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Custodian banks are tailoring services to meet funds' needs.

The phenomenal popularity of exchange-traded funds in recent years has helped propel the stirring growth of money management behemoths like San Francisco°©based Barclays Global Investors, ranked No. 1 in the II 300, Institutional Investor's ranking of the top U.S. money managers. Now leading custodian banks are hoping for a similar fillip to their businesses.

Four banks -- Brown Brothers Harriman & Co., State Street Corp., Bank of New York Mellon Corp. and JPMorgan Worldwide Securities Services -- have invested heavily in recent years to develop systems and technology to support the unique needs of ETFs, including custody, accounting, calculating the value of the underlying baskets of stocks or bonds that ETFs hold, communicating with the Depository Trust & Clearing Corp. and settling the trades. The moves have paid off, and the four dominate the ETF-servicing market.

Worldwide there are now more than 900 ETFs with total assets under management of $666.2 billion, up 16.1 percent this year through May. Assets in ETFs are ex- pected by Morgan Stanley to reach $2 trillion by 2011.

The market stands to grow even further if, as expected, regulators approve the launch of actively managed ETFs within the next year. Up to now, ETFs have been passive products based on indexes such as the Standard & Poor's 500, but active products would enable ETFs to compete with traditional open-end mutual funds.

Timothy Connelly, partner and head of investor services in the Americas for Brown Brothers, which has $10 billion in ETF assets, says many fund companies are still in denial about the growing importance of ETFs for their business. An increasing number of advisers are using ETFs for their core holdings, from small-, mid- and large-cap to foreign allocations, and spicing up their clients' portfolios with other investments, such as hedge funds. "As a service provider, it was eminently clear to us that to compete in the ETF space you needed to make a significant investment in ETF infrastructure or risk having the businesses move away from you," says Connelly.

Other service providers may have to scramble to keep up. PNC Financial Services Group's PFPC subsidiary and Citigroup, which recently acquired fund services provider Bisys Group, are reportedly exploring offering ETF processing. A spokesman for PFPC declined to comment on the company's ETF services.

Brown Brothers is a full-service provider, offering custody, fund accounting, administration, transfer agency, brokerage, cash management and product development support to issuers of ETFs. As one of the smaller providers, it is looking to differentiate itself by offering consulting services to help firms get started in the business. Unlike with some of its other commoditized services, ETF issuers are not necessarily looking for the lowest-cost provider and want to form a true partnership with the custodian, says Connelly. "They're busy racing to get to market," he explains.

JPMorgan Worldwide Securities Services recently ramped up its ETF efforts. In 2005 it had a 2 percent market share. In 2006 that share grew to 14 percent, and this year through July it has increased to 28 percent, according to the firm. Mark Kelley, head of JPMorgan U.S. Fund Services, says the bank has been able to win market share by targeting start-up ETF providers such as ProShare Advisors and Ziegler Exchange Traded Trust's NYSE Arca Tech 100 ETF, which are both clients. The bank is upgrading its systems now to be able to service actively managed ETFs by early next year.

State Street Corp. is the leader in the ETF market, with $103 billion in assets, many of them from its affiliate, State Street Global Advisors. The firm has been processing ETFs since the launch of the Standard & Poor's depositary receipt, one of the first ETFs, in 1993. "That has been the core platform we've used ever since," says Michael Prendergast, head of domestic ETF custody and accounting services at State Street.

With the recent acquisition of custodian Investors Bank & Trust Co., State Street boosted its market share. IBT processes the ETF business for BGI, which controls 60 percent of the market in the U.S. Andrew Fry, senior vice president of investment services, says its long experience gives it a leg up in the market when it comes to industry knowledge as well as pricing.

"Ultimately, we're still in the early stages of the market," says Fry. "We're looking to grow with our major institutional clients as they start to offer these products. And we have the first-mover advantage."