More Regulation Will Help Smaller Custodial Banks Compete

Custody is a topsy-turvy world: Regulation drives innovation, and the result has been consolidation. Ever-larger providers of services such as data generation for regulatory filings have built ever-more-sophisticated computer systems to cope with increasingly complex rules, creating an industry where custodians have won or lost largely through a battle between machines.

Lately, the trend toward greater concentration has moderated, though. Brown Brothers Harriman & Co. ranked 11th in Institutional Investor’s latest World’s Largest Custodians survey, with $3.3 trillion in assets under custody as of June 30, but grew its business 8.2 percent over the previous year. At No. 14, with $2.3 trillion, RBC Investor & Treasury Services saw a 9.6 percent increase.

But now a host of new regulations is again concentrating institutional investors’ minds on how custodians handle their assets. Is the industry set to see another wave of consolidation as the bigger players outsmart smaller competitors by outspending them? Yes, contends Hani Kablawi, London-based head of asset servicing for Europe, the Middle East and Africa at BNY Mellon, the world’s biggest custodial bank, with $26.2 trillion under custody. A “fast and furious environment of regulatory change” will probably prevail for three to five years, he says. BNY Mellon grew its assets by 4 percent for the 12 months ended June 30.

Some of the rules come from the European Commission, such as the 2012 European Market Infrastructure Regulation, which introduced new requirements for derivatives reporting. Others are American or global. BNY Mellon will spend $500 million this year on developing new technology systems and $250 million on maintaining and improving its existing tech infrastructure. Of that total, $250 million to $300 million will go toward dealing with regulatory change. “The strong cash flow of large players can be put back into developing better systems, differentiating us from smaller custodians,” Kablawi says.

If custody were still just about keeping ownership records, it would be governed entirely by scale, says James Economides, director of Amaces, a London firm that helps clients choose and monitor their custodians. But as providers have moved into services such as financial reporting, they’ve found niches. Economides cites Australia’s complex rules for calculating pension funds’ capital-gains-tax liabilities, which local providers typically navigate best, he says.

The biggest players don’t necessarily use their economies of scale to compete on price, he adds. As a percentage of assets under custody, annual fees for an institutional investor with a fairly broad portfolio vary from 3 to 10 basis points. But this range reflects a client’s asset mix and the particular menu of services rather than huge variation in the fees charged by providers. Also, the biggest custodians tend to demand a minimum total fee that effectively excludes smaller customers, Economides notes.

William Tyree, New York–based head of investor services and markets at Brown Brothers Harriman, argues that his firm can compete on scale and expertise in two specialist areas where it ranks in the top five by assets under custody: mutual funds and wholesale custody. The latter is the provision of international services on behalf of another custodian. Tyree says BBH can offer deep experience to investors wondering where to domicile an Undertakings for Collective Investment in Transferable Securities (Ucits) fund — a vehicle designed to be marketed across the European Union.

Anshuman Jaswal, an analyst at research and consulting firm Celent, finds that “some of the smaller custodians have become very good at customer service” to compete with bigger rivals. Economides of Amaces forecasts a role for both: “You may see some more modest consolidation among the smaller specialist players, and the largest custodians will continue more or less as they are,” he says. As long as regulations keep multiplying, bigger doesn’t necessarily mean better. • •

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