“The securities lenders are back,” Lockbaum agrees. “What I’m waiting for is the renewed increase in the demand for securities.” Still, custodians aren’t overly concerned. “Securities lending will continue to be a robust service, an important feature of efficient markets,” says Baillie, adding that it continues to facilitate legitimate hedging and provides liquidity to financial markets.
CIBC Mellon, for one, has had a number of discussions with its clients and investment managers to demonstrate transparency in securities lending. “We regularly draw on securities lending benchmarking information available from U.K.-based consultants. [This] allows us to compare the performance of each client’s lending activity to their peer group or to the market generally,” says Tom Monahan, president and CEO of CIBC Mellon.
For its part, Northern Trust has revamped its securities lending exposure reporting. Through its Web portal, it now provides a securities lending dashboard with data specific to the client, including loan and collateral balances and credit ratings. “This is client-driven,” says Baillie, “the kind of information that clients have been looking for to satisfy the need for transparency.”
Show Me the Money
With the decline in securities lending transactions, how are custodians going to continue to grow revenues? In the last quarter of 2008, some custodians, such as Bank of New York Mellon Corp. and State Street Corp., announced cuts to their workforces. However, workforces remained intact last year as custodians looked beyond their own operations to cut costs.
In 2009, Thomas Murray saw an acceleration of outsourcing to inexpensive locations. “[There’s] a lot more offshoring into India and Malaysia, [for example,] by custodians to ensure that costs are contained,” Sharma affirms.
The larger players in the global custody space—notably, the U.S.-based custodians—are also looking at outside locations as sources of prospective revenue growth. “Those who are preparing or have prepared to expand outside of their own home market will benefit going forward,” Sharma continues. “The U.S. market is pretty mature for many of these players, so from a revenue growth perspective, opportunities will be limited. To ensure that they continue to sustain their leadership, they need to look for new opportunities—and these will exist outside of their home market.”
In December last year, for example, State Street agreed to acquire Italian banking group Intesa Sanpaolo’s securities services business for US$1.87 billion. A month before, JPMorgan acquired Australia/New Zealand’s AUD$99-billion custody services business.
Fewer Fees, Please
Plan sponsors also want to ensure that they are getting the best value for the fees they’re paying. Custody fees are inextricably linked with the bundling of services—which, historically, the industry has promoted. But Sharma believes that unbundling will become an important issue for clients. If a client wants to leave securities lending, for example, what will that do to the fee structure? she asks. “That’s going to be a huge challenge for custodians, in terms of how they balance between different components and still remain competitive.”
Though custodians are aware of the unbundling trend, they’re hesitant to make any promises on the fee scale issue. “From a supplier of services [perspective], I would always like to bundle, but we do custody-only service for some clients,” says Lockbaum. “Depending on the client, the opportunity [and] the deal, we’ll look at the marketplace and try to find the very best fit between the opportunity and what we do.”
While bundling services with one global custodian has been the norm until now, Scobie says his clients aren’t overly concerned about one-stop shopping these days. “They’re willing to have best-of-breed partners and diversify some of their business relationships.” According to Scobie, one large plan sponsor is moving its deferred stock unit plan over to CWT. While the company does not plan to move its large pension assets, it finds service lacking on its smaller plan, he says. “CWT and the sponsor believe it might be a combination of its size, or maybe the people they are dealing with don’t understand the intricacies of the plan.”
Tonelli agrees that some clients will consider a best-of-breed approach. But for those that do—typically the mid- to smaller-size plans, where fees are a concern—“multiplying providers is not necessarily the best way to [minimize fees].”
Under Review
With all of the financial upheaval in the past year and a half, the custody industry has no doubt that it will see more regulation in the future. It’s just a matter of what form that regulation will take.
While the need for a national securities regulator has been widely reported and debated, Robertson says Canada has fared well through the recession. “If you take a look at our banking industry, we stood up pretty well,” he says. “I think that was a reflection of [having] a good regulatory environment in place.”
Securities lending has already been subject to some restrictions, but that wasn’t an ideal solution. “At the height of the crisis, when regulators implemented short-selling rules, it was unclear what the impact might be,” says Don D’Eramo, senior managing director of securities finance with State Street in Canada. “We maintain an ongoing dialogue with regulators [in this area].”
And the custodians agree: if increased regulation is necessary, it needs to be clear on what it’s trying to achieve. “We haven’t been very specific and explicit about what we need more regulation around,” says Robertson. “You’ve heard more about regulation around hedge funds, [but] that will likely have more of an impact in the U.S. versus Canada because there are more hedge fund managers there.”
Consequently, there is a great deal of speculation on where the regulations will fall. One area will likely focus on the adoption of the International Financial Reporting Standards, which will come into effect on Jan. 1, 2011. “We are already providing our clients with the necessary accounting data to meet these new rules,” says Monahan, “and we are delivering it electronically for greater efficiency.”
Others speculate that requirements around due diligence and regulations around derivatives and tax changes may surface. But Lockbaum maintains that regulation is part of the “fabric” of doing business. “What [regulators] want to do is try to create an environment that is not overly burdensome but does create that one more additional layer of comfort around what we’re doing as a custodian.”
For 2010, custodians will continue to focus on revenues and sustaining their businesses. They’ll also work on providing access to information and transparency to meet their clients’ needs. With all of this in mind, plan sponsors may be looking forward to brighter—and clearer—days ahead. BC
Brooke Smith is associate editor of Benefits Canada.
brooke.smith@rci.rogers.com
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© Copyright 2010 Rogers Publishing Ltd. This article first appeared in the February 2010 edition of BENEFITS CANADA magazine.