Features : Custodians Push Toward A New Frontier

Changes in clients needs are driving global custodians beyond their traditional roles

Placido: “Margin pressure is forcing the closer integration of vanilla-execution and post-trade processing”

For almost a decade consolidation and the drive to reduce costs has characterized the global custody business. As investment and money managers embrace new markets and investment vehicles, global custodians are expected to meet their customers ever-changing needs.

Yet in a business characterized by declining margins and increased cost, the investment required to do this has sparked a wave of consolidation. With global custodians such as Mellon reporting increases of 15% to 20% in cross-border trading volumes, the drive to achieve greater economies of scale via consolidation and the need to remain innovative have become constant themes. “Cross-border investment will generate a breadth of product innovation,” says Mark Snowdon, head of custody sales, European Investor Services, The Bank of New York.

Traditionally, the provision of global custody was limited to a core set of services involving the movement, settlement and safekeeping of securities, as well as services such as income collection and corporate actions processing. But as investment managers explore new markets, they are seeking additional and more sophisticated levels of service. “When you break down the custodial side, you are moving cash and securities and setting up collateral,” explains Daniel Wywoda, senior vice president and managing director, product management, Mellon.

But as money managers invest in more complex instruments such as interest rate swaps, Wywoda says they want to see a complete package. “Moving cash and securities is very efficient,” he continues, “but when you have to package the economic parts to create this notional value, that requires another level of sophistication.”

Jos Placido, executive vice president, RBC Global Services, says the evolution of alternative investments from fringe to mainstream asset classes is a key driver of change in terms of creating demand for combined prime brokerage and custodial offerings. “Margin pressure is forcing the closer integration of vanilla execution and post-trade processing, and as a result were seeing unprecedented collaborations between execution service providers, prime brokerage and custody,” he says. Snowdon concurs, saying that the increased focus on alternative investments means clients are looking for “joined-up” solutions across investment classes.

Investors Eye Emerging Markets

Global custodians also have to support increasing investor interest in emerging markets such as China, India, Africa and the Middle East. “We are seeing a change in managers trading activity, which is contributing to higher investment volumes,” observes Alasdair Reid, head of State Streets dedicated asset owner servicing group in Northern Europe, Africa and the Middle East. And as emerging markets evolve, Bank of New Yorks Snowdon maintains, clients need a provider with global expertise and presence. “The development of major emerging markets will continue to push a wedge between those providers that are global and those that arent,” he explains.

The emphasis on pre- and post-trade compliance among investment managers and the need to differentiate themselves in a highly competitive market is also forcing global custodians to move beyond their traditional clearing and settlement role. This is particularly apparent in the area of outsourcing, as global custodians find themselves managing parts of the business that were once considered core.

State Street considers itself a “trailblazer” in the field of outsourcing, securing one of the first lift-out deals, which saw Scottish Widows Investment Partners outsource its back office to the bank. But Reid says the focus is shifting to other parts of the business. “We are seeing a gradual encroachment into areas that would have been considered a core part of fund managers front and middle office five years ago,” he says.

Wywoda maintains that technological advances have furthered the custodians service offerings. “You are almost seeing an element of professional services,” he says. “There is more of a collaborative approach to interacting with the client,” which he says is not just about technology but about having the right people on board. As sophisticated investment managers look to leverage global custodians processes and expertise, Placido of RBC says it has moved to a more comprehensive Global Investor Services model. “Specialists such as analytics boutiques, technology vendors and integrators, specialist outsourcers and administrators will continue to be potential targets for committed players,” he asserts.

Clients Demand Global Footprint

Reid: “We are seeing a change in managers trading activity, which is contributing to higher investment volumes”

In order to succeed, State Streets Reid maintains that global custodians need not only a global client base, business breadth and local expertise, but the capacity to provide a single platform solution, which means clients have to interface with only one system on a global basis. However, in Europe, where cross-border trading costs are substantially higher than in the US, the drive to standardize on one or fewer platforms is hindered by market fragmentation, making it difficult for custodians to offer a truly pan-European service.

Various industry and regulatory initiatives are under way to standardize Europes securities clearing and settlement infrastructure, which Snowdon says should lead to more efficient markets and ultimately lower transaction costs for the customer. But instead of waiting for regulators to effect change, Reid says clients are demanding pan-European solutions today. “The change needs to come from suppliers rather than any regulatory body,” he comments.

Global custodians have responded with the development of pension pooling vehicles, which allow investment managers to benefit from greater economies of scale, enhanced risk management and administration. Northern Trust purports to be the first custodian to implement a cross-border pension pooling solution for multinationals, which allows them to pool assets from their subsidiary plans worldwide using an Irish unit trust. “There are benefits to be obtained from pooling in terms of good governance and economies of scale,” says Kathy Dugan, global product manager, cross-border pooling, Northern Trust. “People are looking to gain more information and effective administration of pension plans in order to control fiduciary risk.” Northern Trust is also working with two multinational clients to launch “tax-transparent” pooling vehicles: an Irish Common Contractual Fund (CCF) and a Luxembourg Fonds Commun de Placement (FCP).

State Street also offers pension pooling in the UK and is developing a tax efficient CCF in Ireland. “Client demand is there, and organizations like ourselves have gone away and said, What can we offer our customers amidst the current tax environment to help them succeed?” Reid explains. Mellons Wywoda is more pragmatic, describing the current state of pension pooling as “a work in progress.” “There is movement but not enough tangible examples that are true products,” he says. Snowdon says, “There is no such thing as a straightforward multinational pooling service. It has to meet the needs of different clients.”

The Pension Drag

While pension pooling is an example of a new innovation by custodians, some things remain constant in the global custody businessthe need to invest in corporate actions and straight-through processing (STP). Although corporate actions (announcements by listed companies that affect the financial performance of a stock) form part of custodians core service offering, their complexity makes them difficult to automate. In addition to implementing strong processes that provide “quasi-STP” where full STP is not possible, Snowdon says the industry needs to achieve as much standardization as possible around corporate actions.

Despite the failure of industry initiatives such as the Global Straight Through Processing Association (GSTPA) and the subsequent cancellation of moves to a shorter settlement cycle (T+1) in the US, STP is an area in which global custodians continue to invest. “If we dont invest in STP, we cannot handle increases in trading volumes every year, which means we wont have the profits to re-invest back into the business,” Wywoda explains. Snowdon adds that investment in STP must be focused on enhancing current services as well as true cutting-edge innovation. “Some players, however, cannot afford to do both,” he says.

Reid believes client demand and competition among global custodians will drive innovation. “It is still about survival, but the focus has shifted slightly away from cost as much of it is about the risk associated with not having STP.”

Snowdon says the key to success for global custodians is balancing investing in innovative value-added services with the need to maintain core efficiencies. Only those that can afford to do both will succeed, he says. “This requires a major player with deep pockets to develop both current and future investment.”

Anita Hawser