Custodians like clients to whom they can cross-sell as many products as possible and who are prepared to utilise, or grow into, a custodian’s international footprint. They also want clients that are willing to migrate to the common operating platforms that custodians have invested in heavily over the past ten years.
These criteria are by no means new, but risk and profitability factors mean these standards will be applied with greater rigour. Any fund manager that is not sympathetic to the custodian’s desires should not be surprised to find themselves receiving poorer deals on foreign exchange trades or lower interest rates on cash balances. One way or another, custodians have to make the business pay.
What custodians want
Susan Ebenston, global head of fund services at JP Morgan Worldwide Securities Services, says: “There is a breadth and depth in our organisation, which includes a retail bank and an investment bank, and we want to bring as many of these areas to bear, where appropriate.”
Rob Wright, global head of product and client segments at RBC Dexia Investor Services, says: “We look for clients that want to use more of our services and geographies to help them build their businesses. As they grow, we grow.”
Similarly, John Campbell, a managing director at State Street, says: “We want clients to leverage our global footprint. Look at Pimco as an example. In 2000, it was a domestic California fund manager, but they leveraged our reach and now they are global.”
He says that State Street also helped take Scottish Widows Investment Partnership (Swip) into the US mutual funds industry.
Ken Back, managing director of strategic solutions at Citi Global Transaction Services in Emea, says geographical and product globality is important, but adds: “We are looking for fund managers that are aggregating – those that will acquire rather than be acquired.”
As fund managers grow, they may outsource other elements of their back and middle offices and custodians like to get a greater slice of business as it becomes available. This has as much to do with controlling risks when a fund manager’s business becomes more complex, as it has to do with increasing a custodian’s margin.
Lou Maiuri, global head of outsourcing at BNY Mellon Asset Servicing, says: “If we use assets under management as a curve for complexity, then if the manager is below $5bn we can provide our middle-office services without any bundled services. At the middle market, $5-25bn, it’s split whether you need to bundle services or not.
“At the higher end of the $25bn-and-above range the operational functions of the fund manager are more complex because their front office is more complex. We then have to think more about bundling services.”
Maiuri also notes: “As you move to larger mandates you have to look at the revenue lines that can support them. You may be taking on offices in three different regions of the world and this is also why bundling has to be looked at.”
Greater emphasis on bundling could mean that the best-of-breed approach to fund management outsourcing – where fund managers select individual providers for certain business – may become tougher. Due to profitability and risk factors, custodians could even refuse business where bundling is not possible (see previous article, p10-14).
There is one crucial tool in a custodian’s business that gives them and their clients greater economies of scale and oversight of risk. It’s a tool that could pleasantly affect everybody’s bottom line too: the common operating platform. To provide all clients in all geographies and asset classes with one portal is the investment service industry’s ultimate aim.
But one platform does not necessarily entail one technology system. Moreover, it is usually a number of systems – such as different accounting and administration tools – brought together along with the people that run them.
In the realm of middle-office outsourcing, which generally covers investment administration, custodians such as State Street and Citi bought systems from fund managers in ‘lift-out’ deals in an effort to build their common platforms in the early noughties. Others, like RBC Dexia and Northern Trust, have built their own.
Meanwhile, JP Morgan abandoned the lift-out model in favour of building its own platform after a deal with Schroders failed in 2005.
It was a disappointment and embarrassment for JP Morgan, but Ebenston, who was not with the business at the time and was brought in to help rebuild the outsourcing strategy, says opting to self-build its platform means the bank does not have the problem of migrating clients from lifted-out legacy platforms.
Refusing to migrate, or being unable to, could easily attract a custodian’s ire. The common platform is fundamental to the investor services business. It achieves efficiencies and scale, and in this business, scale is almost everything.
Ebenston says: ‘We do not have that issue [of migrations], though I am aware some of our competitors do.
“There are some asset managers that feel they have a unique selling point by using a legacy system and it can cause some major issues for the creation of common platforms if they do not want to leave them. None of us are naïve to think that one size fits all, that’s why we talk about a common platform rather than a single one. But the issue is to minimise the amount of operations, to only do things once.”
Asked about the level of integration at RBC Dexia Investor Services, Wright says: “We have a strategic fund accounting platform that goes across 13 geographies and we have global operating models that are fairly well integrated. Most functions are now integrated: fund accounting with custody; transfer agency with custody.”
He adds: “We have migrations that can last six weeks to over a year. Some clients have multiple platforms and we have to migrate them and the people and this will inevitably take longer.”
Wilson Leech, head of Northern Trust’s global fund services business, says: “We have a single investment-accounting platform, a single middle-office and custody platform and a separate fund-accounting platform, all built entirely in-house. We have always done conversions straight on to our platform.”
Migrations at State Street, whose lift-out of Swip in 2000 was a watershed moment in European middle-office outsourcing, will complete in Europe this year.
State Street’s Campbell says: “All UK and South African middle-office clients are now on one platform and the last European client will go on to it this year. All of Asia are on our Enterprise applications and the US are in transit.”
A two-way street
Of course, managers can’t always be blamed for refusing to migrate. If a custodian’s system is not up to scratch – such as those used in over-the-counter trade processing – who can blame managers if they want to keep a legacy system. Setting out their expectations of each other in a bid to ensure outsourcing works is a two-way process between custodian and client.
Custodians talk about forging partnerships with fund managers. It’s like a marriage, they say, and not a mere business transaction. So far custodians have had to be the more compliant of the two partners. But being a service provider no longer means being in a state of servitude. The shock to their business in the past two years has clarified thought and made providers more aware of their self-worth.
The bottom line is that if custodians can be sued more readily for lost assets they safe-keep – even if they are faultless – then they will try to run the outsourcing business more on their terms in future.
©2010 funds europe