In Marathon Man, as Dustin Hoffman squirms and sweats while strapped to a chair in an interrogation room, Laurence Olivier, dental instruments in hand, asks repeatedly, “Is it safe?” That’s the big question custodians are getting these days in relation to their clients’ assets. “The biggest topic on everybody’s mind now, from a custodial standpoint, is safety of assets,” says Scott Scobie, general manager with Canadian Western Trust (CWT).
The declining economy and the need for safety was certainly evident in this year’s survey of custodians. As at Sept. 30, 2008, pension assets under custody were down across the board. RBC Dexia Investor Services (-13.5%), CIBC Mellon Global Securities Services (-11.0%) and State Street Canada (-4.0%) all showed declines. Although The Northern Trust Company, Canada had a 0.6% increase this year, this is minimal compared to its 12.2% increase in 2007. And Desjardins Trust had a 0.7% increase, but again, this is down from its 1.7% increase last year. State Street took the No. 1 spot this year with $374.4 billion in pensions assets under custody, followed by RBC Dexia ($371.0 billion), CIBC Mellon ($204.1 billion), Desjardins ($125.1 billion) and Northern Trust ($54.7 billion).
As with any business, custodians must secure revenues to sustain and grow their businesses. They do this through fees, cash management, foreign exchange and securities lending. But managing these sources of revenues in these economic conditions may have a detrimental impact on a custodian’s bottom line.
“The North American market valuations have gone down 40% [in 2008],” says Arti Sharma, senior vice-president, business development and relationship management, with Thomas Murray North America Inc. (a custodian watchdog). “There is a direct correlation on fees that [custodians are] collecting on the portfolios.”
Retaining cash is another issue. With interest rates at low levels, custodians are not earning the same levels by keeping cash, which, in turn, will affect the bottom line.
Securities lending has also come under increased scrutiny. However, the trend seems to be more negative in Europe and the U.S., where custodians’ clients are starting to pull back from lending. “In Canada, we haven’t seen that level of pullback, but there are definitely questions being asked of the custodian,” says Sharma.
The market has also put enormous pressure on the investment management community, according to Stephen Smit, chief executive officer (CEO) and president of State Street Canada. “As a rule, [they] are compensated on the value of the assets that they manage,” he says. “When you get moves down in equity markets of the magnitude that we saw in 2008, that tends to fall through to the revenue line of most investment management firms.”
Amid all the doom and gloom, though, Sharma sees a bright spot. She’s referring to the foreign exchange activity where custodians are executing trades for their clients. “The swings in just the Canadian and U.S. dollars in the last few months have been significant, [so] that’s one area that, probably, revenues were not impacted as much.”
Smit, too, sees some opportunities—for example, in those investment firms that provide fund accounting on an outsourced basis. In the Canadian marketplace, this has traditionally been an in-sourced function, unlike the U.S, where most of the large mutual fund companies have already outsourced their fund accounting to a custodian. “I think we’re beginning to see cracks appear with mutual fund complexes in Canada now considering outsourcing the accounting function,” he adds.
Global Trends
As a result of shrinking profit margins, the custody industry on the whole may undergo some changes. One negative change that’s hitting virtually every industry is downsizing, and it seems custodians are not immune. Sharma notes that the large parent companies of custodians have had to cut back, too. For example, in November, The Bank of New York Mellon Corp. released a statement that it will reduce its worldwide workforce by roughly 4%—1,800 positions out of 43,000. A month later, State Street Corp. announced its plan to eliminate 1,600 to 1,800 positions, or about 6% of its workforce, and Northern Trust Corp. announced the elimination of approximately 450 positions.
While some positions may be eliminated altogether, others may be outsourced. Although this trend has been going on for some time, during a period when cost containment is a priority, Sharma suggests that the industry may see an increased interest in outsourcing to cheaper locations such as India and Malaysia.
Consolidation will also play a part, as it has in the past, but more so in Europe than in North America. Canada has very few players left, says Sharma. “Definitely in Europe, you’re going to see some of the small- to mid-size global custodians think twice about staying in the business,” she says. “They may not be able to keep up with the investments that are required to remain competitive.”
