It’s the most advanced market in Europe, and probably the most competitive. But the travails of the UK’s financial markets have left parts of the UK’s financial services industry battered and bruised. With funds having to work harder to get returns, and less money in the market, the UK’s custody providers have had to up their games to gain value and remain established within the market.
It’s the most advanced market in Europe, and probably the most competitive. But the travails of the UK’s financial markets have left parts of the UK’s financial services industry battered and bruised. With funds having to work harder to get returns, and less money in the market, the UK’s custody providers have had to up their games to gain value and remain established within the market.
“There’s no such thing as a custody provider any more,” says fund manager Gerry Hooley. “It’s not about the safekeeping of assets and if any provider just did that they would be out of business within weeks. Today’s custodians need to offer far more than they ever had in the past - it’s always about the value added services, which we don’t even consider value-added now. They’re just standard.”
Pretty much every global custodian is represented in the UK, with the largest players - the BNY Mellons, State Streets and Northern Trusts - all having large market share. There’s not a lot of room for the minnows.
And that’s even more true now. While the old adage about custodians doing well in both good financial times and bad still has an element of truth, the new financial environment means that there are far more demands placed upon them.
Clients now have far greater focus on risk management and this is filtering down into the due diligence they place on firms. Although the downfall of Lehman wasn’t related to its custodial business, the collapse sent a shockwave through the industry and firms want to ensure their provider is financially secure and has the ability to invest in its systems and infrastructure.
“Custody used to be thought of as something you needed, not something you thought much about,” says Hooley. “We just looked at the price. If we could shave a couple of points off the cost, then we’d switch. But we now need to look at the provider itself. We often need to go in there and see how they work. We need to meet the people who are going to be looking after us and we need to get assessments of their processes, technology and management. These are all big global corporations so we know that in 99.99 per cent of cases everything is going to be fine, but we need to be seen to be doing it. Our compliance officers, our investors, our regulators all want us to have evidence that we have done the due diligence as thoroughly as we could have.”
So while much of the financial sector has been retreating in the face of the global recession, many custodians have taken the opportunity to invest in their technology and streamline the processes, ensuring that they offer the basic services at the lowest costs and the more valued services of the highest quality.
There’s also an increased need to gain the most value from the assets. Many of the UK’s large defined benefit company pension schemes have shortfalls running into billions of pounds. These funds - which are generally run for employees of privatised companies or those that are not commercially owned, such as the BBC and the Royal Mail - have long run deficits, but the low growth rates over the past couple of years have put the problems into the headlines. This means that services such as securities lending are increasingly being used to add much-needed revenue.
This is leading to the emergence of prime custody, where the providers work much more closely with their clients. In addition to providing the traditional services associated with the back office, there’s more emphasis on research, execution and post-trade services, as well as advice and support on managing the rapidly-changing regulatory environment. This in many circumstances means that the custodians now outsource many of their offerings themselves, with prime brokers reaping some of the dividends.
Roger Braybrooks, head of UK consulting at consultants Investance says: “[This suggests] that broker-dealers of all types should remain open-minded to best practices from across the industry. Newer niche companies should be looking to emulate the strengths of traditional banks, including their powerful brands and scalable processes. Traditional banks, meanwhile, should be looking to build up and demonstrate the capabilities in newer investment strategies and to increase their ability to react quickly to market changes and opportunities.”
Bonus culture
But there is one potential spanner in the works. The UK’s position as the leading financial services centre in Europe - if not the world - is unlikely to be under threat in the near future, but there is an issue that has some bankers concerned. There are mutterings about a cap on bonuses in the banking sector, and already an added ‘banker’s tax’ on bonuses, which have already led to some firms complaining that they are unable to attract the highest calibre of staff.
And while the back office is not known as the highest-earning part of any bank, there are concerns that the higher echelon of management may not want to move to London - or work for a British bank - for financial reasons. “Nothing’s happening yet, but we’re not talking salaries in the multi-millions here,” says one insider. “But someone on a good six-figure salary is going to notice when a big wedge suddenly gets removed. London is not the cheapest place in the world to live or do business anyway, and if they’re going to get their incomes hammered too, they’re going to want to go to Frankfurt or Paris.”
The potential increase in taxation isn’t limited to outsource providers. Asset managers are also rethinking their investment strategies and many have said they are looking for offshore routes - the Channel Islands and Switzerland seemingly the most likely options - for managers to base their teams.
“We’re not going to see a huge exodus,” continues the insider. “The UK will remain a strong centre for investment because that’s where the investment opportunities are. There are also legal restrictions on some fund types that prevent them from going offshore. But where funds can choose their domicile, it’s unlikely that the UK will be at the top of the list. And custody banks aren’t deciding the market; they follow the funds, so I can see more outsource providers increasing their presence there rather than here.”
Not everyone is so downbeat. State Street’s chief executive Jay Hooley is looking for further acquisitions in Europe after already snapping up the businesses of Bank of Ireland and Intesa Sanpaolo in Italy. With its European headquarters in London, and having recently won the custody and fund administration mandate from the government-run National Employment Savings Trust - a fund expected to be worth £100 billion within 30 years - Hooley says that there is plenty of opportunity.
“Most growth is tied to GDP growth and economic growth,” explains Hooley. “We’d like that, but we are also interested in the evolution of asset pools. As asset pools move from government to company sponsored pension plans... there are more things we can do.”
Hooley added that although the financial picture at the moment isn’t great, State Street is focusing on the long term, where increasing funds will see more opportunities for custodians. Margins here are slightly higher than in the US, making it a “more exciting” opportunity.
Regulation
Final agreement has been reached on the European Union’s controversial proposed alternative investment regulations.
A week after France and the UK struck a deal of their own on the directive, paving the way for its approval by the EU’s 27 member states, those states and the European Parliament have reached a deal that assures its passage by the latter. Approval by both bodies is required for the proposal to become law,
The European Commission’s agreement with the parliament contains a few changes from the draft approved by EU governments. But those are relatively minor; the real heavy-lifting on the compromise was accomplished last week by EU finance ministers after an increasingly isolated France agreed to drop its opposition to granting access to all EU markets to foreign hedge funds.
The directive will impose strict new reporting and custody requirements on hedge funds and private equity funds, as well as placing them under the authority of the new European Securities and Markets Authority. Private equity funds will also face new asset-stripping rules.
The controversial passport will not come into effect for EU firms until 2013, and foreign funds will not be eligible until 2015. Until then, the current regime that allows each EU country to decide which funds will have access to their markets remains in place.
The future
So as money starts to return to the markets, the support services are well-placed to offer the highest standards of service. There’s no doubt that custody banks did suffer during the downturn, but the new slimmed-down providers have ensured their costs are at a minimum while their technologies are leading edge.
It would be extremely difficult for a new entrant to gain much traction in the UK; the market is pretty much sewn up by players who are already offering a good quality service at a relatively low cost. Perhaps this is why there are constant rumours of further consolidation - HSBC recently denied that Northern Trust was a target - as it seems that anyone who wants a piece of the UK will have to buy in.
