There's an easy way to build a global custody portfolio: Let a roaring bull market swell assets and boost related fees. Unfortunately, that hasn't been an option for most of the past three years, so custodians have had to look for alternative ways to grow.
One method is to buy. State Street Corp. in January completed its acquisition of Deutsche Bank's E2.2 trillion ($2.4 trillion) global securities services portfolio. The $1.5 billion transaction helped bring State Street's total custody assets up to $8.5 trillion by midyear, putting a little distance between itself and archrivals Bank of New York ($7.8 trillion) and J.P. Morgan Chase & Co. ($6.7 trillion).
The purchase also strengthened State Street's position in a potentially high-growth market, cross-border processing. As of March 31 the Boston-based bank had $1.7 trillion in international custody assets, up 50 percent from a year earlier, lifting it to fourth place from sixth in Institutional Investor's annual ranking of cross-border holdings (see complete table, page 202).
"The U.S. is showing signs of slowing growth," notes Joseph Hooley, head of investor services at State Street. "Meanwhile, markets in Europe are on the front end of pension reform. There's a high likelihood that Europe will grow faster than the U.S., and U.S. fund managers will want access. State Street will be ready to provide them global custody services when they make the move."
State Street is only now beginning to consolidate the Deutsche Bank purchase; it claims to be retaining 90 percent of the revenue from Deutsche's clients.
Other major players found it tough to grow assets amid rugged markets and the declining dollar. The greenback's fall -- 22 percent versus the euro over the survey period -- gave non-U.S. banks' balances a boost.
Bank of New York, Citibank and J.P. Morgan Chase are all within 3 percent of the custody assets that they had at the time of II's 2002 ranking. In the cross-border category Citi grew by 0.5 percent, to $3.5 trillion, to maintain a roughly $1.6 trillion lead over both J.P. Morgan Chase and BoNY, which were off by 3 percent and 1 percent, respectively.
Citibank's global subcustodian assets -- the biggest pool by far in that subcategory -- fell 2 percent, to $2.9 trillion.
Custodians looking to get bigger are also focusing on markets that defy the overall slow growth trend. RBC Financial Group, which in 2002 jumped from No. 13 to No. 8 in global assets, climbed another notch this year, to No. 7, as assets rose 10 percent, to $549 billion. RBC, the parent of Toronto-based Royal Bank of Canada, has set its sights primarily on European countries, particularly in Scandinavia, that are pushing private retirement savings programs, says José Placido, senior vice president of institutional and investor services. The bank also has high hopes for Australia, where pension reform is getting under way.
London's HSBC Bank grew even faster: Its cross-border assets jumped by 53 percent, to $616 billion, good for sixth place in the II ranking, with less than half the assets of No. 5 BNP Paribas.
Of course, custodians can also grow by reeling in new clients. No. 20 Investors Bank & Trust Co. of Boston, up 46 percent, to $98 billion, is reaping the rewards of its 2001 signing of Barclays Global Investors. Other big percentage gainers in global custody included No. 8 Société Générale, 61 percent (41 percent in euro terms), and No. 12 Fortis Bank, 85 percent (51 percent). But the dollars gained in these instances are relatively few as assets become increasingly concentrated among the larger players.
Size is still regarded as the key to profitability. In a low-margin commodity operation, economies of scale -- particularly those linked to technology -- are vital.
The global elite -- BoNY, Citibank, J.P. Morgan Chase and State Street -- are trying to leverage their custody positions by selling additional banking, processing and outsourcing services. The strategy hasn't always worked; asset managers have been cautious about making sizable contractual commitments. In the meantime, the big processing banks are jockeying to be ready for what they see as an inevitable uptick in demand when markets recover.
"We continue to add functionality," says Thompson Swayne, head of the investor services unit at J.P. Morgan Chase, citing, among other things, its acquisition last year of Plexus Group, a leading provider of transaction-cost analytics. Custody clients, he says, are attracted by J.P. Morgan's "business presence, not only in custody, but the bank itself as a complete franchise globally."
The other big custodians naturally put a different spin on size. Citi, whose full-service profile is similar to that of J.P. Morgan Chase, emphasizes relationship banking, offering ready access to cash management, treasury management and trade finance, says Sandra Jaffee, executive vice president of Citigroup Global Transaction Services.
BoNY and State Street take a more specialized, processing-focused tack.
"I don't buy that model," BoNY investment services executive Thomas Perna says of J.P. Morgan Chase's multibusiness positioning. "You need to be able to go in and provide a broad range of services within the asset servicing business." According to Perna, that includes foreign exchange, securities lending and fund accounting.
State Street's Hooley sees no inherent benefit in owning both a custody and an investment banking business, the way J.P. Morgan does, and he contends that his company's independence was instrumental in its ability to take over Deutsche Bank's portfolio. "Deutsche Bank continues to have [relationships with] these customers in other parts of its business, and the custody went to a set of hands that could properly handle their clients' needs," says Hooley.
A number of smaller players -- including U.S. regional banks Mellon Group and Northern Trust Co. as well as France's BNP Paribas and SocGen -- echo BoNY and State Street in stressing the advantages of a tight focus. Investors Bank, for example, says that its concentration on custody gives it an edge over rivals that also must be concerned about consumer services or corporate lending.
From any perspective competition in custody is shaping up to be a technological arms race, which doesn't bode well for smaller operators, says Hooley of State Street, which spends $800 million annually on technology. "The niche players are good competitors, but to the extent that this business demands global services, I think it will be a stretch for them."
Adds J.P. Morgan Chase's Swayne: "Scale is absolutely important. The technology costs put massive pressures on firms that are not of a certain size. You have to be pretty substantial to afford the investment in technology to stay current. We spend over $500 million a year."
If markets continue rallying, growth may come a little easier. On June 30 the Big Four custodians combined were managing $2 trillion more than they had on the March 31 survey date.
The survey is based on information provided by the custodians to II. Researcher Michele Bickford gathered the data, under the guidance of Senior Editor Jane B. Kenney.