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Global Custody

Size begets strength as biggest custodians widen their lead.

From the time Bank of New York Co. and Mellon Financial Corp. announced plans to merge, in December 2006, until they completed the deal and Bank of New York Mellon Corp. was born, in July 2007, the banks’ combined assets under custody ballooned by $3 trillion, to $21 trillion. BNY Mellon has picked up a further $2 trillion from the merger through March 31. The growth is attributable at least in part to pension funds, mutual funds and other big investors eager to avail themselves of the economies of scale that only a custodial behemoth can offer. But smaller customers wanted in on the action too, to benefit from the state-of-the-art technology that bigger investors ­demand.

“Clients like big. Bigger means resources, more connections in emerging markets, better ­global networks and the perception of ­cutting-edge technology,” explains Dayle Scher, a research director in the investment management division of Tower­Group, a Needham, ­Massachusetts–based financial ser­vices consulting firm.

The 2007 merger made BNY Mellon, with $23 trillion, by far the world’s biggest custodian, with ­roughly 47 percent more assets than No. 2 ­JPMorgan’s $15.7 trillion, according to Institutional Investor’s annual global custody ranking. This year firms are ranked by total assets under custody — a measure of each bank’s full-­­service custody business — rather than by global custody assets, the cross-­border subset of the business. The table below lists the firms by their 2008 rank, based on assets as of March 31, and shows how they would have fared last year had they been ranked by total rather than global assets under custody. The 2007 rank for BNY Mellon is based on the New York– and Pittsburgh-­­based banks’ combined custody assets before the merger; BNY Mellon would have out­paced ­JPMorgan by 27.3 ­percent.

James Palermo, Boston-­based co–chief executive officer of BNY Mellon Asset Ser­vicing and former global head of Mellon Asset Ser­vicing, believes custodial clients understood that the BNY Mellon deal was different. “Unlike previous consolidations in asset ser­vicing, this was made up of two very large players,” he says. “In the past ­you’ve seen large firms acquiring small players, or the strong buying the weak.”

The merger accelerated asset growth by bringing together two pieces of the custody puzzle: Mellon’s $1 trillion in assets under management and in custody, and BNY’s back-­office ser­vices. The combined firm can cross-sell custody and asset servicing to the respective banks’ money manager, pension fund and other ­clients.

Clients apparently accept the ­bigger-is-­better argument. Palermo says BNY Mellon has won mandates from investors at a ­higher rate than ­either bank enjoyed on its own. Winning 30 to 40 percent of deals is considered good, he says; BNY Mellon has won 60 percent of those for which it competed in the past year.

Other big custodians are ­also growing faster than their ­smaller rivals. For example, custodial assets grew year-­over-year at third-place State Street Corp. by 20.8 percent, to $14.9 trillion; at fourth-place ­Citi by 21.3 percent, to $12.9 trillion; and at fifth-place HSBC Group by 29.6 percent, to $6.3 trillion.

Those figures stand in sharp contrast to the growth rates at smaller operators. No. 8 Northern Trust Co. saw its custody assets increase by only 4.8 percent, to $4 trillion, while No. 12 Brown Brothers Harriman & Co. saw an increase of 14.4 percent, to just under $2 ­trillion.

Size does not tell the whole story, says Timothy Theriault, president of corporate and institutional ser­vices at Chicago’s Northern Trust. “Our size and our scale are an advantage in this market, because expertise and ser­vice are so important to institutional clients that are dealing with increasing regulatory and compliance burdens in an ­era of market volatility and rapid change,” he states. “Our size keeps us nimble, so we can ­quickly develop solutions to help clients respond to ­events.”

Theriault adds that Northern Trust’s pretax profit margin of 42 percent for the 12 months ­ended March 31 is well above the industry average of 31 percent. ­Also, more than 50 percent of its assets are in ­global custody, the ­faster-­growing segment of the business. That percentage is higher than at most competitors. Theriault credits the bank’s having only one technology platform for enabling it to expand ­into new businesses such as fund administration. “As we extend ­into new areas, our incremental costs are low,” Theriault explains. “We can add capabilities for clients and reward shareholders at the same time.”

Northern Trust says it allocates roughly $395 million to technology each year, far less than the $650 million reported by BNY Mellon and JPMorgan’s $600 million, but Theriault points out that the dollars spent on technology may be misleading because it costs less to maintain and expand a single, integrated platform than multiple systems. He says the airline industry provides an apt comparison. “United may be the biggest, but does it have scale?” he asks. “No, Southwest does. It ­uses one kind of airplane around the world. We use the Southwest ­model.”