(Pictured: Pat Liddy)
Securities servicing is going through a period of significant disruption. The SMSF movement, technological advances and heightened competition have combined to make 2015 one of the most challenging that the industry is likely to have seen. In this special report, PATRICK LIDDY rates the players and looks at the likely landscape for securities servicing companies in the future.
Many people may be surprised to know that there is a sun inside the sun, and we have just experienced the oddest solar cycle for 200 years. Or, according to the latest cutting edge solar science, it is the sun’s changing brightness – and not human activity – that’s altering our earth’s temperature. The solar statistical data maintains global cooling is on the cards, not increasing temperatures – but only in the short term. Alas the future, by definition, is truly uncertain. What’s more, a ‘macro’ player like the sun is very likely to trump ‘micro’ events here on earth. It’s simply a view on perspective. But, whatever, there will be interaction between the two and both will have an effect on the climate here on earth.
So, when trying to be predictive it is sometimes useful to isolate the macro-economic forces from the micro-economic. Which seems fine until enough micro get together and it becomes macro. With custody the simplest way is to compartmentalise and look first at the companies’ playing in this space, then consider their futures. After this, look at the macro-economic forces that will dictate change and what may be the impact on the industry as a whole. There is already a case that newer nimbler technologies are at the gates and sweeping change is coming to the investment area as a whole and custody in particular.
The master custody industry now consists of six main players: NAB, JP Morgan, BNP Paribas, Citibank, State Street and Northern Trust (RBC also provides a similar service, but only for fund managers). The last five years has witnessed much growth in total assets with the major winners in market share being JP Morgan, BNP, Northern Trust and Citibank. State Street is interesting as it suffered a major setback with the loss of AXA, but has come back strongly through the diversification of new business lines.
Now, let us consider the participants and their respective positions in the landscape in 10 years time.
NAB, at $673 billion, is still the largest player. But five years ago it was double the size of it’s nearest rival, JP Morgan. This gap has narrowed. The fact that it has been ‘put on the block’ for sale and there were no takers would seem to bode ill for this player. NAB also has some of its major clients out to tender at the moment and momentum seems to be swinging against them at this time. However, NAB does what could be termed the ‘essentials of custody’ very well, has some good kit – retail unit registry – that the other players do not, has a solid reason to like deposits and, given its home-country advantage, can respond quickly to client needs. This gives NAB an edge in the market. But the next few steps will be its most important. How well the steps are taken will determine its future.
Two things are consistent though: all NAB’s competitors believe it’s on the ropes, but NAB just keeps proving them all wrong. NAB is the wild card in the custody deck and just a few of the majors might rue the day that they did not offer enough to take them out.
JP Morgan, at $464 billion, has made a lot of headway over the last five years. But they have not gone along without mishap and misadventure. Their largest strategic blunder was to announce they were leaving DST, which may have been a smart thing to do, but it was a very difficult objective to achieve. They have also suffered some major client losses. Even given this, JP Morgan is one of the most successful companies worldwide. It is likely to earn $20 billion this year. JP Morgan is also deemed the world’s most “systemically important” bank by the global regulators. The thing about JP Morgan is if you have a lot of money they know how to look after you and make you feel special, which should never be underrated. Their business model means that they can do just about anything you want. The major concern with JPM is the regulator, or even themselves, it may seem economically sensible to ‘break up’ the company. They may have made themselves the ‘Standard Oil’ of banking. Failing that they may become to ‘shit scared’ of the regulators to do anything out of the ‘norm’. Making them inflexible and highly bureaucratic when dealing with clients and prospects. In any event, should the macro environment stay largely similar, I see JP Morgan making their way forward in the league ladders over the next 10 years.
BNP, at $312 billion, is one of the most underrated, yet consistently performing, custodians in the market share stakes. They have made some solid hiring decisions and are getting the right people in the right places. They are matching up the relationship side with the clients admirably. This is telling as BNP is number three, and keeps making inroads. The majority of the client base seems satisfied.
But BNP suffers in perception from being a European bank. This is a shame really as the Danish Institute for International Studies and data from Keefe, Bruyette & Woods Inc. showed BNP Paribas was above the cutoff point for liquidity, while 28 other banks failed. It is, in fact, the other European banks that tarnish BNP custody in Australia. Accordingly, it is hard not to believe they will continue to build sensibly and increase market share.
Citibank is a difficult one. It has had a rapid rise in the figures and now has $257 billion in assets. It won HostPlus and has some big manager clients. Put simply, Citi has a strong footprint in two major segments. They also have some strong entrenched advantages in the market. They run a lot of their own sub-custody network, which should mean they have good control over the end-to-end process. This should reflect in both efficiency and pricing. But with Citibank you get the feeling of ‘off again, on again’ as the vagaries of the capitalist swings take their toll. This is also a pity because out of all the offshore banks Citibank has the longest track record in custody. They were the first US bank to be granted a banking license and have had continuity ever since. It would be difficult for Citibank not to make further inroads into the Australian market over the next 10 years.
State Street once dominated the Australian market like no other custodian before or since. They had close to 100 per cent in the early stages, in the 1980s, when they pioneered master custody in this market. And for my money they are the only ‘pure’ custodian in the market. Everything they do – foreign exchange, index funds, ETFs, middle office, fund accounting, securities lending and so on – is simply an extension of their core business. That business is custody. No other ‘custody’ company comes close to this. Not even Bank of New York Mellon. Some State Streeters may say custody is in their DNA; my view is custody is their DNA. For that reason alone State Street will move further up the league tables. It is their natural position.
Northern Trust, at $167 billion, has the least market share of any of the majors. But that is changing and it’s changing because of the real strength in Northern’s armoury is that they are a team. They play extremely well together and the have none of the ‘egos’ generally associated with large companies. This and the canny positioning of their brand name have been instrumental in them having some of the best client names in the Australian market. They continue to capitalise on this again with their recent $20 billion GESB win. They won four tenders in a row away from JP Morgan last year. This is a solid, united and unpretentious company. And if they can hold that unity of purpose will continue to gain further momentum in this market.
However, custody is a technology business, so the real threat to custodians is not each other it is technology. In particular it is technology that will enable nimble non-custody players to take certain parts of their existing markets. The rise of SMSF’s is a case to note. In 1997 SMSFs were 14 per cent of the market now they make up 32 per cent of the market, it is predicted they will go to 40 per cent in 2025. Now interestingly, this type of business, although it is over a third of the market, does not end up with the major custodians. This will be compounded as people are now giving away the taxation and accounting reporting for the SMSF segment for free. For master custodians and their customers this is going to become more frightening. What it means is that the ‘barriers to entry’ for people going into SMSFs has been substantially lowered. As the cost of running SMSFs decreases more people shall use them. The flow on effect is that more people will leave retail and industry funds to enter the self managed realm. This will decrease market share of corporate, industry, government and retail funds. This has happened over the last ten years and there are few reasons to assume it will not continue. Even given the funds erstwhile defensive strategies.
This will have a macro effect on custodians if they do not watch and help their existing client bases. If the custodian’s clients lose members or investors, the custodians lose assets under custody.
So, the best way for custodians to predict the future is to look at what their clients’ clients are doing. And market share statistics would indicate they are leaving their clients.
Custodians need a retail solution for their custody operations. So as the sun will be the dominant macro effect on our climate, so the most major impact for master custodians may not be each other but the greater power of technological empowerment.
Note: Patrick Liddy is the principal of MSI Group, which advises funds and managers on custody, platforms and investment operational matters.