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Magazine Issues » October 2010

EXECUTIVE INTERVIEW: Susan Livingstone, BBH, talks to Funds Europe

Susan_LivingstoneThe stock lending debacle of recent times will lead to new business flows for BBH, the US global custodian, Susan Livingston tells Nick Fitzpatrick

Many clients of custody banks who are stuck in stock lending contracts with ‘underwater’ loans stemming from the financial crisis, would lose money if they cancelled them now, but once they prize themselves free they will head to Brown Brothers Harriman (BBH).

This is the expectation of Susan Livingston, partner and global head of investor services for asset managers and funds at BBH, the US global custody bank that expanded its Asian securities lending operation earlier this year as part of a broader push in the lending segment.

“We are in a unique position as a provider that had no impaired collateral,” says Livingston. “Other banks may say that they had no losses, but it is important to differentiate between realised and unrealised losses. Some clients in other [stock lending] programmes have been locked into agreements. If they want to close out their positions, they may need to realise large losses.”

Livingston then says: “Large numbers of people say to us that when they can get out of their underwater loans, they will come to us.”

It will be interesting to see how, over time, this affects BBH’s assets under custody, which ranked twelfth in this year’s Funds Europe Global Custody Survey, published in September.

The bank currently has US$2trn (€1.3trn) of assets under custody. This is sizeable, though significantly smaller than, say, BNY Mellon with circa $20trn. However, a characteristic of BBH is that it is happy to limit its business in some areas, such as hedge funds – a client group that certain rivals continue to clamour for.

“Hedge funds are a growing part of our business, but in terms of overall business, they are not a major thrust for us,” says Livingston. “We service certain hedge funds, but primarily the offshore mutual fund segment and only for our largest clients.”

If this sounds like a prudent strategy in the increasingly risky world of custody and asset servicing, then it probably stems from the fact that BBH is privately owned and no doubt its numerous partners are patting themselves on the back to a certain extent for not ending up with the stock lending complications that others have.

How BBH came to avoid these problems is partly down to better borrowing agreements, says Livingston.

“Everyone has standard agreements, but our legal and risk people had negotiated better conditions in our agreements for borrowing.”

The superior agreements meant that BBH could recall securities in one day, even though the standard is three days.

“This means we got people out of Lehman Brothers in one day. Others took three, or never got out at all.” 

Stock lending aside, another area of expansion for BBH’s investor services unit is exchange-traded funds (ETFs), and this is a business that Livingston has a personal insight into.

“A lot of non-profits and endowments are buying ETFs now. I’m a director of a non-profit organisation and I can see that if you are a director of a pension plan and the pension plan underperforms a benchmark there is potential liability. 

“An ETF could be a good benchmark option to replace an active manager because you would not have to worry about tracking error.”

BBH investor services has been building its ETF business five years, she says, and is hiring more people, such as Shawn McNinch from BGI, who runs the ETF service offering.

Relations with China
China is said to be interested in the ETF market, and BBH has made significant inroads in that country. BBH entered China to start building relationships five years before the country opened to foreign investments.

Livingston adds: “Five years ago we hired Sam Shi as a salesman in Hong Kong investor services after I advertised for a Chinese MBA in the Boston Globe. Sam had previously worked for Dell and it was Sam who sold the first Dell computer in China,” says Livingston.

BBH won the first custody mandate for a qualified domestic institution investor scheme, which allows Chinese investors to invest offshore. The mandate was from the large Chinese financial institution, ICBC.

“No one could believe that BBH had won the first mandate. People were surprised because there had been other organisations that had been in the region for a long time and that had built up large numbers of staff,” says Livingston. “I think it surprised people because they had not realised that we had made such a large commitment to China.”

This is a long way from the 1960s when BBH began to specialise in global custody for the then sleepy mutual funds industry in the US. The bank entered the business after an approach by Fidelity’s Bermuda arm, which wanted a global custody service.

After this, it was fortuitous, says Livingston, that a lot of other mutual fund companies were located and started in Boston [where BBH has a strong link], like Fidelity, Putnam, Pioneer and Scudder, Stevens & Clark. 

Mutual funds remained a sleepy business until the 1980s, she says, when suddenly beneficial tax regulation from the SEC came about that was supportive of the industry’s desire to invest globally. The regulations allowed investors to hold securities overseas, and the sector took off. 

“Providing valuation has always been big business for us. When mutual funds went international we developed a speciality in single-country funds that needed net asset valuations (NAVs).  Korea was one of the first for us. We then did Brazil funds, India, Indonesia, etc.”

Through Fidelity, the bank had offshore mutual fund expertise with Bermuda funds and then BBH developed its offshore business in Luxembourg and Cayman in 1989 and Dublin in 1995.

Livingstone says: “When we looked at other custody segments away from mutual funds, we felt it was harder to differentiate ourselves and that there were less profitable opportunities. We did not want to be a ‘me too’ provider. Trying to do this, like some of our competitors do, just erodes efficiencies.”

So BBH’s other main client segment is ‘financial institutions’, which consists of predominantly foreign banks.
“We have a 40% market share in Switzerland, where the Swiss private banks work with us. Swiss private banks invest in funds and so they have come on to our platform to buy them for clients. This gives us a synergy between our segments and links brokerage and custody. We also have a large market share in Scandinavia.”

The bank opened up in Tokyo in 1984, where a lot of clients started using BBH for US sub-custody and, within a few years, for global custody. Mitsubishi is one of the largest clients.

BBH investor services provides close to 80% of the group’s revenue, which compares to about 10-15% 25 years ago. By geography its revenue sources are Europe 40%, US 40%, and the rest of the world 20%, with Asia as the fastest growing segment.

Luxembourg links
In Europe, BBH has a major presence in Luxembourg. Livingston even holds a fancy title there: honorary consul to the Grand Duchy of Luxembourg for the Commonwealth of Massachusetts. This appears to provide a chance for a little lobbying on behalf of US fund managers.

“I pass on information to the Luxembourg government about the concerns of US businesses. I also pass on the concerns of the mutual funds.”

Such as?

“People want the fund tax in Luxembourg to go away,” she says.

Something else that many want to go away is Europe’s Alternative Investment Fund Managers (AIFM) Directive, which threatens to make custody and related services more risky to provide. The directive imposes a strict liability on custodians, meaning if assets are lost in cases such as fraud or counterparty failures, custodians will have to compensate fund managers despite being blameless. It is anticipated that fees would have to increase to compensate investor services providers for the extra liability.

“AIFM won’t change what business custodians do but we will be smarter about analysing risk. The industry has no interest in seeing fees go up. In 25 years, clients have only seen them come down,” says Livingston.

“But if Europe does put through regulations that increase liability, like in any business, you would normally want to be compensated more.

She warns: “A collision course has been set between custodians and the asset managers who want lower settlement costs.”

You had better hope you aren’t on a collision course with Livingston when driving in Luxembourg. Her diplomatic status affords her diplomatic number plates and the privileges that go with it.

©2010 funds europe