? A number of custodians are offering their own performance measurement in a bid to differentiate themselves from the competition, one custody manager says. "But they don't have the universe that WM or CAPS have," he says.
These 'value-added' services push up the overall cost of having a custodian - a service already out of reach for many smaller pension funds. Batten says there is a greater awareness of the risks in-volved in custody and the safekeeping of assets. Clients are asking them to take on more risk and this drives up prices.
"Buyers are more mature, more reasonable - and they understand they get what they pay for," says Bilbé. "Price is always going to be one of the major buying criteria, but we don't see it as the key criterion," he says.
But in general, custody fees for UK clients have stabilised, Lloyds' Thatcher says. "There's always someone out there who will offer you a lower price, but it depends on the quality of service," he says. "At the end of the day, custody is an expensive business," he adds.
Revenue from securities lending can undoubtedly soften the effect of custody fees. The number of pension funds using the service is very low, but growing, custodians say. Some estimate only around 5% of larger pension funds are involved in stock lending. "Pension funds are under pressure to find new revenue, and securities lending is an extremely good way of generating it," Bilbé says.
"Stock lending... had bad press with the Maxwell scandal and took a while to recover, but it's coming back now," says Thatcher.
But it is a myth that any pension fund can engage in securities lending. Funds with largely FTSE 100 stocks are, depending on size, un-likely to be as successful as those with specialist portfolios, such as UK or US smaller companies or technology stocks, where more opportunities for stock lending ex-ist, Thatcher says.
And Stubbs notes that not all pension funds have trustees who have sanctioned securities lending. Rebates or returns on securities lending are shrinking all the time, says Batten. "Many people would say there's a finite amount of securities out there to be lent."
The wave of mergers washing through the custody industry has worried clients, Stubbs says. "A pension fund goes through the review process and appoints a custodian, but next week finds he's doing business with someone else. Would he have contracted with that party in the first place?"
Generally private and public sector pension fund clients take the core custody services of settlement, income and dividend collection for granted. "But they need to be confident that they align themselves to an institution with a strong legal agreement and one that has a demonstrable commitment to the business."
What does the future hold for the UK marketplace? Bilbé says he sees a trend towards a small group of universal custodians, who can provide virtually any type of service for clients, anywhere. "If you look at short lists of custodians, there is a small group of players," he says.
Hester sees US banks continuing to dominate although he adds MSS and Trust Bank still have a large client base. "Consultants will be key drivers of services and shaping of requirements for clients and now focus on this business more than ever before," he says."