Securities Services: Liabilities into assets

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As large, maturing pension schemes turn to liability-driven investing, Benjie Fraser talks to Martin Steward about the opportunities available to custodians that can draw on broader institutional capacity and expertise

For Benjie Fraser, managing director, worldwide securities services EMEA at JPMorgan, there is a reason why athe 300 or so large corporate pension schemes that administer half of the world's defined benefit assets are beefing up their investment officers and hiring CIOs. And there is also good reason why the CIOs being hired are often drawn from investment banks.

"People are recognising that these big schemes are a huge captive insurance play," he says. "Solvency II will only accelerate this if it goes beyond the German and Nordic pension markets. That means a further move to de-risk, to move out of equities and into bonds, and what that creates is a giant mark-to-market scenario that will necessitate further and greater use of strategic hedges around interest rates and inflation.

"These big, mature pension funds don't need pension fund managers. They need two key people: someone to chair the trustee company and someone who can run the fund on a mark-to-market basis. That means an investment banker, because the key skills they bring are skills in managing liabilities in mark-to-market context."

What does that mean for securities services? It will not change the importance of core
services, says Fraser - what he calls "making sure that the lights all come on when people come in each the morning and flick the switches". Custody of real assets will continue to play a big part, even as funds use more derivatives. The move from active management to alpha/beta separation will create new demand for transition management.

But differentiation will increasingly come from convincing trustees that banks can help with complex securities, that they have the scale and resources to do so and can demonstrate experience working with investment banking clients on similar positions.

"All of this is opportunity for us because we are able to move up- or downstream, depending on what a pension fund wants," says Fraser. "JPMorgan's investment bank can work with the corporate to discuss liabilities, and of course we have an asset management arm as well. But downstream, at the trade and post-trade stages, the Worldwide Securities Services division also has to demonstrate skills and experience in dealing with liabilities and every possible interpretation of the word ‘risk'.

"Once we have secured a custody contract, finance directors are likely to come to us to use similar types of tools that they are used to exploiting to manage their inventories. As a result of those trends, where we are seeing most work, as funds implement LDI, is in independent accounting of the swaps portfolio. Funds could go with the accounting that their managers provide, but want something independent."

Valuation discipline in particular is changing profoundly, says Fraser. The ‘300 Club' increasingly demands daily portfolio valuations, partly to reflect and facilitate the move towards greater in-house asset management, partly to reflect the realities of marking to market, and partly to improve their ability to model, respond to - or at least stay on top of - future ruptures of systemic risk. Investors will want to look at more ‘what-if?' scenarios, following the economic downturn," says Fraser. "That will challenge us in terms of offering more in our reports than simply performance, compliance and value-at-risk."

Smaller schemes outside the 300 Club do not escape these pressures - they have to deal with them differently. This is about delegation, and Fraser sees the rise of solvency management advisers and their expansion beyond the Netherlands as a trend to watch. "They will continue to win business," he predicts. "They will want more information and greater depth of reporting from their custodians. We had success in the 1990s as funds began to move from balanced managers to specialists and the housekeeping issues around that started to grow, but if we were just looking at the long-only, real asset world now, I don't think that we would have been as successful as we have been, nor as successful as we can be as these trends progress. The fact that pension schemes of virtually all sizes are now looking at the liabilities gives us a huge connection with trustees."

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