September 2009

CUSTODY: flight to strength

Strong and stable custodians have benefited from the financial crisis as clients have sought a safe place for their assets. But it’s not just the largest custodians that have won business. In some ways the crisis has been a great leveller, says Nick Fitzpatrick...
bird.jpgA ‘flight to strength’ over the past twelve months in global custody resulted from clients seeking to park their cash holdings in banks with strong credit ratings. But it was not just the largest banks that benefited.
Pictet, the Swiss bank, has €214.9bn in assets under custody, our latest survey finds. But despite being at the smaller end of the asset scale, Pictet noted an increase in demand for straightforward global custody from pension funds “seeking a stable and risk averse custodian bank”.

Pictet may well have picked up some of this from the custody service of UBS, where assets have fallen from €2.426 trillion to €1.717 trillion. As is well known, UBS AG has had severe difficulties in its investment banking division and other divisions have seen outflows. However, the bank’s Q2 financials, which still show a loss for the third consecutive quarter, report a stronger capital adequacy ratio.

Asked about its inflows, Marc Briol, head of custody at Pictet, says: “Pictet, which has made its way unscathed throughout the financial crisis, has been increasingly regarded as a pillar of solidity in an otherwise troubled banking sector. As such, the bank has benefited over the past nine months from influxes of net new money coming from various sources on a scale rarely witnessed in Pictet’s more than bicentennial history.”

But if anything has equalled the need for stability, it is the ability to communicate with clients.

UBS notes that online reporting and real-time figures were the most in-demand services over the past year. The custodian plans to enhance web-based reporting and to provide ways that allow clients to create PDF reports based on on-line data.

Other custodians note the need to enhance reporting, particularly in tandem with risk management.

A less risky business
Caceis, the French custodian with €2.120 trillion assets, notes an increased demand for risk management tools. SEB, the Nordic provider with €395bn of assets, highlights demand for risk and compliance monitoring. Julius Baer, with €38.4bn of assets, says it will enhance web-based communications.

In general, client reporting, particularly in relation to counterparty exposures, is of heightened importance.

There is already evidence from the fund management world to suggest that good client communications can help retain business even as investment performance falters. Greenwich Associates, a consulting and research firm, has shown the termination rates of asset managers with a stronger client service ethos were 70% less than of those with below-average client service, in spite of all the firms surveyed having generated poor performance. The firm strongly advises its investment management clients to focus cost-reduction efforts on non-client facing functions.

The same may be true for custodians.

Nick Titmuss, head of global custody EMEA at Citi, which has €7.740 trillion of assets, says that one of the greatest challenges for custodians in the past year was to assure clients that market infrastructure could support the strains placed on it.

But he also feels smaller custodians would have struggled to handle specialised reporting for clients and requests about market developments as a huge spike in the volume of transactions occurred.

Yet Pictet’s experience, again, might show that smaller providers can also hold their own if they prioritise client contact. The bank notes an increased demand for unbundled reporting capabilities for funds on the one hand, but the fact that it saw a demand in third-party custody from other banks could be evidence of its ability to communicate effectively.

It is the first time Pictet has entered our survey. Could this be a sign that players outside the big league want to raise their game?

Declan Kehir, head of custody Europe at PNC Global Investment Servicing, which despite €405bn under custody is still small in comparison to other banks, says the firm intends to increase its global network in the coming year and enhance securities lending. It will also enhance support for exchange-traded funds (ETFs), which have been a key driver of its business lately.

Another ambitious smaller provider in the survey is Swedbank, based in Stockholm with €100bn under custody. Although it uses JP Morgan as a global custodian and leverages its sub-custodian network, it plans to position itself as a gateway to Central and Eastern European markets and has appointed its own sub-custodians in many countries there.

SEB, meanwhile, plans to grow its transition management capability.

Custodians, big and small, see opportunities arising from the crisis. Many see opportunities in the hedge fund and fund of hedge funds sector, which is not surprising given the criticism of hedge funds that custody assets with their prime broker.

State Street, which has €8.539 trillion of assets under custody, says: “Hedge funds are adjusting to what will undoubtedly be a fundamentally different environment. For a start, their investors are likely to demand independent custody and administration of their investments. Although many large hedge funds will be understandably reluctant to walk away from their substantial investment in internal administration, they will find it increasingly difficult to say no
to clients’ demands for the increased assurance that comes of independent pricing and administration.”
Opportunity abounds, then, but maintaining profitability for ongoing business is a challenge.

BNY Mellon Asset Servicing, with €13.8 trillion under custody, reports that eroded asset values and significant deleveraging has occured, but it remains profitable.

Asked about the challenges for the custodian industry, Nadine Chakar, head of Emea asset servicing at BNY, says: “The challenge in the year ahead is simple: to continue to grow in a low or even zero growth environment. That will require us to continue to prioritise service excellence and to innovate, whether by leveraging existing capabilities within our wider organisation or by extending our offering into new areas within the trade lifecycle.”

Eye on ratings
Similarly, Stephen Baker, director of custody at Bank of Ireland Securities Services, which has €113.6bn of assets under custody, says: “Despite poor market values, volumes have remained strong. This high level of activity generates cost but lower asset values are negatively impacting income. Managing balance between cost and income is still
a challenge.”

And all this will take place under the microscope of credit rating agencies and regulators with an eye on capital adequacy rules. Maintaining ratings is a key challenge for all custodians if they are to benefit from the flight to strength.

©2009 funds europe

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