Stymied in their pursuit of big institutional outsourcing contracts, custodians set their sights on European retail accounts.
By Heather McKenzie
November 2001
Institutional Investor Magazine
Stymied in their pursuit of big institutional outsourcing contracts, custodians set their sights on European retail accounts.
The giants of global custody are nothing if not persistent - even stubborn.
On their most prominent growth initiative of the past couple of years - an attempt to build broader outsourcing services around basic custodianship - Bank of New York, State Street Corp. and their rivals have fallen well short of expectations. Despite this disappointment and the worldwide drop in trading volume that has hurt their core securities-processing businesses, the custodians show no signs of abandoning the expansion strategy.
If anything, their ambitions are growing. While institutional investors have been slow to accept additional back- and middle-office services such as foreign exchange or securities lending, the custodians are fine-tuning their approaches to a traditionally overlooked sector, retail. Their precise target? Fund managers and brokerages in Europe, where self-directed investing and privatization of government pension programs are expected to spur demand for the high-volume, cross-border transaction services that global custodians are ideally equipped to provide. Outsourcing remains a key tenet.
But market trends aren’t cooperating. Online brokerage customers have lost their enthusiasm for trading dot-com and other high-tech shares, and even though governments are retreating from their roles as primary pension providers, it could take years for Europe’s retirement systems to resemble the U.S.'s $2 trillion defined contribution market.
Still, the custodians believe that the growth is coming and that over time even the most technologically astute asset managers will seek outsourcing help as they confront the rising costs and complexity of transaction processing, compliance and customer service. And once the markets start to rebound, so too will retail institutions’ demand for clearing and settlement support. European firms catering to retail clients will have trouble coping not only with the sheer volume, but also with the heavy administrative and settlement burdens of multinational transactions.
Says Reto Faber, global product manager for financial intermediaries at Citibank Worldwide Securities Services: “The retail segment is interesting for us to expand into. Even if trading activity is on a downward trend and may remain so for one or two years, the overall trend is positive.”
A similarly upbeat BoNY is developing a pan-European fund administration service based in Luxembourg. “Despite the global market downturn, optimism remains high. There have been relatively high inflows of new money [into European funds] this year, allied to enthusiasm among sponsors for new funds,” notes Jeffrey Tessler, BoNY’s general manager for Europe.
One indication of the trend: The number of mutual funds administered in Dublin’s tax-advantaged International Financial Services Centre rose some 20 percent in the 12 months through June 30, to 1,617, while assets also increased 20 percent, to $213.6 billion, according to Fitzrovia International, a London-based research and publishing firm.
A Schroder Salomon Smith Barney report shows that net inflows into European mutual funds totaled $51 billion in the 12 months through August. That’s down 66 percent from the 12-month figure through November 2000, but it’s still a big amount and a challenge to European firms, says Citi’s Faber.
“We found that retail banks and brokerages, whom we knew from existing relationships with their institutional businesses, were having increasing problems servicing the acceleration during the past two years in cross-border trading,” Faber says. “These banks had no automated links to their networks of correspondents on the custody and brokerage side. This meant there were many manual connections and processes.”
Manual processes will be hard-pressed to keep pace as settlement timetables get shorter - as in the T+1, or trade date plus one day, standard that the U.S. securities industry wants to have in place by 2005. Europe, with its inherent cross-border complications, might look even more enticing to the international sides of the custodians’ operations.
The top custodians can also bring their U.S. experience to bear as financial innovations spread to Europe. “There are new instruments, such as exchange-traded funds, which we can expect to see launched before the end of the year, and there is growth of alternative investments such as hedge funds,” says Tessler at $7 trillion custody giant BoNY, which has a 25 percent share of the U.K. retail market, with clients such as Abbey National’s Inscape unit and Legal & General Assurance Society.
Jeffrey Conway, State Street’s London-based managing director of custody and administration services for the U.K. and Europe, says that his operation aims to “leverage its mutual fund practices and expertise in the U.S.,” where it is the No. 1 transfer agency, to garner a leading role in Europe.
Citibank, the biggest cross-border custodian, doesn’t plan to enter the retail fray directly; it sees retail institutions as capable of handling the basics like statement delivery and tax compliance. Explains Faber: “What retail banks can’t do is the cross-border part. They need quick and efficient execution.”
Enter CitiConnect for Securities, which combines Citibank’s global clearing platform with Salomon Smith Barney’s trading system. This high-volume, retail-oriented processing platform incorporates elements of fully automated straight-through processing, including trade order routing, execution, settlement and safekeeping. Pushing the outsourcing theme, Citi offers customers additional bank services such as research, foreign exchange, treasury and cash management.
Thomas Abraham, head of Citibank’s investment advisory services group in London, says that a comprehensive, end-to-end service from portfolio management through all trading and processing steps will best serve institutions seeking to reduce operational complexity and maximize efficiency. And that’s where a diversified global custodian can shine. Citibank fills that bill with a front-office “Fix engine” based on the financial information exchange protocol for transmitting trade orders, says Abraham. The bank claims that its combination of skills and systems enables it to bridge the gap between Fix, which is widely used by brokerages, and the Swift network on which banks depend.
State Street’s Conway sees a major opportunity in supporting retail funds that post their values on a daily basis. State Street’s accounting system can close the books on funds each day and in some cases, such as active U.K. unit trusts, several times a day. Such demands force custodians to “get into the retail mind-set,” Conway asserts.
At Citibank, the individual investing mind-set extends to efforts in support of retail banks’ and brokerages’ customer education. Says Abraham: “Consumers are not as sophisticated as they ought to be. Citibank will deliver information and research on companies to our wholesale clients so that they can more easily educate their own clients.”
The range of services that custodians are taking into the retail market underscores how they are augmenting their traditional, narrowly defined safekeeping and trust roles with both presettlement-processing services and broader outsourced offerings, such as foreign exchange and performance measurement. Though they went this route with much fanfare in 1999 and 2000, custodians have signed only a handful of outsourcing contracts, notably a BoNY deal with Julius Baer International and State Street’s with Pacific Investment Management Co.
In Europe BoNY touts a “one-stop shop” that combines its Luxembourg administrative unit with a full menu of trade and order management services and consulting support. And State Street recently launched iFast, a multilingual, multicurrency shareholder recordkeeping system.
Conway describes State Street’s offering as a “powerful bundled service,” and he expects that retail fund managers will outsource more as they come under increasing cost pressures. “Outsourcing enables the fund manager to focus on managing money and allows us to leverage our transaction-processing expertise,” he says.
Citibank’s Faber says the ultimate goal is “the ability to access global equities markets and integrate trading and settlement in an end-to-end process that is fully automated.” He adds: “In retail trading a lot of banks are operating in uncharted territory, and they do not have sufficient experience or resources to develop and automate the cross-border component. Trading levels will come back, and the retail sector represents a large level of activity that we can tap into.”
