Custody industry consolidates

The finalisation of the Bank of New York and Mellon Corporation merger in July created the largest custodian and asset servicer with more than $18trn (€13.2trn) in assets under custody and administration. But did it also create less choice for pension funds and investment managers?

Shortly after the completion of the merger, Mellon Bank agreed to purchase ABN Amro's 50% share in ABN Amro Mellon Global Securities Services, a joint venture company established by the shareholders in 2003 to provide global custody and related services to institutions outside North America. When the transaction closes in the third quarter this year, ABN Amro Mellon will become part of BNY Mellon Corporation.

Other notable mergers in the custody world were State Street's acquisition of Investors Financial Services for $4.2bn.

This acquisition adds $2.3trn in assets to State Street, bringing the total to $14.1trn under custody. BNP Paribas has signed a memorandum of agreement for the acquisition of a stake of 33.4% in SLIB - a wholly owned securities services subsidiary of Natixis and has bought Exelbank, a specialist custody and depository banking firm which was owned by Banco Sabadell in Spain. France's Caceis will at the end of this take over the securities and custodial services business of Germany's HypoVereinsbank (HVB).

While on paper it may appear that such mergers create less choice for custody clients, Ross Whitehill, chief operating officer at London-based custody and capital market infrastructure ratings company Thomas Murray, says while there has been consolidation of providers, there also has been expansion.

"There are more suppliers in the market now than there were five to 10 years ago," he says, pointing out that suppliers such as HSBC Securities Services, KAS Bank, RBC Dexia, Societé Generale Securities Services and Caceis have been putting effort into building up their global custody capabilities.

He believes the growth in pension plans in Europe, and indeed worldwide, has attracted financial institutions, which are providing other services such as trading. Why not build on the experience and client base they have in different countries by offering securities services? There's also an argument that the merged providers can offer more choice in terms of product range, a concept propounded not unsurprisingly by Tim Keaney, co-head of the merged entity, BNY Mellon Asset Servicing.

"There is no doubt consolidation is continuing in this industry and while you may be seeing less choice as some of the very domestic players exit the business, clients are getting higher quality, committed players with a full range of products and services. That is good for securities services customers," he says.

The BNY Mellon merger is unique in that it is a combination of two substantial players in the industry that are both growing, says Keaney. "M&A in this industry in the past has been usually a big company buying a small one, or a strong company has bought a weak company."

Not only is BNY Mellon now the world's number one global custodian, it is also among the top five asset managers in the US and the top ten globally, with more than $1.1trn AUM. It is a leading provider of corporate trust and depository receipts services and a leading provider of correspondent and government securities clearing and collateral management services globally.

Both parties in the merger have areas of strength, the result of which will be an ability to bring "the best of the best" to clients, says Keaney. For example, Mellon's cash management products will be offered to BNY clients, as will Workbench, Mellon's browser-based information delivery system, which Keaney says should prove very attractive as a front-end to BNY's infrastructure.

"Our legacy BNY clients will be able to take advantage of these Mellon tools while remaining on the BNY platform."

In securities lending, BNY has traditionally been strong in fixed income lending, while Mellon has greater expertise in international equities lending. Clients will be able to take advantage of these services immediately, says Keaney.

BNY Mellon has been keen to stress that the integration of the two providers will not be rushed. Says Keaney: "Some previous mergers in the industry have been done too fast. Our integration will not be a big bang, but rather a series of pops. A good portion of the ‘heavy lifting' of the integration will be done over three years, and perhaps some of it up to five years."

Thomas Murray's Whitehill says it is encouraging that BNY Mellon has indicated it will not rush the merger. "Both CEOs have said they want to do the merger properly and would rather it takes longer in order to get it done right. We are encouraged by that."

Whitehill says past mergers have been driven by a desire to squeeze out economies of scale by building bigger groups. Some of the bigger groups have failed, he says, because they did not consider the "economies of scope", failing to hire enough people to manage relationships. For this reason, many of the smaller asset services are more highly regarded in the market.

"These smaller operators may not be more cost effective, but clients see an advantage in niche providers. To some extent, I think the bigger groups are waking up to this."

Consolidation to provide scale is an outmoded dynamic, says Neeraj Sahai, global head of securities and fund services at Citi. Driven by the first wave of outsourcing, where providers offered commoditised products at low costs, such consolidation was driven by a desire to provide scale, which would drive down costs for the provider and thereby lower fees for clients.

"The front end activities of asset managers are increasingly complex, driven by the use of derivatives and complemented by the use of multiple strategies across many more markets than in the past," he says.

"This complexity at the front end is reflected in the complexity at the back end. If the back office infrastructure cannot cope with complexity, innovation at the front end will not be possible."

Commoditised products offered by scale players are out of synch with current requirements, he says, because such complexity offsets the benefits of scale.

Sahai says clients must look for a provider that bridges two contradictory trends: the ability to provide services at a manageable cost, and the ability to provide an operating architecture than enables their growth.

"A balance has to be made between economies of scale and scope. In doing so, they need to find a provider that is less of a vendor and more of a partner," he says. This trend is happening, albeit slowly says Sahai.

The supporting architecture must be open and modular, in order not only to meet the short term requirements of clients but also to meet long term strategies.

"Providers need to move from the paradigm of feature and function and more towards a strategic alignment with clients, based on the current and future view of the client. In this way, the client gets the best of breed solution that doesn't limit their ability to grow," he says.

Since the announcement of the BNY Mellon merger, Keaney says the custodian has won or retained 41 mandates, which equals all of the combined new business won by its competitors. For example, in July, MGM Assurance awarded BNY Mellon a mandate to provide a comprehensive derivatives margin management solution that facilitates the administrative and processing requirements associated with posting and receiving collateral in connection with OTC derivatives trades.

As part of the appointment, The Bank of New York Mellon will monitor performance under MGM Assurance's ISDA Credit Support Annex, the legal document widely used to govern OTC derivatives trades, including calculating derivatives exposure, receiving and delivering of collateral, and reinvesting cash collateral. Nigel Sherry, chief operating officer at MGM Assurance, said of the announcement: "Derivatives have become increasingly important as a risk management tool for our insurance and pensions related products. We were therefore keen to identify a provider who had expertise in monitoring complex derivative transactions and proven systems for comprehensive, speedy settlement."

In August, Scottish Widows Investment Partnership retained BNY Mellon Asset Servicing to provide transfer agency services for its UK-based funds registered under Scottish Widows Investment Partnership, Swip Fund Management, and Swip Multi-Manager Funds. The funds have a combined value of £12.5bn (€18.5bn).

Arun Sarwal, chief operating officer at Swip said the company's activity in the fund sector had grown significantly during the past two years. One factor in the retention was BNY Mellon's "commitment to evolve their service in line with changing needs", he said.

Keaney says BNY Mellon is "in the information business. We give people the equivalent of a BBC, broadcasting live information 24 hours a day. Our clients make important investment decisions based on what we do".

The result is enormous demand to reinvest in products and people, says Keaney, a fact that is the "thin edge of the wedge" for some of the smaller custody players. "This is a challenging business because it continues to evolve and I think we will see the asset servicing business continue to consolidate as a result," he says.

Whitehill believes the market will eventually consolidated down to a "handful of extremely large providers", but that there still will be room for tier two and three providers. There may be less of such smaller providers because of the cost of supporting alternative asset classes, but they may find a niche in servicing clients that don't use alternatives and are more domestic in outlook.