Riches keep growing for $bn industryThe move towards equity-based investments has been good news for the banks that process trades for fund managers, writes Simon Targett
 Global custody is a dry term that hardly does justice to a business that routinely registers success in thousands of billions of dollars.
Custody, which at its most fundamental is the safe keeping of assets and settlement of trades on behalf of fund managers, is fast becoming a boom industry.
Global trends are driving this growth. First, banks and insurance giants are paying large premiums to acquire fund management operations, and this in turn is benefiting the custodians that serve them.
Second, financial assets worldwide are increasing - one estimate predicts they will grow by 45 per cent to $65,000bn by 2003. These assets are being invested in new ways as the state retreats from its role of primary pension provider, and citizens are obliged to invest in mutual funds and defined contribution pensions in record numbers.
Again, custodians, large and small, are gaining from this - the large catering for corporate pension funds and their managers, and the small catering for high net worth individuals and their managers.
But the big US custody banks are poised to win most of the business.
The big three - Bank of New York, State Street, and Chase Manhattan - control almost 40 per cent of the international custody market, according to PaineWebber, the US consultancy. This compares with just 17 per cent in 1995.
This rising market share is predicted to continue, as the big custodians export their hard-learned skills to Europe, where the shift towards private pension provision is likely to be most dramatic in the next decade.
The big custodians can also expect to benefit from the trend towards consolidation, as local banks and other traditional custodians leave a sector that is peripheral to their core business. PaineWebber forecasts that as much as 70 per cent of assets under custody will be consolidated among the top five players within the next three to five years.
| Top 10 global custody banks* |
| By total assets ($bn) |
|
| Bank of New York |
6,700 |
| State Street |
6,200 |
| Chase Manhattan |
5,700 |
| Citibank |
3,900 |
| Deutsche Bank |
3,900 |
| ABN Amro Mellon |
2,700 |
| Northern Trust |
1,600 |
| HSBC (Global Investor Service) |
1,141 |
| BNP Paribas |
953 |
| Brown Brothers Harriman |
890 |
|
Figures provided by banks listed
|
| Source: globalcustody.net ©2000 globalcustody.net |
In the past two years, Bank of New York has bought Royal Bank of Scotland's custody business, State Street has won significant parts of Lloyds TSB's custody operation, and Chase Manhattan has absorbed Morgan Stanley Dean Witter's custody business.
These banks have bowed out of custody, not least because the costs of staying competitive are rising. The main contenders are forcing the pace by spending ever greater sums on technological innovation. For the big custodians, $300m per year or more is standard expenditure. Bank of New York, for example, expects this year to spend $455m on technology - 14 per cent up on last year.
This is because custody is, like most financial services today, increasingly driven by technological change. With the extension of trading hours and the widespread move towards decimalisation, the pressure on existing infrastructure is likely to continue relentlessly. Also, new standards that require custodians to settle the day after the trade was made - the so-called T+1 - are expected to come into force in the US by June 2002, adding to the technology burden.
Custody has, because of the rising importance of technology, become, at its most basic level, a low-margin commodity business. This fact is driving banks to acquire scale, so they can deliver the returns on the significant investments in technology infrastructure.
But the custody business is likely to become more profitable because of two trends: one is the growing appetite among clients for "added-value" services, such as performance and risk measurement; the other is the decision by some fund managers to outsource both their back office and middle office operations.
The safekeeping of assets and settlement of trades remain the core of the custody business - the "plain vanilla" as custodians like to call it. But custodians have also been smart in devising a series of toppings to tempt fund managers who, of course, will pay a little bit extra. These include cash management and electronic reporting, proxy voting, securities lending, derivatives clearing, and offshore fund administration.
For some custodians, the ultimate ambition is to become a type of business consultant, which suggests a continuing long-term relationship rather than a patchy product-by-product arrangement.
This trend is ensuring that analysts are upbeat about the prospects of the custody business. Wall Street analysts are expecting double-digit earnings growth for the large custodians, with some business lines, notably international custody, enjoying 30-plus per cent growth.
But the eldorado for the custody business is the nascent trend for fund managers to outsource custody operations to the specialists.
Just as banks are rethinking their strategies, and looking to become more focused, so, too, are fund managers. They realise they are paid for investment performance, rather than the smooth running of their back and middle-office operations, and that any significant spending on technology should be allocated to systems that help towards that goal.
Bank of New York is to run the back-office operation of JP Morgan's asset management business and other similar outsourcing arrangements are widely anticipated. A study by Tower Group, a consultancy found that, of 1,400 asset managers studied, some 479 firms outsource middle office functions such as trade execution, analysis and compliance. By 2002, this number is expected to have risen to 736, roughly half of all those surveyed.
eanwhile, the increasing competition means that both large banks and niche players keep a close eye on the latest league tables, which are being published in ever-greater numbers.
There is no single league table that is recognised as the industry standard, so each bank points to the one in which it performs most creditably. Yet, across the industry, the big three US institutions are usually ranked at or near the top, while the so-called niche players, such as Pictet & Cie, the Swiss private bank, and Brown Brothers Harriman, the Boston institution, often top the charts that favour client services, for example, rather than size.
These top custodians are redefining and extending the boundaries of the business, and may soon come up with a new name for global custody - one that more accurately reflects the industry's vibrant prospects.
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