© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the February 2006 edition of BENEFITS CANADA magazine.
Reaching out – 2006 Custody Report
Many custodians looked beyond Canada in 2006 as they invested in new technological systems and new partners that can transition their largest clients into international investments. But are institutional investors ready?
By Anna Sharratt

JOSÉ PLACIDO is used to flying. The chief executive officer of RBC Dexia Investor Services says he spends about 40% to 50% of his time traveling, whether it’s to the U.K. or Australia. He refers to the trip to Montreal as “a commute” the way someone would describe the 30-minute drive home from work.

That’s a good thing in light of RBC Global Services’ recent joint venture with Dexia Investor Services, headquartered in Luxembourg. Under the terms of the agreements, announced in June of 2005, Placido will be traveling extensively, dividing time between Toronto and the firm’s London office. He, like his recreated company, will be straddling major markets—a potentially precarious balancing act in the quest for global dominance.

But Placido says it’s the natural evolution of the mature Canadian custodial market. He believes that as investors’ appetites for new global products grow, they will look beyond Canada’s borders to diversify their portfolios. And if custodians don’t have the sophistication and global partnerships in place, they’ll lose business. Add to that the entrance of highly specialized administrators predominantly from the U.S. and the competition will only intensify.

“We have a mature market here in Canada and have three major players who service this market very well. If we want to be successful and service our Canadian clients, we’ll have to see growth in this business. It is a prudent and good strategy to diversify your revenue flows,” he says.

But Placido’s strategy—the first transatlantic transformational deal of its kind in Canada—is a challenge. After all, the word “customer service” punctuates every custodian’s speech. And when you’re integrating operations with a new strategic partner, things can fall by the wayside. So say industry insiders who feel the firm’s new focus on Europe could prove to be a risky undertaking with Canadian clients.

Tom Macmillan, president and chief executive officer of CIBC Mellon in Toronto, which celebrates the 10th anniversary of its joint venture this year(Mellon Financial Corp. and Toronto-based Canadian Imperial Bank of Commerce established an institutional trust and custody business in 1996)says it’s a decided shift. “There’s no denying it’s a new focus for our competitor. But I run a Canadian-based company. So when I see a competitor focusing elsewhere, we’re going to work even harder to be strongly focused on the opportunities right here in Canada.”

What’s clear is that custodians in Canada are no longer merely concentrating their energies on product development. Instead, they are recreating themselves, developing new technology and upgrading front-office functionality.

“We have actually departed from the word custody as it doesn’t represent the breadth of our expertise, and have really translated that into an investor services focus,” explains Kevin Drynan, senior vice-president and managing director, relationship management with State Street Trust Co. Canada in Toronto. “We see ourselves as being much more than a trade settlement agency and income collector for our customers. Our model really truly does go beyond that.”

That model is targeted to the largest, most sophisticated clients who have been heating up demands for transition management, securities lending and currency overlay: a reflection of their increasing interest in global markets and a need for risk management.

Transition management, which allows a cost-effective move from one manager to another, was certainly hot in 2005. The reason: plan sponsors shuffled their money managers after the removal of Foreign Property Rule(FPR)in the spring. Though the FPR’s removal didn’t create a sea change in investment thinking among investors, it did mean plan sponsors had to replace managers as cost-efficiently as possible.

“Clients have become much more focused on expanding their foreign investments; they want to take the risk out of those markets,” says Doreen Rigby, senior vice-president and managing director with State Street in Toronto. “And the other thing is they want to transition as safely as they can from one manager to another in order to change that allocation.”

The heightened concern with managing risks also meant securities lending, which allows institutional investors to earn extra income on investment and pension portfolios with minimal risk by lending their securities to qualified borrowers, became more popular. So did currency risk management—which involves delivering a consistent stream of positive returns while smoothing out the volatility normally associated with investment in foreign currency assets.

Competition between providers has also heated up. “I think it has intensified,” says Jeff Conover, president and chief executive officer of Northern Trust Company, Canada in Toronto. “It’s not that there are new plans being created all of the time. And often you hear about new players coming in.”

Citigroup, a new global entrant into the Canadian space, is certainly one such threat. Though it’s just beginning to move into the pension custody administration field since its merger with Unisen, a fund administrator, it could pose a threat to larger Canadian custodians.

The firm certainly has lofty goals. “Citigroup is currently extending our capabilities in order to service pension assets,” says Neeraj Sahai, global head of securities and fund services, Citigroup corporate and investment banking in New York. “Our goal is to be the provider of choice of services to pension fund managers throughout North America.”

Placido believes there will be more niche players entering the Canadian market, rather than more consolidation occuring within the market itself. He thinks players that can provide specialized administration services, rather than large global custodians, will be trying their hand.

But Macmillan feels the entry of these players will be limited, given the finite size of the Canadian market. And he feels the U.S. players rumored to be heading north might think twice. “I can’t believe they would [say] ‘there are no more foreign investment restrictions, let’s come up to Canada.’ To a [U.S.] company, the Canadian market may look the same, smell the same but is in fact quite different. There’s a lot of Canadianization you need to do.”

Yet he agrees there are opportunities for specialized players to enter the Canadian market. “We don’t all have to be Macy’s.”

As for smaller, boutique firms and traditional custodian providers targeting the small to mid-size market, opportunities could grow as the large custodians look beyond Canada’s borders. For Adrian Baker, vice-president and chief operating officer of Canadian Western Trust(CWT)in Vancouver, it could well be a boon for business. He feels that smaller players are often left out of the custodial equation.

“We are not attempting to reinvent ourselves as the new consultants of the pension industry. Instead, CWT believes in sticking to our core competencies, settling trades, paying much-needed pension cheques.”

Governance issues came to the forefront in 2005, the result of Sarbanes-Oxley legislation kicking in in the U.S. More than ever, institutional investors are concerned about ensuring their operations and those of their providers are in line with regulatory standards. “They’re faced with new demands and challenges around compliance, governance; their world has changed as much as ours and they’re looking for us to help them in meeting these new challenges,” says Drynan.

And meeting those new sponsor concerns requires a well-thought out, proactive stance from custodians.“To adapt is not good enough,” says Paul Owens, plan manager and chief executive officer at the Colleges of Applied Arts and Technology Pension Plan in Toronto. “I think [they need] to anticipate trends so that when clients make the move to new or modified asset classes, they don’t have to wait for the custodian to come up with an answer: in other words, identifying problems before they become problems.”

Macmillan agrees that anticipating client needs is his main objective as institutional investors move into the global realm. “We have demanding clients who are entering more global markets and more sophisticated investment and we have to make sure we are in a position to properly administer that for them. The minute you relax and think you’ve got it made, you’re swimming.”

There certainly won’t be much relaxation in the coming year: one which will tell the tale whether the Canadian custodial landscape will see new players from the U.S., or more European partnerships. Having purchased Barings Financial Service Group last year, Conover says Europe is being seen as a place to grow for Canadian-based players.“Everybody and their brother is piling into Europe.”

The question is whether such moves will help institutional investors diversify their portfolios or if the global forays will be seen as a shift away from Canada. And if it’s the latter scenario, will there be room for new entrants?

Robert Smuk, CEO of GTS at Citigroup in Toronto, is hoping that going global will be the ticket for custodians trying to stay ahead of the curve. “Asset managers will be looking for service providers with a global footprint and the ability to service clients wherever they do business,” says Smuk. If he’s right, Jose Placido will be flying high.

Moderate Growth

Pension assets under custody of the nine participants in BENEFITS CANADA’s 2006 Custody Report grew this year to $897.7 billion— an 8.8% increase as of Sept. 30, 2005. And the top three players held on to their respective spots this year. RBC Global Services reported $348 billion in pension assets under custody—a 16.7% increase; State Street had $252 billion—rising 15% and CIBC Mellon reported $175.3 billion—up 8.5% year over year.

On the mutual pooled fund side, assets under custody cleared $1 trillion—an increase of 15.9% from $879.1 billion in 2004. While RBC Global Services held on to top spot with $413 billion in assets under custody, CIBC Mellon had the highest asset growth, increasing 30% to $342.8 billion. State Street saw a small increase to $145 billion from $142 billion last year.

Anna Sharratt is managing editor of BENEFITS CANADA.