1999-2008

ANALYSIS ARCHIVE

WHAT A DIFFERENCE A YEAR MAKES

We could be saying goodbye to some top-tier providers in 2009

25 November 2008: If there is one racing certainty for 2009, it is this: not all the players in the existing line-up of the top 12 global custodians and administrators will still be there by year-end. Your immediate reaction will be to speed-read to the bottom of this article to see if I am bold enough to predict who will survive and, more excitingly, who will fold. True, there is no fool like an old fool, but I am not quite ready to confirm that through my own words.

Recent history shows that the hurdle for survival has been significantly raised, and that the scarcity of capital will make it difficult for smaller providers to maintain their independence. That same issue – the need to raise capital – dogs even the largest banks in the world, as Citi spectacularly proved after its rescue by the U.S. Treasury. That challenge has already done for some providers, such as Fortis, which was probably already considering the sale of its Prime Solutions business before it was forced into the arms of BNP Paribas.

Who, then, is next? At the bottom of the food chain, KAS BANK has had a dreadful time of the credit crisis, but you have to wonder who would want to spend the time and effort in acquiring and integrating this ‘nice-but-niche’ business. For most of the banks with serious money to spend – which includes the three US trust banks flush with cash from the US bank bail-out – KAS does not look like a compelling target.

More attractive, perhaps, are the host of independent players who might offer new product capabilities, regional expertise or, just as importantly, warm bodies. The recent news that GlobeOp is to expand operations in Dublin is an example of the HR problem: GlobeOp will have to find its staff from the existing pool of skilled labour (unless, like others, they import expertise from Poland), putting further pressure on supply and, inevitably, raising compensation costs. Buying a business that delivers additional staff is just as attractive as getting your hands on new product management abilities.

Many of these players are hurting badly. SEI Investments, one of the more significant independent administrators, reported reduced income, revenue and EPS for the third quarter, taking a USD40.8m pre-tax charge related to structured investment vehicles. The SEI model has worked well during the good times: big bank competitors will be watching closely to see how resilient it is in current market conditions.

It may be that SEI can weather the storm, but smaller players may find that access to capital is choked off, giving clients a good reason to move elsewhere. Ultimately, clients decide the fate of businesses: just look at the demise of Investors Financial, which failed to win enough new mandates to cover its product investment costs.

On the other side of the coin, it will not just be the large US and European custodians who dominate M&A activity. Japanese banks have already proved their willingness to take advantage of the credit crisis to pick up new assets, and only a fool would believe that Japanese investors are happy to see their global custody market dominated by foreigners. At some time in the past all the major Japanese banks have tried – and failed – to make a go of the global custody business, but an acquisition that catapulted them into the premier league would present an unrivalled opportunity to have another shot.

Similarly, Deutsche Bank cannot be ignored. Rumours of its ambitions to re-enter the market have been running for too long, but its acquisition earlier this year of HedgeWorks, a tiny hedge fund administrator, suggests that it is dipping its toe in the water. The problem for Deutsche is that there is hardly anyone left in the bank who understands the business – and those who do are scarred by previous experiences.

Are there sellers amongst the biggest players? Citi has wobbled and Vikram Pandit, who is said to be a big fan of transaction services, needs to stay on and continue to commit capital the business – or else his successor, if Pandit is forced out, may well decide to break it up and sell off the clearing, settlement and investor services operations. The trust banks have all taken money from the U.S. Treasury and look strongly committed, but they all need to demonstrate that the worst of the losses on SIVs and collateral reinvestment are behind them.

The two top tier players that look most susceptible to change in 2009 are RBC Dexia and Brown Brothers Harriman. After a lethargic start, RBC Dexia is doing well – but how much better would it perform if it were freed from the tortuous corporate governance structure that was devised by its parents? The value of the franchise to the two partners is by no means equal, according to their own reports. The JV delivers roughly 40pct of RBC’s international banking revenues, whilst investor services at Dexia contributed just EUR18m of net income in the third quarter of 2008. With the structure of the JV reportedly under review, and both sides beginning to think about their put and call options, 2009 could be a turning point.

Brown Brothers is more problematic. Without the financial resources to compete in the technology arms race, BBH needs to find niches that are profitable and sustainable. This is why it has been so taken by the ‘blue ocean’ strategy, which suggests that it should operate away from the red ocean, where all it competitors are bleeding heavily. But those patches of blue ocean are increasingly difficult to find – and bigger players are happy to spend the money to find them and then dominate them. Should BBH follow the Goldman Sachs example, and invite in a corporate partner, as the investment bank did with Sumitomo in 1986? If it does not, it is difficult to see how this exceptionally talented, but severely constrained, firm can continue to promote itself as a true alternative to the big global complexes.

But, as history also teaches us, nothing turns out the way we thought it would. It will be just as much fun observing what actually happens as it is predicting what might. We are fortunate to be living in such interesting times.

LIFE AFTER VaR AND OTHER MARKET CHALLENGES

There are great opportunities for the custodians, if they have the courage to take them

16 October 2008: It is almost a year since Merrill Lynch disastrously fumbled its handling of the write-downs it would need to take on mortgage-backed securities. In the space of less than a month, the thundering herd had been mortally wounded by its own management’s inability to accurately value its exposures to sub-prime debt.

With plenty of time on his hands, Merrill’s former leader, the much-vilified Stan O’Neal, may care to read ‘The Black Swan’, Nassim Taleb’s 2007 book about the way in which we think about the predictability and randomness of events, risks and the future. Now, Taleb may not be to everyone’s taste, but he has some credibility: consider what he said in 1997 about VaR:

“Nor am I swayed with the usual argument that the VaR's widespread use by financial institutions should give it a measure of scientific credibility. Banks have the ingrained habit of plunging headlong into mistakes together where blame-minimising managers appear to feel comfortable making blunders so long as their competitors are making the same ones. The state of the Japanese and French banking systems, the stories of lending to Latin America, the chronic real estate booms and bust and the S&L debacle provide us with an interesting cycle of communal irrationality. I believe that the VaR is the alibi bankers will give shareholders (and the bailing-out taxpayer) to show documented due diligence and will express that their blow-up came from truly unforeseeable circumstances and events with low probability - not from taking large risks they did not understand. But my sense of social responsibility will force me to menacingly point my finger. I maintain that the due-diligence VaR tool encourages untrained people to take misdirected risk with the shareholders’, and ultimately the taxpayers’, money.”

So, what have the markets learnt since Taleb launched this attack on one of the key principles of the risk management industry? Remarkably little, as we have seen. At a recent hedge fund seminar in London organised by SS&C, one brave fund manager wanted to discuss the death of VaR but others clearly thought he was just having a bad day. In the absence of anything better, it seems the market is prepared to continue with a discredited methodology.

Building new risk models is clearly a priority. Consider CDO squared, the concept of CDOs made up of CDOs. As Jamie Dimon said recently: “CDOs squared? What the hell were we thinking? These things were way too complicated.” As far back as 2005, some people were already warning about the complexity of these instruments. “If you think you will be able to analyse each underlying CDO, then look at the overall structure and get a clean answer about risk, you are mistaken. It’s way too complex,” said Janet Tavakoli, a structured finance consultant in Chicago. Did anyone hear an echo?

Risk measurement, however, is not the only problem. Governments and regulators are now arguing over valuation methodologies. Remember the old management saw, that ‘you can’t manage what you can’t measure’? That has been precisely the problem facing the market. If you are a CDO squared investor, for example, where do you get your fair market value from? No wonder Merrill Lynch couldn’t decide how much it was losing – no one, not even its own rocket scientists, could say how much (if anything) its investments were worth.

Shouldn’t the first question that any risk manager should ask be this: how will we get a price? If you cannot value a security, doesn’t that make it worthless? Valuations are entirely reliant on a two-way market, that someone will be willing to buy what you’re thinking of selling. That is something that the market seems to have forgotten.

And who are the self-proclaimed champions of the valuation business? So far, you have not seen the custodians stepping forward to fill the void, advise Hank Paulson and Nicolas Sarkozy on fair market valuation or come up with a better solution. The reason for their reticence is simple: they do not want to put themselves in a position where they have to stand behind their valuations – and, without that, clients are not going to pay a premium price for the service, which will cost a lot to deliver.

So niche players such as Markit and SuperDerivatives are filling the gap. With lower overheads, better technology and smarter people, the specialists have opened up a clear lead over the custodians – but that is unlikely to be the end of the story. Just as performance measurement used to be the exclusive domain of smart independents such as WM, the pricing space will eventually be invaded by the custodians. They will throw money at the problem and the specialists will eventually capitulate in the face of highly lucrative deals and, as importantly, an absence of capital for expansion. Custodian banks are never the first to solve a problem: their skill is in letting others do all the intellectual work before moving in to add their own muscle.

Even when they do come up with a bright idea – e.g. RiskMetrics at J.P. Morgan, spun off in 1998 – they often fail to capitalise on it. J.P. Morgan is now edging its way back into the risk arena with its acquisition of Measurisk as part of the Bear transaction, and others are sure to follow. Did it really require a financial firestorm to re-ignite the custodians’ interest in risk and valuation services? Having watched the prime brokerage opportunity turn to ash in the last year, will custodians blow this golden chance to earn some serious revenue from something other than market volatility? Don’t bet against it.

THE LINE OF LEAST RESISTANCE

Regulatory responses to short-selling are simplistic and wrong.

29 September 2008: Has there been a collective loss of reason over the financial sector crisis? When we have a publicity-seeking English Archbishop feeling the need to comment on short-selling – a technique that has been supported by those pension funds now condemning it – it would be easy to conclude that world order has irrevocably collapsed. Not even the analysis of much-respected consultants Data Explorers, which exploded the myth about short-sellers being responsible for bringing down HBOS in the UK, has tempered the ill-considered and misinformed comment about ‘bank robbers and asset strippers’.

The market hasn’t helped itself. ISLA chief executive David Rule looked blinded by the limelight as he stumbled his way through an interview on BBC’s Newsnight programme, failing to emphasise the point that regulatory restrictions on short-selling, however well-intentioned, went against the whole ethos of capitalism. What next, he should have asked? Governments are happy to see speculation on futures markets that drives down the price of oil, for example, but isn’t the principle the same? Why are traders allowed to deal on negative views in some markets but not others?

But the system must be protected at all costs, say the legislators and regulators. Let us just remind ourselves of the system. Hedge funds borrow stock from prime brokers, who get it from lending agents who get it from pension funds (including, perhaps, those run by ecclesiastical authorities) and other beneficial owners. Those hedge funds can then short that stock. Thus we had a situation where Lehman Brothers was, in effect, facilitating its own demise through its financing of the hedge funds that were speculating against its stock. Is this the system that needs protecting at all costs?

Pumping in USD700bn – or whatever number the authorities have come up with today that looks sufficiently impressive – and effectively nationalising bank losses is no way to fix a system which has been broken for a long time. Not only has the principle of moral hazard been ignored – a potentially fatal error on the part of the regulators – but it also highlights the absolute paucity of incisive thinking within the US Treasury and the Fed. Spending tax-payers’ money to bail out the banks may be easy, but is hardly a long-term solution to the deep troubles of global financial markets.

It would be nice to say that custody banks have remained untouched by what is going on around them. The USD425m after-tax charge to be incurred by BNY Mellon demonstrates that this is far from the case. Both BNY Mellon and State Street are already nursing serious book losses on their asset-backed CP programmes, whilst KAS BANK reported a poor first half and losses on its Lehman holdings. Other custodians are almost certain to have to record losses on their collateral reinvestment and STIF products, although Northern has already said that the Lehman bankruptcy will have a negligible effect.

Custodians have been hoping that they could intermediate in the PB model and earn richer returns, but the PB model no longer works. They now have to go back to the drawing board and think of a new way to do business with hedge funds – but first, they must come up with better ways to manage their risks.

PROTECTING THE FOURTH ESTATE

A UK regulator should be punished for its disproportionate response to a story it didn't want to see published

20 August 2008: In this industry, the dangers to journalists are few. Your editor may receive aggrieved calls from pompous PR people demanding your resignation; you may occasionally run into unnervingly aggressive media relations staff (Morgan Stanley used to set the standards); or you might suffer from that most professional of approaches, the big sulk.

Yet the story of Jenna Towler, a journalist with the UK’s trade paper, Professional Pensions, takes us into new territory. According to a report in yesterday’s Daily Telegraph, Ms Towler was the target of a very unpleasant threat by the Pensions Regulator, an unloved public body.

The Daily Telegraph said: "The regulator - whose powers over British business were dramatically and controversially extended this spring - is said to have contacted Professional Pensions journalist Jenna Towler last Thursday with a draconian warning that a factually accurate story about one of its investigations could land her in jail. Ken Young, the regulator's head of communications, also wrote to the publication's editor-in-chief, saying: 'Breach of these provisions [in the Pensions Act] is a criminal offence. It is for this reason that we take such a serious view of your story. We are now considering whether there has been any potential breach of the restricted information provisions and what (if any) action to take.'"

I do not know Ms Towler, but I do know that she deserves the unswerving defence and support of everyone who believes in the freedom of the press. No one denies that Ms Towler’s story is factually accurate, having been confirmed as such by the Pensions Regulator, which issued a press release on 14 August which matched Ms Towler's version of events. What, therefore, was the motivation for such an aggressive response to a story which was true?

This body, intoxicated by its own power and its complete lack of accountability, despite spending other people’s money for its survival, typifies everything that is wrong with the public sector. Unelected officials make poor guardians of standards of care and responsibility, and often make the crucial error of confusing confidentiality and secrecy. Confidentiality is sometimes necessary; secrecy is an admission that something bad has happened and must be concealed. 

In threatening Ms Towler, the Pensions Regulator has demonstrated its inability to understand its own limitations (in this country, the judiciary still makes those decisions) as well as its complete lack of perspective. Behaviour of this nature must not be tolerated – yet who will call this body to account? Credit to the national press, and to Ms Towler’s publisher and its lawyers, for making a fuss about it, but is anyone listening? Bureaucrats everywhere have been given licence to erode hard-won freedoms, and seem intent on doing so. The bovine reaction of the Pensions Regulator to a story it didn’t like demonstrates how serious that threat has become.

PUSHING ON AN OPEN DOOR

Custodians should take advantage of the fall of Bear and move on to the prime brokers' territory

August 5, 2008: Further evidence, as if it were needed, that the lunatics really have taken over the asylum: a recent article in Financial News reported that hedge funds have started lending to hedge funds. Several have set up direct finance arms, reportedly in response to the tightening market for liquidity and the increased margins being demanded by banks.

It is a strange world indeed. The prime brokerage model is badly broken and will be further disabled by the time the regulators have finished with it, and who should step into the gap created by the banks than…the hedge funds themselves? Imaginative? Yes. Sustainable? No.

The collapse of Bear Stearns has given the market a fantastic opportunity to build a better model. Every significant prime broker will be analysing the true cost of being in the business and looking much more closely at the risk/reward ratio. PB makes a lot of money, but at what cost? If the regulators decide to treat investment banks as they do commercial banks, PB may not be such an attractive business, from both a compliance and cost perspective. What happens to hedge funds then?

A few custodians have understood that these problems present them with an opportunity. Some have been arguing since well before the Bear affair that the PB model was no longer fit for purpose, and that custodians needed to step up their services, developing some form of PB-lite offering. Few trust banks can afford to offer their balance sheet to hedge funds, but there are other ways to get more involved in the business.

The first, and most obvious, is to become the trusted third party in the relationship between the hedge fund and the PB. Tri-party collateral management should be the standard for hedge funds, with custodians standing in between the two counterparties. Hedge funds have already started the process of moving assets – especially cash –away from their PBs as they take a much greater interest in counterparty risk. The custodians are the beneficiaries of this, with managers prodding them to come up with better solutions and services to the tricky issue of counterparty risk.

The second opportunity must be to develop a product that works on the same principles as master trust. Hedge funds maintain multiple PB relationships, as well as their links to custodians and administrators. Enterprising custodians should be able to build systems that pool all the data and present it to the manager in a common format. A ‘master prime’ service doesn’t need to include direct financing, but it could quite easily facilitate financing from other sources.

Do custodians have the imagination to build these products? Hedge fund managers are crying out for help, but are the custodians listening? We will only know once we have seen the impact of Bear’s integration into JPMorgan, and how effectively that firm can cross-sell PB and administration products. Plenty of custodians are nibbling at the margins without yet having the courage to put a lot of research and development money into products that may break the PB mould for good. This is their chance to be bold, innovative and market-leading, not adjectives normally associated with the industry. They can prove that they actually do listen to clients, and that they can lead rather than follow. The door is waiting to be pushed open, with much higher margins as the ultimate reward. This is precisely the time to be investing in the next generation of administration products, if only custodians can shake off their natural tendencies to stick with the safe options.

MAKING SIZE PAY

BNY Mellon delivers on one of its promises

July 7, 2008: The momentum behind BNY Mellon is hard to resist, judging by the mandates table for the first half of 2008. Dwarfing the performance of its rivals, BNY Mellon has demonstrated one of its key strengths: pricing power. Yet it would be harsh to attribute its success to that alone: the firm is playing to its strengths and has been selling products across the board and across the world. It is no longer fair to say that BNY Mellon cannot handle complexity, as many of its new mandates involve a broad range of value-added services.

Its peers will respond by saying that they have all won many more mandates than they are able to publicise. True, but BNY Mellon could make precisely the same point. The stark reality is that, on the admittedly narrow measurement of announced mandate wins, there are only two classes: BNY Mellon and the others.

© 2008 JLG Enterprises. Reproduction of this chart in full or part is forbidden without the express written permission of the publisher.

GOODNIGHT MR TOM

Renyi was a deal-maker, but could he run a bank?

June 23, 2008: Did Tom Renyi do a good job at The Bank of New York? As he prepares to stand down early from his post as executive chairman of BNY Mellon, the market should be assessing his stewardship of BNY, where he was chairman and CEO for 10 years.

When he assumed the leadership from Carter Bacot, he carried on the firm’s tradition of being aggressively acquisitive whilst maintaining a firm grip on costs. But the story behind the scenes wasn’t quite as straightforward. The aftershock of 9/11 was devastating for BNY, as it confronted enormous bills for new disaster recovery and data management centres. The firm’s legendary cost disciplines seemed to desert it, just at the very time when it needed to generate more capital to invest in new product development.

By 2004, BNY was obviously in the grip of a serious malaise. When Tom Perna left, the bank appeared to be sleepwalking: Perna was not replaced until Tim Keaney was appointed to head up asset servicing in 2006. Wherever their focus was, it was clear that the bank’s senior management team wasn’t concentrating on clients.

Instead, the bank was preoccupied with getting costs under control. Jobs were moved to lower-cost locations, like Syracuse and Manchester, as the firm struggled to convince analysts that it had a coherent plan and that its stock was undervalued.

Renyi’s personal stock, which had already taken a battering, wasn’t improved when Forbes magazine identified him as one of the worst-performing CEOs in the US in 2005. (Interestingly, Mellon’s Marty McGuinn also featured near the bottom of this league.) Renyi’s six-year average compensation package was estimated at just shy of USD14m p.a., and Forbes openly questioned the independence of the board’s compensation committee.

The bank was hurting on all fronts. Its efforts to make itself a major player in the execution business had sucked far too much capital away from other business lines. Having paid USD159m for Lynch, Jones & Ryan in 2005, BNY threw in the towel in 2006 and spun off its securities group into a new company, BNY ConvergEx, in which it retained a stake of about one-third.

On the investor services side, product development had all but ground to a halt. BNY’s traditional solution to filling product gaps was to buy another business, but that was becoming more difficult and more expensive. In 2006, BNY actually reversed the trend and sold Rufus, its European TA platform, to Bravura for just GBP32m. Instead of buying product specialists, BNY had turned its attention to geographic expansion through a network of alliances that were cheap to establish. Between September 2004 and October 2005 it struck five alliance deals, only one of which was product-related.

Capital remained the key issue. The firm simply wasn’t generating enough money to invest in new products or acquire other businesses. Senior managers openly admitted that the bank needed to reprice services and adjust tariffs, but that was whistling in the wind. Whilst State Street and JPMorgan built out their alternative servicing capabilities, BNY was struggling to reinvent itself as a bank that was capable of handling complexity. Despite its noted successes in the outsourcing space, clients remained sceptical about its abilities in other areas. Too many of its mandates were plain-vanilla custody.

All these problems were not unique to BNY, however. The other lowly-rated custody CEO, Marty McGuinn, was battling precisely the same issues, although Mellon had something that BNY coveted: a flourishing asset management business. That wasn’t enough to save McGuinn, who was removed at the beginning of 2006 and replaced by Bob Kelly, now CEO of BNY Mellon. But executives at both banks could see the logic of a deal between the two, eight years after Renyi’s failed effort to acquire Mellon – and an unsuccessful run at State Street.

BNY managers have admitted to several strategic errors – the lack of a scale asset management business, the failure to capitalise on its acquisition of RBS Trust Bank in the UK, the weakness of its franchise in Asia, the lack of depth of its international management team, inter alia – and blame must be laid at the doors of Renyi and his president, Gerald Hassell. But the principal charge against Renyi and his lieutenants is that they were good at acquiring businesses, but much less good at running and integrating them. BNY wanted to be the biggest in all three of its markets - investor, intermediary and issues services – yet it never developed a clear strategy about what it would do when it had achieved those goals.

Ironically, it was a senior Mellon executive who once said that scale is only valuable if you operate off a single platform. That was never an option for BNY, which found itself spending far too much of its huge IT budget on trying to make all its legacy platforms talk to each other. Under Renyi, BNY was entirely deal-driven. The absence of a long-term strategy eventually caught up with the bank, which was finding it increasingly difficult to make all its components produce the returns that could fund further investments and keep shareholders happy. It was good fortune indeed that Bob Kelly had concluded that Mellon needed to confront precisely the same challenge, and had the courage to look for an external solution to the bank’s problems. Renyi’s last deal was his best, and history may ultimately forgive him for his chronic lack of strategic vision.

LIFE IN A PARALLEL UNIVERSE

Jacques-Philippe Marson should spend less time on self-serving pronouncements and more time fixing the shortcomings of his business

June 3, 2008: Alarm bells should be ringing through the hallways of BNP Paribas. The increasingly bizarre outbursts of Jacques-Philippe Marson, who has overseen the unspectacular progress of BNP Paribas’ securities services business since 2000, suggest that this is a man who is in danger of losing touch with reality. The self-regarding Marson has always wanted to be the centre of attention, and has said some pretty ridiculous things in his bid to be seen as something of a visionary, rather than an underperforming  fonctionnaire at the head of a highly dysfunctional business unit.

In 2007 the symptoms of this affliction rose to new levels, as Marson claimed that BNP Paribas had “blocked the big US players out of Europe because we grew faster than they did. We took that decision early on, and we are now servicing their clients.” It was a highly spurious claim for which Marson gave no evidence – and a claim that all the big US players found risible - yet it was only the latest in a series of public comments that might well have been designed to divert attention from the undistinguished record of the business he ran.

Marson has been at it again. In an incredibly soft interview with Financial News last month, which read more like an advertorial, Marson delivered more of his extraordinary insights. First, he said that only two custodians, BNP Paribas and BNY Mellon, have a balanced portfolio of buyside and sellside clients. So where exactly does that leave Citi, BNP Paribas’ fiercest competitor in Europe over the last decade?

Well, perhaps Marson has already written off Citi. After all, he claims to have written a paper describing how the fund servicing industry will look in 2036, at which point he predicts that there will only be two global custodians left in business. Without comment, the newspaper faithfully records that Marson is “working on ensuring that BNP Paribas is one of them”.

Further, Marson claims that the bank initially focused on “being the European champion and that has been achieved by a long shot. We’re now catching up with the big US providers.” In fact, BNP Paribas is not the largest global custodian in Europe: HSBC overtook it in 2007, after the French bank was unable to announce any growth in its euro-denominated AUC figure for the year. A long shot? Again, Financial News published Marson’s incorrect claim as fact, as well as stating that the business generated USD1.6bn of net income in 2007, a figure which would make it larger than State Street Corporation.

Does any of this matter? In a way, it does not. BNP Paribas is a marginal player in all the world’s major capital markets. It recently lost one of its largest UK clients, Pearl Group, to State Street, and market rumour suggests that another major client is out for review. It has consistently failed to persuade AXA, the bank’s largest shareholder, that it should play a major administration role, with State Street again being the big winner. Its lack of self-confidence – in stark contrast to Marson’s public posturing – was evidenced this year by its refusal to support the R&M Global Custody Survey, motivated no doubt by the fact that it knew how poor its scores would be.

Do the big US players lose sleep over BNP Paribas? Of course not, but it is important that someone pricks the bubble of hot air that Marson generates. His relentlessly ego-centric publicity campaign is diametrically opposed to what everyone knows to be the true state of affairs at the business he leads. The best thing that could happen to that business would be a wholesale change of the senior management team, starting right at the top.

IT’S THE PRODUCT, STUPID

Client service will only improve if product managers start to understand market requirements

April 9, 2008: Warren Buffett was not specifically referring to custodians when he made his astute observation that, “You only find out who is swimming naked when the tide goes out”, but it applies as well to them as it does to investment banks. Having boasted for years about their expertise at dealing with complexity, their clients have given them an alarm call in the 2008 R&M custody survey. Scores are down and, with the honourable exception of BNY Mellon, the big players are clearly failing when it comes to administering high volumes of structured products.

The essential weakness at the heart of most custodians is their inability to identify the next big thing. Despite their efforts to get closer to clients, most of the custodian banks simply do not understand the investment business well enough to predict market trends. Almost all of them have been found wanting with OTC derivatives, the latest in a long line of failures to see what was coming down the track. With some custodians unlikely to have an automated, end-to-end solution for derivatives processing before 2009, clients are understandably frustrated by their inability to accelerate the pace of product development.

Significantly, it was BNY Mellon that recently acknowledged that the custodians were not getting things right. Tim Keaney, BNY Mellon’s head of international asset servicing, said: “All of us could do a better job of understanding clients, but we are all starting to ask the right questions.” The problem is that custodians do not have enough people who have the expertise and buyside knowledge to ask those questions – or to know what to do next when they get the answers.

This is where the big money-centre banks should be at a significant advantage. They have all that expertise in-house, within their investment banking and asset management operations. Most have been slow to capitalise on this built-in advantage, but are beginning to see the light: JPMorgan and SocGen are already using internal capabilities effectively to develop better servicing packages, whilst Citi is starting to leverage its capital markets strengths.

This was one of the key motivations behind The Bank of New York’s decision to pursue a merger with Mellon. The bank realised that, without an asset management business of any scale, it was missing out on product development opportunities and access to buyside thinking. They knew that they needed the spur of an in-house fund management operation to add momentum to their development plans.

It is far too early to tell whether this will prove to be the case, but at least BNY Mellon can point to its performance in the R&M survey as evidence that it is committed to improving the client service experience. Critically, that commitment has come right from the top, which is a new experience for BNY people, who never truly bought into the need for so-called ‘soft skills’, such as relationship management and human resources.

Many custodians seem to be missing the point when it comes to effective client service. The answer does not lie in throwing more resources at the problem. It lies instead in the way in which product management and development is run within the firm. A custodian that genuinely understands what its clients want and expect, and has the resources to deliver those services, is going to be much more successful than one which is always trying to catch up because it has failed to identify market trends. Instead of using product management as a staging post in the construction of a career, custodians should be paying buyside market rates for the brightest and the best to come in and deliver client-driven services.

BNY Mellon is starting to learn this lesson. Its head of product management for the asset servicing business, Gunjan Kedia, is not a lifelong custody stalwart. She only came into Mellon in 2004, having worked at McKinsey and Price Waterhouse. Kedia has one of the most important jobs in the firm’s asset servicing business: she has to decide which products to keep, which to decommission, and which to build. Those decisions will ultimately determine the success of the business, as well as having a profound impact on client servicing.

Others are starting to think in the same way. State Street brought in external expertise when it realised that it needed to overhaul its derivatives processing strategy, whilst JPMorgan hired Susan Ebenston, a former chief operating officer of Scottish Widows Investment Partnership, to run the international side of its product management group. Yet there is still a long way to go before the custodians can seriously claim that they are asking all the right questions, and acting on the answers.

REDEMPTION SONG

Custodians can expect more grief from clients in 2008 as the challenges of complexity pile up. Are they fit enough to deal with it all? 

January 4, 2008: At a cocktail party towards the end of 2007, a swaggering custody sales manager was trying to show off about the successes of the year. He was late to the party, he claimed, because he had just signed up a hedge fund manager for a major administration mandate. The manager, he boasted, had given the bank just 72 hours to come up with an acceptable deal – and the bank had delivered.

Putting the bluster to one side, the story said much about this particular bank’s view of due diligence. How could the bank possibly have reached any major conclusions about the soundness of the manager’s strategy, the competence of the senior management team to implement it, and the effectiveness of the firm’s operational and risk management infrastructure? The answer, of course, is that it could not. If the sales manager’s version of events was to be believed, such concerns were secondary to the need to win the mandate.

It is not only asset managers that get caught out when they become involved with strategies that they do not fully understand. Custodians and administrators are just as likely to get their fingers burnt, even if they are better at hiding the evidence. Yet there is little to suggest that the leading custodian banks have become significantly smarter about client risk assessment and the need for tougher covenants in their legal agreements. There remains a whiff of complacency about the banks, despite their assurances that they have significantly strengthened their risk management procedures.

2008 could well be the year when this contention is properly tested. In an early warning of what may lie ahead, State Street has implicitly admitted that its senior management oversight of SSgA, the firm’s fund management business, was inadequate. Bill Hunt, the CEO of SSgA, quit after the bank set up a USD618m reserve fund to cover legal and other costs related to the underperformance of some fixed-income funds. State Street now has to reassure the market that what appears to have been a loose grip on its asset management operations has not been replicated in the asset servicing or trading business lines.

The core of the problem, at State Street and elsewhere, may lie in the huge demands on management time and attention. M&A activity last year was significant across the board, with State Street itself closing three deals collectively valued at over USD5bn. With BNY and Mellon merging, and Citi acquiring Bisys, three of the top four custodians were involved in major transactions, whilst JPMorgan was engaged in an ambitious plan to merge the operations of investor services and the investment bank whilst losing the head of worldwide securities services, Mike Clark.

Added to this is the relative inexperience of the custodians’ senior managers at dealing with the new complexities of alternative investments. Whilst investment bankers may understand how to handle OTC derivatives and other alpha-based products, custodians are still some way off the pace. They are trying to correct that, either by hiring in the expertise or by working more closely with their in-house investment bank colleagues, but it is a slow and expensive process. In the meantime, clients are not waiting for them, but are ploughing ahead into ever more complicated products.

For alternative managers, 2007 was a tough year, yet the custodians insist that their clients were not the ones to suffer. But, even if that is true, any substantial extension of the market’s problems into 2008 will lead to a contagious outbreak that will affect a growing proportion of their clients, whether traditional, alternative or hybrid. The key question for this year will be whether custodians have the right controls, resources and management in place to withstand such pressures.

HEIDI PLAYS SAFE

The latest reorganisation at JPMorgan suggests that management is satisfied with more of the same. It shouldn't be.

31 October 2007: There are two ways of looking at the decision by Heidi Miller not to take the opportunity for a radical reorganisation of the WSS business unit (see article immediately below). The first is that she lacked the courage, or the conviction, to shake things up in an operation that has only recently left the intensive care unit and is enmeshed in a complex merger with the firm’s investment bank operations.

That is a possibility. Miller has certainly gone with the safe option. She has handed a significantly greater level of responsibility to Conrad Kozak, who has seen his fortunes rise remarkably since he was in the rather lower-profile post of head of strategy for treasury and securities services. Kozak now adds securities lending and execution products, and alternative investment services, to his portfolio, giving him total control over all product for investor services. Although the organisational chart resembles a wiring plan for the Space Shuttle, Kozak is very clearly the man in charge. How that will go down with Liz Nolan and Sandra O’Connor, who now report directly to him, remains to be seen. Nolan, in particular, is viewed as coming from the Mike Clark camp, and may not be wildly happy with the new order.

This is a big step up for Kozak. Like Mike Clark, he is not perceived as an industry leader, but as a manager who gets things done and makes sure that all the basics are covered. In his elevated position, he urgently needs to tighten up the firm’s focus and strategy, and to make sense of the opportunities created by the investment bank merger. He does not need to worry about product scope, but will have to concentrate on better delivery: JPMorgan has a lot of product, but is not the best at cross-selling it.

But the question will remain: does Kozak have what it takes to make the JPMorgan franchise the most powerful in the industry? He has earned his shot at the top job because, under Clark, he rebuilt the business, hired good people and won lots of mandates. Clark gave him the tools and he did the job – but that is only half the story. Managing a turnaround requires special skills, but they are not the same attributes as those needed to crack open new markets – where, for instance, is the firm in China? – or knit together the combined strengths of WSS and the investment bank to create a cohesive and compelling product set.

Kozak has surrounded himself with some very smart people, and he will be heavily reliant on them to deliver the next phase of growth and development. As a former strategist, he will know that he should spend more time shaping the direction of the business and worrying about the bigger picture, rather than getting too involved in some of the more immediate challenges that he had been dealing with under Clark.

The second way of looking at things is possibly less likely but more intriguing. By changing very little, Miller may have been anticipating that bigger plans are on the way which will supersede anything she might have done to the organisation. Perhaps an acquisition is in the offing, or a corporate restructuring. Miller herself has been in charge of T&SS since 2004, and was widely expected to have been rewarded for her stewardship with a more senior role by now.

Whatever her reasons, Miller has shied away from major surgery. Reorganisations are always unsettling, and she may have felt that this would distract attention from substantial projects, such as Threadneedle and the progressive implementation of new technology. But shake-ups also concentrate minds wonderfully, and a new perspective on the business would have added impetus to a business that can still appear uncertain and insecure about its place in the world.

A CHANCE FOR CHANGE

JPMorgan needs to take advantage of Mike Clark's resignation to come up with a new business model

8 October 2007: The departure of Mike Clark from JPMorgan, where he was head of worldwide securities services, is an opportunity that has not even bothered to disguise itself as a problem. Clark, who is off to a very senior job at Fidelity, stabilised the investor services business after the dead hand of the previous management team had let the franchise fall apart. Most of the new team that he brought in have proved to be more adept, although there are still strong reservations about the strategic vision of the business, possibly because one or two of the top team still think like transaction bankers rather than problem-solvers.

Clark did not do the vision thing very well. To his credit, he signed up to the operational merger with the investment bank’s back office – although, with Frank Bisignano as one of the deal’s key sponsors, he didn’t have much option. But he tended to loose off ideas and plans like a poorly controlled machine gun, and it was left to his managers to determine what was really important. In the main, they have got this right, turning around the business and coming up with a more focused plan of attack.

Following Clark’s departure, the four key product units – investor services, clearance and agency, alternative investment services and securities lending – will all report to Heidi Miller, head of treasury and securities services. The soft option would be to have a look around internally and hire some headhunters to see if they can find some external candidates to fill the job. This would be wrong. The last thing WSS needs at the moment is to maintain the status quo. The investor services business is moving in the right direction, but it needs greater momentum and a change of mindset.

The firm has belatedly realised that its strongest suit is not its pre-eminence in leveraged loans processing or private equity administration. What it has is access to a very bright group of people, both at JPMorgan Asset Management and within the investment bank. Trust banks do not have this luxury, however large their trading rooms may be. But HSBC, Citi, SocGen and even BNP Paribas can all boast some powerful capital markets capabilities, and they are all moving in the same direction. JPMorgan needs to capitalise fully on what is has within its four walls, not on its ability to sell global custody to USD40m US pension plans.

The best people to manage this change of emphasis are probably not going to come out of the transaction banking world. JPMorgan’s business has already seen some of its operations taken over by investment banking professionals, and Heidi Miller now needs to use her forthcoming management offsite to think carefully about whether WSS has a future in its current format, and what alternatives might deliver the firm more effectively to clients. She has already demonstrated boldness with the investment bank deal, and she now has the opportunity to recast the securities servicing model in a way that no other bank has done. It may be something of a blow to lose Clark, but the upside is that it presents a genuine chance for change and transformation.

CITI WINS THE CONSOLATION PRIZE

Losing out on the race to buy Investors Financial may have hurt, but buying BISYS could be the next best thing

May 3, 2007: Ever since Citi acquired Forum Financial, the fund administration business, in 2003, the bank has been searching for a follow-up transaction that would establish it as a significant player in its home market. Citi’s weakness in the US is legendary: unlike the three largest players, it is a bigger provider overseas than it is in the US. The head of Citi’s securities and fund services business, Neeraj Sahai, has made it clear that he considers it important that Citi has a significant presence in every OECD market, which goes some way to explaining its 2005 acquisition of Unisen in Canada.

Its failure to acquire Investors Financial showed that the bank had the money and the will to think big. Ultimately, IFIN was worth more to State Street, but Citi remained keen to strike a transformational deal. Some years ago, State Street itself might have been the answer: when State Street was under siege from The Bank of New York, it was Citi that called Marsh Carter, the CEO, to offer itself as a white knight.

Today, BISYS is the solution. Since the firm announced last August that it was evaluating its strategic alternatives, a sale and break-up looked the most likely outcome. BISYS is a rag-bag of businesses that share little synergy, from exam services to trucking and transportation insurance. It is a firm that has been built almost entirely by acquisition, starting life as a lift-out from ADP in 1989.

But Citi has done a good deal, buying the bits it wants – fund services – and selling on the rest to JC Flowers. What it ends up with is a business that will certainly give it scale in the US, as well as a very handy portfolio of alternative assets and some new product servicing capabilities.

BISYS will deliver $500bn of fund administration assets, as well as $60bn from private equity and $200bn of hedge fund assets. Importantly, Citi should pick up some strong capabilities in Dublin, where BISYS remained after closing down its UK operation. In hedge fund administration, Citi should jump up the rankings to become the third largest provider.

But there will be some significant challenges ahead. Because of the nature of the BISYS business, there are lots of small clients and several different operating platforms. Citi believes that it can manage this, but it has not distinguished itself with its integration of Forum, which has turned out to be a major disappointment. BISYS will prove to be much tougher, and Sahai will have to assign his top team to the transition project if it is to become a value-added acquisition.

That said, this looks like precisely the sort of deal that Citi should strike. It is keen to build market share in the US, especially in the funds space, and it wants to expand the geographic coverage of MultiFonds, its strategic accounting platform, which is untested in the States. US fund managers are increasingly keen on outsourcing – Citi itself won an outsourcing deal from Dimensional Fund Advisors in 2006 – and the BISYS product set should help it to compete more aggressively in this sector.

This is a brave deal by a bank that, until recently, lacked the confidence to close out major acquisitions, being a semi-permanent fixture on short lists but rarely winning. Citi now has to ensure that BISYS becomes a positive transformational experience by putting the right people in place to capitalise on the strengths it has bought.

THE BUZZ-PHRASE GENERATOR

Amaze your friends and colleagues with your easy mastery of the language of the industry

March 12, 2007: Some years ago the Canadian Defence Department drew up three lists of words that, used together, would give users “instant expertise on matters pertaining to defence”, giving them “that proper ring of decisive, progressive, knowledgeable authority”.

The Canadians called this the ‘buzz-phrase generator’. Others appeared, especially amongst civil servants. Many of you will probably have spent many happy hours in meetings playing Buzzword Bingo, which is not particularly challenging in the financial sector. Yet this widespread ridicule has done nothing to stop the pernicious spread of these words and phrases – and, in the spirit of the age, it is only right that this website should offer you the chance to keep up with the latest trends.

The Custody Buzz-Phrase Generator appears below. The procedure is simple. You think of a random three-digit number and take the corresponding word from each column. Thus, 601 gives you ‘transformational operating functionality’. You can see from this example how easy it is to build a lexicon of authoritative phrases that you can slip into client presentations, press releases or proposals (the Generator should be particularly good for those working in RFP teams).

Of course, this list is not definitive and I am hopeful that you will forward me your own favourite buzzwords so that they can be incorporated, thus building an industry database that will be a valuable resource for those struggling to find the mot juste.

Try it today and see how easily you can enhance your communications skills. You’ll wonder how you ever managed without it.

BEANTOWN BONANZA

State Street's acquisition of IFIN looks expensive, but the strategy makes a lot of sense

February 6, 2007: You did not need to have the instincts of a jungle predator to realise that Investors (IFIN) was fatally wounded. 2006 was a painful year, with sluggish growth from new clients, an unhelpful yield curve and a spiralling expense base. The only question was how long it would take for someone to come in and rescue it. Fortunately for IFIN’s shareholders, there was a lot of interest: the bank has an enviable, if limited, client list and a very attractive mix of assets, specifically in the mutual fund and alternatives sectors. It is also one of the last pure plays: it doesn’t come loaded down with asset management, lending, retail or private banking businesses, and its client base is almost entirely US domestic. For any of the large players, integration would be straightforward.

Yet IFIN proved to be more valuable to State Street, its Boston neighbour, than to any other custodian, despite the huge overlap in business profile. Both are big in mutual funds and hedge funds; both have large operations in Dublin; and both have a lot of staff in Boston. The State Street acquisition plan calls for 1,700 IFIN jobs to disappear, some 40pct of the total workforce, and most of its platforms will be ditched. That tells you everything you need to know about the deal: this is all about consolidation, revenue growth, access to new clients and an entry point into private equity administration. It is not about the wonderful people at IFIN or their client service model.

At no stage during its investor and media presentations did State Street mention IFIN’s service reputation, and it was vague about finding positions for any of the senior management team. State Street saw an opportunity to buy market share in growing sectors – and, as importantly, it was prepared to pay a very full price to see off the threat of another bank setting up camp in its back yard. State Street did not fancy having Citigroup as a close neighbour.

He who buys land buys many stones, and there are some significant challenges. The first will be to hang on to the BGI outsourcing mandate in the US and Canada. BGI and State Street go head-to-head as asset managers and it would be a fairly uncomfortable decision to sleep with your worst enemy, but State Street is making soothing noises, promising to keep the Sacramento service centre as well as the current operating platform. IFIN is heavily reliant on BGI – the most recent number was 18pct of revenues – and a handful of other key clients. Lose any of those and the deal starts to look less sensible.

Clients who used IFIN may not be delirious about the prospect of signing up with State Street, which will have about USD14trn of assets. Just in case anyone forgets, there is an alternative down the street: Brown Brothers Harriman is a small, focused, mutual fund specialist with a great reputation for client service and product innovation. There is bound to be some leakage as the BBH team emphasise the attractions of their service and approach.

State Street is reckoning on a 10pct revenue attrition rate but plans to offset that with revenue synergies and cross-sell. Where it should score is by selling new trading services to IFIN’s clients: Currenex, the trading platform, will be a key factor in the success of its cross-sell strategy. State Street doesn’t have many other products to push to the new clients that IFIN wasn’t already selling: IFIN has been highly successful with its value-added services, which contributed 28pct of its 2006 asset servicing revenues.

But is it a good deal? Clearly there are defensive elements to it and it involves a significant amount of consolidation, rather than an expansion of product or geographic coverage. State Street will have to be ruthless to achieve the promised cost savings – 50pct of IFIN’s 2007 estimated operating expenses – at the same time as ensuring that the top clients do not panic and leave. Despite all that, the transaction leaves it in tremendous shape in both the mutual fund and alternatives sectors, which are where future growth will come from. With IFIN, there are no ugly lumps of static, low-margin defined benefit assets: the book is about as good as you could wish for if you were looking for exposure to growth sectors. No wonder others were keen to get their hands on it, and State Street was so determined to stop them. If it can execute the deal quickly and cleanly, the price may turn out to have been more of a bargain than analysts realise.

SURVIVAL OF THE FITTEST

The custodians had a good 2006, but the party mood was spoilt by the the marriage announcement from BNY and Mellon. Is consolidation going to dominate the agenda for 2007?

January 2, 2007: Just when you thought it was safe to go back into the water…A decade after BNY kicked off the long process of consolidation that was meant to culminate in a small group of über custodians, the east coast sharks again smelt blood in the water and sent out discreet signals about the possibility of a friendly liaison with Mellon. BNY had learnt its lesson the hard way: when it tried the hostile route in 1998 it was seen off by a combination of protectionist Pennsylvania laws and a chairman, Frank Cahouet, who was very keen on maintaining Mellon’s independence, regardless of the cost to its shareholders.

Set aside the fact that BNY’s 1998 offer valued Mellon at some USD23bn, compared with today’s market cap of around USD17.6bn. What really matters is that neither BNY (USD12.2trn AUC) nor Mellon (USD4.4trn AUC) believed that they were generating enough cash individually to pay for the incredibly high cost of staying in the business. Analysts seem to agree, with one going so far as to say that the world doesn’t need more than three large global custodians. The consensus is that there will be more consolidation in 2007.

For clients, however, the merits of consolidation remain elusive. There are few clear success stories and plenty of evidence to suggest that, when it comes to M&A, clients never get the promised gains. M&A transactions appear to be driven primarily by the need to satisfy stockholders, even more so since hedge funds started taking an interest. Forgetting about clients – under the doctor’s dictum of ‘Do No Harm’ – is never a good idea, as BNY knows from its clumsy handling of the RBS Trust Bank acquisition in 1999: instead of listening to clients, it simply took the word of the Trust Bank managers about what was required. The result was a fumbled implementation, scores of unhappy clients, and a failure to capitalise on its market-leading position in the UK pension fund market.

There are equal and opposite forces at work here. On the one hand, shareholders want better performance and returns. On the other, clients (which are often also shareholders) want a competitive environment to control prices and stimulate product development initiatives. BNY and Mellon argue that their merger will satisfy both sides of the debate. If it does, it will break new ground. But, before other banks decide that they, too, have to get bigger to survive, they should learn the clear lessons from the world’s three largest players. BNY has had to admit that its strategy was wrong. JPMorgan got fat and lazy and spent five years in the wilderness. State Street took far too long to swallow the GSS brick and had to ease out its chairman and CEO to get it focused on what really matters. Good role models?

Like it or not, the momentum behind consolidation means that we are likely to see more deals. Some players have little choice: it is difficult, for example, to see how Investors Bank & Trust can stay in the race without access to a much bigger pot of capital, whilst the news that BISYS is considering going private will almost certainly flush out potential suitors (JPMorgan is known to have taken a close interest in developments). If institutional investors were hoping for a peaceful 2007, they are going to be disappointed, with custody directors having one eye on potential targets and the other on potential predators. If it proves true that Deutsche Bank is contemplating a move back into the business – it is rumoured to have hired consultants to look at possible acquisitions and headhunters to find good people – then the pressure will only increase.

So which banks came out of 2006 in the best shape to confront these challenges?

THE BANK OF NEW YORK

A pity that it never gave its young management team a chance to try out its new strategy. BNY’s track record on successful integration of acquisitions is patchy at best, so the team, led by Tom Renyi, has to prove that it has learnt the history lessons. In the interim, what will happen to product development? Just as BNY was starting to roll out some interesting new product – such as the risk and performance alliance with Wilshire, which will almost certainly be scrapped – it will have to sit on its hands for most of 2007. Frustrated clients, who have had to wait too long for BNY to focus on product development, are unlikely to be impressed.

JPMORGAN

Miller and Clark are delivering on their promises, hiring good people (Ebenston, Kelley and Jackson, amongst others) and getting to grips with product and client management problems. Threadneedle now becomes the litmus test: with the first deliverables due in 2008, JPM cannot afford any slippage or distractions. But it will be a contender if interesting businesses come up for sale, as Clark is a deal-maker and wants to be an even bigger custodian. Still weak in alternatives, with the exception of PEq, but expertise from the investment bank will help it to catch up.

STATE STREET

Even if you dislike the bank, you cannot fault its execution since Ron Logue took over as chairman. Is it bothered by the BNY/Mellon deal? Only if it pays attention to analysts. It has dominant market share in outsourcing and US mutual fund administration, and a stronger international business than its peers, including the new BNY Mellon. People say that it has proved how to do deals after GSS, but that experience might also have made it wary of doing more. Logue and his people have learnt all about focus the hard way and they will not be easily distracted, especially when BNY and JPM are so far behind them.

CITIGROUP

It is almost a reflex reaction to hold your breath and wait for Citi to implode, but things have changed and it continues to make progress. The new AEGON outsourcing deal in the Netherlands is innovative and the senior management team has withstood significant losses (Bisignano, Kelley) without too much disruption. It is definitely in the market for acquisitions and is well-positioned for growth because of its huge international network. Its global custody mandate from China’s National Social Security Fund shows that it is beginning to use that network to good advantage.

MELLON

Too many unanswered questions surround the deal with BNY. CEO Bob Kelly clearly felt that it had nowhere to go as an independent player, but how much of its soul will he have to sacrifice in the ‘merger’? Mellon sweated blood to earn an outstanding reputation for client service, but BNY has an entirely different culture. Kelly has been doing the right things in his first year – especially with his recognition of Jim Palermo and Nadine Chakar – and business has been good, with ABN AMRO Mellon looking better all the time.

BNP PARIBAS

A complete absence of a discernible strategy, and the low morale of staff from top to bottom, have not stopped the bank from performing well this year, with its scatter-gun approach winning it mandates across pretty much all geographies and industries ex-US. It completed a tricky outsourcing conversion for Martin Currie in under a year and has also finished the DeAM transition for Aberdeen, as well as winning an interesting administration mandate from ING under the noses of BNY and others. But what’s the frequency, Kenneth? It has been so busy thrashing around overseas that it has let CACEIS and SocGen gain significantly in France, and its shortage of quality senior management has led to some bizarre and unpopular reassignments of staff. Management changes at this highest level are well overdue if it wants to remain in contention.

HSBC

Having snatched away the key RLAM administration relationship from long-time provider, JPMorgan, HSBC can rightly claim to be a mainstream contender in the outsourcing space. It has slowly expanded its reach and is now thriving in Germany, as well as building up its Luxembourg presence with the acquisition of the Liberty Ermitage administration business. But there are concerns over the new group management structure and the way in which the transaction banking business is being used as a political football. If this unsettles the very strong management team under Mike Martin, the bank will lose its hard-won momentum, as well as some of its best people. It also needs to make 2007 the year in which it delivers on its long-running technology promises and integrates the alternative and institutional fund servicing units.

NORTHERN TRUST

The bank hardly put a foot wrong in 2006, with its biggest challenge being management of its strong growth across all sectors. If it is a takeover target – which is what the analysts want – it is difficult to think of a management team that could do a better job than CEO Bill Osborn and his people. Few acquisitions have worked as well as FSG, which was integrated effectively and is already delivering real value. Northern needs to devote more resources to US fund administration, where it has always been weak, but not at the expense of its booming international business. Its faith in China was rewarded with the mandate from the National Social Security Fund and there is still a lot of potential to grow in Europe.

RBC DEXIA

A solid first year for a business that could well prove that the whole is greater than the sum of its parts. First priority for management was to keep clients happy and avoid major changes that might unsettle them, which they seem to have achieved. Now they must prove that they can do more and that the complementary skills of the two teams have been integrated to deliver genuine added value. Geographic expansion is on the cards, but the team should focus primarily on making major advances in Europe and Asia Pacific, where it already has bricks and mortar and brand recognition.

SOCIETE GENERALE

The bank muscled its way into the top 10 in 2006, with its acquisitions of 2S Banca and European Fund Services. A strong senior management team under Alain Closier should be causing other custodians some sleepless nights, just as HSBC has over the last few years. Strong on technology and, in keeping with the French investment banks, good with derivatives and alternatives. Unlike BNP Paribas, the bank has not let its ambitions run ahead of its capabilities and it remains clear-headed about acquisitions. It has a great reputation for client service which will now be tested with its integration of the Pioneer business, so 2007 will be a crucial year in its development.

BROWN BROTHERS HARRIMAN

Another year in which BBH read the trends well and made many of its competitors look rather slow-witted. BBH is a different beast to the rest and is not easily diverted from its strategy of looking to serve complex clients with complex needs. With Infomediary, it could play a major role in cleaning up the processing of European mutual funds, a goal it has held for many years. The addition of Simon Cleary, the long-serving SWIFT executive, as head of fund solutions in Europe could prove to be a smart move as it seeks to score that goal.

BIG IS BY NO MEANS BEAUTIFUL

The merger of two underperforming businesses is not the solution to their problems, as clients may well discover to their cost

December 5, 2006: Ron Logue, chairman and chief executive officer, is known to be a pretty serious wine collector and connoisseur. Last night, he might well have been tempted to crack open a case of a particularly fine vintage – the 1990 Pétrus is drinking well - and share it with his senior management team. For it is his good fortune to have seen not one, but both, of his closest competitors stumble in the race for global domination of the investor services industry. Even better, State Street itself has rarely been in finer form, having used 2006 to implement its existing outsourcing deals and stay well away from trouble.

First it was JPMorgan, which is one year into a three-year recovery programme that became necessary after the new management discovered just how delinquent the old management had been. JPMorgan will make it – there are encouraging signs of clearer thinking and better resource management – but it is currently too far off the pace, in terms of outsourcing, alternatives and just about anything else you can think of, to give Logue any sleepless nights or any reason to stay off the claret.

Then, astonishingly, The Bank of New York ditched its freshly baked strategy, that was less than a year old, in favour of a ‘merger’ with Mellon. The grand plans of chairman and CEO Tom Renyi and president Gerald Hassell, both of whom have been under pressure to deliver a strategy that creates shareholder value, have been discarded in favour of a ‘size-is-everything’ deal that bills the new firm as “a global financial services growth company”.

Putting aside the obvious concerns about how the current senior managers can generate that growth, there are four key questions that need to be addressed before deciding on the merits of the deal.

How will clients benefit?

How will employees react?

How will the market react?

Will stockholders get a better deal?

Clients:

As usual in an M&A transaction, clients come last. The banks have rolled out a rather embarrassing mantra of ‘lose no customers’, at the same time as admitting that they have set an (unpublicised) attrition rate. BNY has a long-established history of treating clients poorly, as industry surveys have repeatedly shown, yet the new management team talks about its commitment to ‘maintaining’ its number one customer service standards and levels. The real attitude appeared to be summed up by a casual remark in the deal conference by one of the seniors, along the lines of: “If you don’t do anything bad to customers, they won’t leave”. Experience may well prove different.

Clients are unlikely to see any benefit from this merger for years to come, if ever. They will be confronted by years of systems and operational changes as the two sides argue over which has the better products and platforms. Having co-heads of asset servicing – Tim Keaney and Jim Palermo – is an early indication of the new management’s unwillingness to confront turf issues. In a deal that looks suspiciously like an exercise in cost management, analysts may be excited, but clients will probably have to wait until way past tomorrow for any jam.

Employees:

Apart from patting each others’ backs, and agreeing on what a wonderful team they will make, the senior managers have said little about why this will be good for the staff that hold on to their jobs (a great motivational tool). Expect an exodus as employees react to the merger by calling their closest headhunter. Both parties have a hard-won reputation for being tight with salaries and benefits, so employees are unlikely to enjoy any windfalls from the merger. Nearly half the USD1.3bn merger costs have been allocated to ‘personnel-related’ issues, which will act as an incentive for long-serving employees to hang on and wait for a pay-off. This is not normally considered to be the best way to create an atmosphere in which to maintain market-leading customer service levels and standards. 

The Market:

Genuine shock greeted the announcement but, once the dust has settled, the market must look more closely at the rationale behind the deal. The key issue to bear in mind is that this merger creates a very large US custodian that generates just a quarter of its revenue from international markets (cf State Street, with more than 40pct). The US is a mature, oversupplied market with thin margins, so why increase your exposure to it? Scope and scale arguments would be fine if there was any short-term prospect of the two parties agreeing on a single platform. Mellon has tirelessly argued in the past that this is the only way to get the true benefits of scale – yet the anticipated merger costs of USD350m for technology are remarkably optimistic for a business that will have to make some very tough, and expensive, systems decisions.

Competitors will be delighted. Just as BNY relentlessly stalked State Street’s clients during the GSS merger, every other bank will be targeting BNY Mellon’s clients now. Especially in Europe, where the two banks will have to tread very carefully in order to avoid upsetting major clients and partners (e.g. ING and ABN AMRO), the gloves are off and rivals will be doing everything in their power to undermine confidence in the new player.

Stockholders:

Analysts are a strange breed. Having moaned for years about the poor performance of both Mellon and BNY – moaning which eventually helped to see off Mellon’s previous chairman and CEO, Marty McGuinn – they now seem to think that this merger will magically transform the fortunes of the two banks. They love the cost synergies, even if they think they are conservative, and seem to have swallowed the growth story without demur.

But there is one little niggle about all this: aren’t these the same people who were unable to contain costs and generate international growth? When BNY’s cost management regime was found severely wanting in 2004, who was the CFO? And who will be the CFO of BNY Mellon? Bruce Van Saun on both counts. Mellon’s recent record is no better: over the first nine months of 2006 its non-interest revenue rose by 9.6pct, whilst operating expenses rose by 16.8pct. A good deal of faith is being invested in a group of senior managers that, with the exception of new boy Bob Kelly, has hardly distinguished itself in generating significant shareholder value.

Is this a harsh assessment? It depends which way you look at it. As an analyst, you like the cost savings and the rather woolly, unquantified revenue synergies that have been dangled in front of you. But, as a client, you should probably be wondering why this is good for you. It just isn’t acceptable to say that things won’t get any worse, which is the implied message. Things have to be an awful lot better – otherwise, why not go to a provider that can promise stability? Numerous reviews will be initiated as a result of this merger, and some clients will choose to leave before it even closes (as was the case when BNY acquired JPMorgan’s global custody business a decade ago). BNY Mellon needs to put a much more compelling business case to its clients if it is to have any hope of achieving its long-term goals.

VIVE LA DIFFERENCE!

The French banks are not perfect, but they have endured when most other European players have given in. Now they want to do more.

23 November 2006: With the notable exception of the French themselves, who do not suffer from any false pretensions of modesty, very few would have predicted that, by the end of 2006, three of the world’s top 10 global custodians would be from France. After the American banks began their own version of the ‘shock and awe’ tactics that led to huge territorial gains in Europe, there seemed to be no way back for local players. UK banks retreated without much resistance, and in most other countries there were few banks worthy of the title of global custodian. Once ABN AMRO had abandoned its disastrous strategy in the Dutch market, there wasn’t much else left for the Americans to contend with.

The French are different, however. The big asset gatherers are banks, and most have always had their own asset administration businesses. These were dismissed by the Americans as nothing more than in-house operations that were poorly managed and existed only after heavy subsidies from the parent – which may have been true, but didn’t alter the fact that they held the assets and were not about to let the transatlantic invaders get their hands on them.

When BNP Paribas hired J-P Marson from State Street to run its securities services business at the end of the nineties, it was a sure sign that the French banks meant to make a go of custody as a standalone business. When it subsequently bought Cogent in 2002, it merely confirmed that the French were serious. By that time, SocGen was beginning to register on the radar screen, making its debut in the R&M Consultants’ custody survey that year in second place. After its acquisition of 2S Banca is completed, SocGen will have EUR2trn of assets under custody, making it the world’s ninth largest player.

The emergence of the French banks as a significant bloc does not only presage a tougher competitive environment. It also alters the balance of power in more subtle ways: the battle for good staff is heating up as these banks look to broaden their pool of international talent. Reports from Italy, for instance, suggest that foreign banks are having to rethink their compensation packages to try and stop their star performers leaving to join SocGen, now that it is such a powerful local player. CACEIS, the third force, also has big expansion plans and is thought to be on the shortlist to buy the securities services business of HVB, the German bank owned by Unicredit. Along with SocGen, it will be looking to bolster its management team, putting further pressure on the bigger custodians.

Both SocGen and CACEIS need to tread carefully, however, if they are to avoid the fate of BNP Paribas. In its desperation to become a major global custodian, it paid well over the odds to acquire Cogent and then abjectly failed to capitalise on the deal. Today, BNP Paribas is drifting aimlessly, lacking clarity in both strategy and direction. Its aim to be the most important foreign provider in each of its chosen markets is almost laughable and it has even managed to lose its status as France’s largest player. Both SocGen and CACEIS look as if they will go for a strategy of growth through acquisition, and the experiences of BNP Paribas should act as a strong incentive to focus very carefully on outcomes and objectives.

France is not a foreigner-free state. State Street has AXA, BNY has Natexis and HSBC has CCF. But this is one European market that did not roll over and play dead when the big battalions rolled in. Institutional investors have every reason to be grateful to the French for ensuring that there are genuine alternatives in Europe.

All figures as at June 30, 2006

Source: The Greensted Report, company figures

© 2006 JLG Enterprises

OF PARADIGMS, PRICING AND PRODUCTS

BNY has come through a rough couple of years but things are starting to look up and Tim Keaney should be able to take advantage

3 August 2006: Stock market investors are a tough bunch to please, as Tom Renyi knows only too well. The chairman and CEO of The Bank of New York has been trying his hardest to get the share price to move in the right direction, whether through better quality earnings, management reorganisations or reducing the bank’s exposure to capital-intensive businesses. But the stock price stubbornly refuses to reflect these efforts, or the plain fact that BNY is in much better shape today than it was even 18 months ago.

A lot of ‘behind the curtains’ work has now been completed: not only has the bank reconfigured its data processing and management centres since 9/11 and the 2003 Interagency White Paper in the US, but it has also undertaken an enormous programme of change, including a broad regulatory compliance review and the continuing shift of thousands of jobs from high-cost to lower-cost locations.

This work inevitably diverted management attention from what matters most: clients. Some things suffered particularly badly, such as service quality and client-facing systems. As Renyi and his team struggled with generating positive operating leverage and finding a way out of the execution business, as well as negotiating the asset swap with JPMorgan, there was an uncomfortable hiatus within investor services.

But analysts heard a very positive assessment of the prospects for this business at a seminar last month. The new global head of investor services, Tim Keaney, was understandably bullish, even to the extent of boasting that not one of its primary competitors could match its product range (a claim that both State Street and JPMorgan would hotly dispute). Keaney identified key product opportunities, target markets and client sectors – not, you might think, a revolutionary concept, but one which BNY has often failed to carry out in public. So many of its past presentations have focused on cost control and financial issues, you sometimes wondered if anyone in the bank was worrying about clients and products.

Keaney is. He is running a USD2bn business and the bank will be increasingly reliant on his contribution after spinning off BNY Securities, its execution business. Keaney has been given a huge task and a huge responsibility, handed a list of challenges that are the legacy of senior management neglect – no one has focused properly on investor services since Tom Perna quit in 2004. Product management and development now come under Keaney’s control, and it is up to him to ensure that the bank starts building market-leading solutions, rather than automatically reaching for its wallet to buy someone else’s product set.

Keaney’s two most pressing concerns should be product and price. It has been slow to roll out its new strategic global accounting package, which has definitely contributed to client losses and general dissatisfaction in the pension fund sector. Clients have also waited too long to see improvements to its web-based reporting service. Although its hedge fund servicing business is growing rapidly – isn’t everybody’s? – it is still way behind State Street and admits to issues over compensation for its services. It is also off the pace with transition management – now to be part of BNY ConvergEx – and was caught cold by the market’s interest in cross-border pooling.

In a recent analyst presentation the bank’s CFO referred to the need to “enhance the pricing paradigm”, which was a CFO’s way of saying that it isn’t charging enough for its services. The bank says that there are extensive repricing exercises taking place in Europe, but it has been a recurrent theme since the poor 2004 results that BNY is not charging enough for what it does. As noted in the article below on outsourcing, the bank was prepared to sacrifice an interesting chunk of ING’s business in Luxembourg partly because it was not prepared to do the deal at the terms on offer. Keaney has to hold his nerve and hold this line.

That will not be so easy when part of his strategy is to go after US public and corporate pension plans, where pricing is one of the key selection criteria. With Mellon also targeting US plans, there will be no easy wins in the sector, regardless of the bank’s faith in its new accounting platform.

Despite all this, Keaney has much about which to be positive. Over two reorganisations, Renyi has sharpened management focus so that it will now pay fuller attention to the investor services business. The bank does have leadership positions in several key areas - most notably outsourcing – and its network of European alliances will eventually start to deliver strong asset flows from external clients. Keaney must hope that Torry Berntsen, who heads up the newly-formed global client management group, will finally nail the bank’s poor reputation for relationship management, thus helping to change the long-held perception of BNY as nothing more than a securities processor. Only when this has happened will clients pay more for what they get – and, just possibly, analysts will start to like the bank’s new paradigm. 

CAVEAT VENDOR

JPMorgan has reverted to an outdated outsourcing model, and may have given away too much to Threadneedle, in its enthusiasm to do the deal

3 July 2006: Outsourcing took a step backwards last month. Just when it was beginning to look as if all the spin about ‘partnerships’ had some basis in truth, and that providers and their clients were behaving more rationally, along came a deal that appears to defy commercial logic and repeat the sins of the past.

The progress of Threadneedle’s outsourcing agreement with JPMorgan has been well publicised (see article below). Competitors have been predictably vocal in their condemnation of the transaction, with several claiming to have withdrawn over what they said were unreasonable demands, both in terms of product and financials. There is no doubt that Threadneedle is a tough negotiator, as The Bank of New York discovered when it took over the asset manager’s retail fund administration centre in Swindon in 2004. At the time, Threadneedle described the lift-out as a ‘win-win deal’: executives at BNY have had cause to question that claim ever since.

Aside from BNY, JPMorgan always looked like the bank with the biggest stake in the future of Threadneedle’s investment operations. Since 1996, JPMorgan has been the manager’s equities custodian, with HSBC handling fixed income. HSBC had no pressing need to do another outsourcing deal, especially as it was recently confirmed as the provider to Royal London Asset Management, a JPMorgan client. So it was no surprise when market rumours began to circulate about JPMorgan’s enthusiastic pursuit of the mandate, and its adoption as a talismanic transaction in the eyes of senior management.

But, as with Schroders, an underlying weakness of the JPMorgan pitch was its poor coverage of OTC derivatives. During the evaluation process, it did not impress Threadneedle with its derivatives processing capabilities, which is becoming one of the industry’s toughest challenges. Undaunted, JPMorgan has agreed to fund and develop a new OTC derivatives processing platform. Crispin Henderson of Threadneedle made it clear that he expects the bank to deliver on its promise. “Our clients will benefit from JPMorgan’s strengths in service administration and commitment to providing state–of–the–art capabilities in derivatives and complex instruments – an integral part of many of Threadneedle’s products,” he said in a press release last month.

That commitment may come back to haunt JPMorgan, just as its determination to hang on to Threadneedle may give it cause for grief at a later stage. Its relentless approach to the Threadneedle transaction is a very clear indication of the bank’s immaturity in the outsourcing sector, a weakness that is highlighted by the more measured attitude of one of its main rivals, The Bank of New York, over another outsourcing transaction.

BNY established a European marketing alliance with ING in 2002, covering Germany, Benelux, central and eastern Europe. BNY has prospered from the deal in terms of mandates from the ING group of companies, although the success of the alliance with external clients is less obvious. So it came as something of a surprise to learn that ING has recently agreed a deal with BNP Paribas for the French bank to provide fund administration and investment compliance monitoring services for ING’s Belgian and Luxembourg-domiciled funds.

BNY’s response to this has been pragmatic. It points out that, regardless of the attractions of any particular mandate, it will not compromise on the basic margins that it needs to generate to make the business worthwhile. It also says that this particular deal would have required it to make changes to its established servicing model in Luxembourg, which was less than ideal. And, quite reasonably, it accepts that ING, and others, will farm out packets of business to other providers as a prudent risk management practice.

BNY is at a stage where it can afford to be magnanimous in defeat. JPMorgan does not yet enjoy that luxury, as it seeks to establish some credibility after its inglorious record in the outsourcing sector. But the suspicion remains that it has given away too much to Threadneedle in its drive to secure the mandate, and that recovering its investment, let alone earning a decent return, will be a very tough act. It will end up paying a substantial amount of money to protect its existing business with Threadneedle, which is the old outsourcing model that most of its competitors have already ditched.

With some justification, JPMorgan will claim that it was damned if it did and damned if it didn’t. If it had failed to win the deal – especially if it had been beaten by BNP Paribas, a second division contender - it would have been dead in the water. Now that it has won, everyone outside the tent – and, it has to be said, several inside – is asking whether the benefits will ever outweigh the costs. If this is to be a’ win-win deal’, JPMorgan is going to have to do more than employ some creative accounting techniques. It will have to prove that Threadneedle set it on a successful course in the outsourcing sector, evidenced by fresh mandates that help to recover its investment and earn serious additional revenues.

IT'S THE CLIENTS, STUPID

JPMorgan has surrendered one of its historic strengths in its effort to regain lost momentum - and winning Threadneedle won't help to restore the balance

30 May 2006: There are rumblings of panic within the bowels of JPMorgan. Just as it was beginning to feel as if Heidi Miller and Mike Clark had got to grips with the investor services business, bringing in some new faces and sharpening its focus, some of its less appealing old habits have re-emerged.

Two factors have combined to make JPM so twitchy. The first is unreliable relationship management. Ever since Jumbo Jewitt, a consummate relationship banker, retired from running the investor services business in EMEA in 2001, the bank’s formerly sure touch with clients has noticeably declined. Instead of putting experts into the role, JPM appears to have been using the relationship management slot as a convenient place to park managers looking to burnish their CVs. Jewitt’s successor, Ramy Bourgi, was good on transactions, but not so accomplished at building and leading a strong relationship team.

These weaknesses persist today. Clark may have shaken up senior management, and started the process of leading the business through product rather than sales, but client relations remains a problem. Three high-profile client losses in the UK – RailPen, Merchant Navy and Royal London – clearly show that the business desperately needs better relationship management skills.

The second factor is linked to this. One of Mike Clark’s early pledges was that he would stop the business being diverted by transactions. By this, he meant that he wanted to set a strategy that his managers could deliver without the constant pressure of needing to do deals. The team would be focused on strategically important mandates that played to its strengths.

All of which sounds completely convincing until you examine the evidence surrounding the bank’s increasingly frantic attempts to win the outsourcing mandate for Threadneedle Investments. Threadneedle is an existing client: JPM handles equity custody, with HSBC as custodian for fixed income assets. Having outsourced retail fund administration to The Bank of New York in 2004, Threadneedle is now down to the final two – JPM and BNP Paribas – in its search for an outsourcing partner for the rest of its operations.

It is a dangerous path to believe everything that custodians say about mandates they haven’t won, but there is an overwhelmingly bad feeling in the market about this deal. Major contenders claim that Threadneedle has been unrealistic about its own growth projections and consequent tariff demands, which are considered by many to be uneconomic. Threadneedle has a reputation for striking very aggressive deals with its suppliers, which caused some potential contenders to withdraw early from the bidding process.

This, however, has not deterred JPM. Internally, it has been made abundantly clear that the bank has to win this mandate – insiders report that there is an explicit threat of heads rolling if it doesn’t – and responsibility for managing the bid has been moved away from the relationship management team to the product group, with ultimate oversight by Heidi Miller.

Reports suggest that BNP Paribas is still in the race because it has outshone JPM on its derivatives processing capabilities – a weakness that was a significant problem in JPM’s outsourcing relationship with Schroders – and because of its European branch network.

The undertone of desperation within JPM is troubling. It looks as if it is determined to strike this deal at almost any cost, regardless of its longer-term strategy. Its enthusiasm to be seen as a credible outsourcing provider has bounced it into this position, especially as it has failed to convince one of its existing administration clients, Royal London Asset Management, of its merits. In announcing its decision to partner with HSBC, RLAM said that it was the “cultural fit that sealed the deal”. That is a damning assessment of JPM’s relationship management skills.

JPM is certainly being diverted by Threadneedle. It has not publicly announced a mandate win of any description since October 2005. This January Schroders announced that it was quitting the custody business in the UK and would recommend JPM as an alternative provider, citing its “highly competitive” tariff as a consideration. JPM claims that it has picked up significant business from this, but has so far failed to announce any specific deals.

Win or lose, JPM has given itself an unnecessary challenge with Threadneedle. It has not yet stemmed the flow of departing clients, which should have been Clark’s top priority. So far, he has done nothing to suggest that strong client relations matter more than doing deals, despite the rhetoric. Scan JPM’s senior management and you will search in vain for any depth of relationship banking experience: they are all transaction bankers, and that is beginning to cost the business dearly. In the long run, keeping clients happy is a lot cheaper than having to go out and buy new ones, a basic financial rule that JPM has forgotten in its dash for growth.

ROOM AT THE TOP

Major management changes are healthy for the business – so what is the reason for State Street’s stasis?

10 May 2006: Ron Logue must feel as if he’s missing something. The chairman and CEO of State Street has so far resisted the urge felt by most of his competitors to indulge in some changes at the top. Since JPMorgan’s night of the long knives last October, when both Neil Henderson and Ramy Bourgi were eighty-sixed, Logue has looked on as Citi, HSBC, Northern and Mellon have all implemented changes within the senior echelons. Citi now has Ellen Alemany in charge of transaction services, replacing Frank Bisgnano, who moved to JPMorgan; HSBC will shortly welcome Tim Howell as John Gubert’s replacement as head of securities services; Northern appointed Rick Waddell, head of corporate and institutional services, to the long vacant office of president; and Mellon’s new chief, Bob Kelly, fixed the ridiculous management structure within the asset servicing business.

Kelly’s pragmatic decision to appoint Jim Palermo as global head of asset servicing reverses one of Mellon’s barmier schemes, in which Palermo jointly headed the investor services business with Jack Klinck, another vice chairman who had run Europe until his return to Pittsburgh last summer. Despite rather foolish protestations that the two would work “in lockstep”, it was clear from the start that this was an unworkable arrangement, especially as the then chairman, Marty McGuinn, implemented precisely the opposite structure for the asset management business.

Klinck will no doubt feel slightly bruised by his effective demotion – he is now COO of the asset servicing business, reporting to Palermo – but the bank, and its clients, will be grateful. Cross-selling will be easier without the turf wars raging, and Palermo can get on with moving the business forward, rather than fighting pointless internal battles.

But that is only one notch on Kelly’s gun barrel. He still has to deal with the issue of Steve Elliott, senior vice chairman and Palermo’s boss. Elliott, at one time considered the probable successor to McGuinn, is too closely associated with the former chairman’s failures: if Kelly is in the mood for action, an elegant Elliott exit plan must be high on his list of priorities.

Credit to Kelly for his decisiveness – but what of Ron Logue, who has not filled the post of president and chief operating officer since he vacated it to become chairman and CEO in 2004? There are substantial rumblings from the buyside about State Street’s lack of direction and its inability to develop the business. Insiders suggest that Jeff Conway was moved back to Boston from London to address some of these shortcomings, looking at the corporate strategy (which he may first have to write) and setting some new, non-financial goals.

Logue needs to shake things up a bit. The senior management team is too comfortable and too insular. The investor services business is primarily a sales-led organisation, with product development coming a distant second. An injection of some fresh thinking, and a conscious effort to move some of his lieutenants out of the HQ comfort zone and into the theatre of war, would work wonders.

He should look to JPMorgan for inspiration: everyone round there is slightly uneasy, as Heidi Miller and Mike Clark light some fires and ask tough questions. State Street needs a course of the same treatment, before it gets too flabby to defend itself against sprightlier contenders. A crop of new leaders, with new ideas and plans, are just waiting for the chance to catch State Street off balance and deliver a few hefty blows. Logue has to make sure that the bank is fit and alert enough to beat off the challenge. 

STEADY AS SHE GOES

The pilots in the JPMorgan Chase wheelhouse should resist the temptation to sell or swap the investor services business

3 April 2006: It is that time of year again. The perennial rumours about an asset swap between The Bank of New York and JPMorgan Chase started early this year, after some loose-tongued employees in JPM’s trust services business suggested that a deal with BNY was imminent. This was a new spin on an old story: traditionally, BNY would approach JPM every year to suggest swapping its branch network for JPM’s custody business and, just as traditionally, JPM would politely decline the offer. But the current angle is that BNY would actually like to take the institutional trust business, rather than the investor services operation, in exchange for its branches.

Only recently, JPM was questioning the practicality of such a deal, saying privately that, however much it might like to add those BNY branches, restrictions on its market share in New York would make it impossible to do so. But last week’s story in the FT suggests that the two sides are talking about a deal of some kind, although there was a notable absence of any official comment from either bank.

The obvious question is whether JPM is really ready to get rid of some part of its securities services business. The answer, just as obviously, is yes. As long ago as 2000 it was selling parts of its business, getting rid of its advisor custody unit to Investors Bank and pulling out of ChaseMellon Shareholder Services; as recently as this January it sold the CD Clearing Centre, a legacy from the Bank One merger, to Deutsche Bank. Heidi Miller and Mike Clark are reshaping the worldwide securities services business, and that inevitably involves both acquisition and divestiture.

Additionally, JPM is not nearly as obsessed with market leadership as BNY, at least in the securities services space. The BNY strategy pretty much calls for leadership positions in every industry it serves – one reason for spending $2bn on Pershing in 2003, and $159m for Lynch, Jones, Ryan last year – and the attractions of a non-cash deal to pick up a chunk of JPM’s market share are obvious.

But that does not mean that JPM’s investor services unit is the target. For a start, JPM looks increasingly unwilling to get out of the business. It is still buying and is still hiring. Investor services in the strongest part of the WSS unit, generating 55pct of revenues in 2005, compared to 31pct from trust and 14pct from clearing and collateral management. Investor services recorded a 24pct increase in revenues last year, the highest growth rate of any business in Miller’s Treasury & Securities Services division.

Is this a franchise that JPM would really want to give up, bearing in mind its huge impact on firmwide revenues? Informed opinion suggests that the bank is keener than ever to make it work: at an analysts’ presentation in February, Heidi Miller said that the T&SS ship had been turned round, and that the bank would continue to invest in growing the franchise and focus on core products. Investor services looks increasingly like a core product: neither trust services, nor clearing and collateral, can realistically make the same claim. Either, or both, could be sold or swapped without too much disruption to client relationships and revenue streams.

A merger of the two banks’ investor services businesses would create a $22trn monster, but it is far from clear that BNY would gain anything that it doesn’t already have, apart from additional scale. Only $7trn of those combined assets would be non-domestic (cf. Citi, which already has $4.8trn of global assets), and $16bn would be held on behalf of North American clients. It would be massive, but sluggish, and would probably disqualify itself from many major mandates for years to come as it struggled to rationalise resources. State Street’s experience with GSS should inform its decision.

There may well be a deal brewing, but it appears highly unlikely that the hard-nosed accountants at JPM are going to be willing to part with a business that offers them so much potential. With all its relationship linkages, and cross-sell opportunities, the investor services franchise could and should become a more highly-prized element of JPMorgan Chase’s product family: a sale now would cost it very dearly.

BETWEEN A BLACKROCK AND A HARD PLACE

M&A can wreak havoc with the best laid plans of outsourcing providers

20 February 2006: There must be mixed emotions in the halls of The Bank of New York as the bank’s senior managers absorb the news that BlackRock is to take over Merrill Lynch Investment Managers. The new firm, to operate under the BlackRock brand, will start with $1trn of AUM, pushing it into the top ten managers globally.

BNY has a high-profile relationship with MLIM. Last year, after gruelling negotiations that went to the very top of both organisations, BNY and MLIM agreed to unwind their outsourcing arrangement: MLIM took back trade processing and client reporting, while BNY held on to European custody, fund accounting and related services for $100bn of assets. MLIM would base its operation on an in-house platform originally designed for the US business. Many in the industry suggested that this was a plan that would end in tears for MLIM.

Now that BlackRock is calling the shots, that plan will probably never see the light of day. BlackRock itself has a business that sells technology solutions to the buyside, including an investment accounting platform. But what happens to BNY in the meantime? One of the fundamental issues in its longstanding relationship with MLIM was the continuing use of CLASS, the system that MLIM inherited from Mercury when it acquired it in 1997. BNY wanted MLIM to move on to SmartSource, the bank’s strategic outsourcing platform, but MLIM refused. Now BNY wants to switch off CLASS as soon as possible, but this could be delayed by the BlackRock deal, which is scheduled to close in the third quarter.

There is no easy solution for BNY as it works out how to position itself against the new firm. It is already a custodian for BlackRock in the US, and will need to protect that franchise as well as the European business. But does it also create an opportunity to do more? Is it worth the pain of extending the CLASS agreement in Europe as a sign of goodwill?

Problems like these are regularly confronting custodians as they watch their clients merge. With parts of Gartmore up for sale, HSBC will be anxiously studying its outsourcing contract to make sure that any takeover will not destabilise the relationship. Potential buyers are said to include Henderson – which has an outsourcing deal with BNP Paribas – and Schroders, which famously ditched JPMorgan last year. As Mellon discovered when F&C took over ISIS in the UK, these deals do not always lead to a bigger, stronger relationship: Mellon eventually told F&C that its demands for an outsourcing deal with ISIS were unacceptable, leaving neither party in a particularly happy position.

All outsourcing providers talk about the need to pick winners, and to take a very rigorous approach to client selection. Hitching up with the right manager can be a superb growth strategy, as Paribas has proved with Aberdeen and State Street with PIMCO. But mergers and acquisitions can upset the balance and create opportunities to revisit established agreements, even when the contracts look watertight and the relationship is healthy.

Every self-respecting custodian will be presenting their credentials to BlackRock’s top brass in the coming months, hoping to engineer a leading position in the firm’s administration pecking order. BNY, and other incumbent providers to MLIM and BlackRock, will need to act smartly to stay in the race. 

WILL VALUE EVER OUTWEIGH PRICE?

In 2006, suppliers will need to ask for more money if they are asked to service more complexity. Only the smart will.

3 January 2006: With 20 deals announced in 2005, as well as the renewal of the Scottish Widows/State Street agreement, it would be pretty harsh to suggest that it was a disappointing year for outsourcing. True, Schroders, F&C and Merrill Lynch have all unfortunately ended up on the debit side of the industry, but there is no arguing against the momentum behind outsourcing. The economic model isn’t yet right, and providers and their clients need to do a lot more work on the substance behind the concept of partnership, but outsourcing is now firmly established as a core element of asset servicing. (Only Brown Brothers Harriman believes otherwise – and, it has to be acknowledged, they do have an annoying habit of being right).

That being said, the custodians are still some way short of finding, let alone developing, enough seriously smart people to run their businesses. Last July, for example, JPMorgan was confidently predicting that it would hire an exceptionally impressive outsourcing supremo – but to date, there has been a resounding silence on that front, apart from grim rumours about some of the supposed candidates. When a good one moves – like Richard Godfrey, from Mellon to HSBC- it has profound and long-lasting effects on both sides. But people like him are few and far between, and the answer isn’t simply to go and look at the buy-side, because there is a scarcity of talent on that side of the fence as well.

There are also horrendous shortages of talent in the more marginal, but fastest-growing, businesses – the alternatives sector. Private equity, property and hedge funds, for example, all require skills that are not easy to manufacture, and are expensive to acquire. With most of the custodians looking to expand in this field, they can expect to pay a hefty premium for genuine talent, which may have to be imported from prime brokerages or hedge funds themselves. Is the pricing model right for alternatives administration? Only the most Panglossian of administrators think it is. Something will have to give in 2006.

That will be the theme of the next 12 months. Custodians – especially the trust banks that do not have the broader banking relationship to fall back on - cannot be expected to subsidise client operations forever. Increased complexity demands increased compensation. Some custodians have yet to come to terms with that concept, inured as they are to under-bidding to win low-value mandates. The winners will be those that pick the clients who understand the argument and appreciate the investment in higher service levels. And just how are they all looking as we kick off the new year?

STATE STREET

Stuck to its promise to stay away from big outsourcing deals, and nailed down a healthy extension to its contract with Scottish Widows. It has yet to make good on its commitment to reduce its dependence on market-related revenue, with its trading services business growing strongly. The bank remains the best of the big boys, although it really must do something about its awful client service record: poor showings in the R&M and Global Investor surveys suggest a deep-seated problem. It also needs to prove that its flagship outsourcing deals in Europe are strategically intelligent and significantly revenue-enhancing – not an easy job in either France or the Netherlands.

THE BANK OF NEW YORK

A splendid end to the year with confirmation of its exclusive outsourcing negotiations with Hermes, bucking it up after the trials and tribulations of its negotiations with Merrill Lynch Investment Managers. Senior management is also starting to push forward the next generation of leaders, with Europe chief Tim Keaney assuming a vastly increased portfolio after a management reshuffle. Developments across Europe (e.g. Nordea, Natexis, BHF) suggest that the bank may finally have grasped the full extent of the opportunity on the continent. But sloppy client service, especially with UK pension funds, shows that it still has much work to do on the basics.

JPMORGAN

A year of consolidation is the politest way of describing 2005 for this custody giant that has completely lost its way. Mike Clark, the new chief of worldwide securities services, has a thousand ideas and probably even more products, but the fact remains that there is still no discernible strategy or direction. Off the pace – off the map, more accurately – on outsourcing, and way behind State Street and BNY on value-added, having wasted time and money on its failed information products business. Fourth-quarter sackings cannot disguise the fact that JPM has a mountain to climb in 2006 if it wants to regain momentum.

CITIGROUP

Coruscating performance in 2005, and Citi now looks like a genuine contender against the top three players. Outsourcing deals with AEGON and Winterthur in the UK show that it is fully committed to the business, and the addition of Ken Back to the European team gives it further credibility. Loss of Bisignano as head of transaction services is a blow, and Citi-watchers will be analysing the succession process very carefully. Now has to prove that it can leverage its successes in UK and the Netherlands to become a truly pan-European provider.

BNP PARIBAS

A good year for the biggest European player, rounded off nicely with its announcement about the Martin Currie outsourcing contract. Got a result with the DeAM acquisition by Aberdeen, which will add substantially to its outsourcing book. Acquisition of Invesco’s depotbank in Germany is also a step in the right direction. But is the bank fully committed to securities services? With one half of the business in terminal decline, J-P Marson and his team need to accelerate the growth of investor services to prove its worth to the bank’s senior management team, which may have its mind on mergers and acquisitions.

MELLON

Mixed fortunes in 2005 for a bank that almost seems to enjoy making life difficult for itself. It will eventually gain the recognition it deserves for walking away from the ISIS part of the F&C deal, and the year-end announcement of an outsourcing agreement with F&C in the Netherlands – via its well-performing JV with ABN AMRO – was a good result. Needs to show that it has the necessary focus to succeed in key markets, and that all its groundwork in places like Luxembourg is going to start paying off.

HSBC

Blotted its near-immaculate copybook with its fumbling of the Hermes contract, which was in its hands for most of the evaluation process. This should not detract from another very good performance by HSBC, which has possibly the strongest management team in the top 10 and which has made thoughtful progress. It is resisting the temptation to look towards the US for acquisitions; now it must link together all its European businesses – and build a similarly strong management team - to come up with a strong continental proposition.

NORTHERN

A bank that likes reorganisations – another major one right at the end of the year – should have completed all the hard work on its FSG acquisition in 2005, if it is to make good on its commitment to make FSG accretive in 2006. Even though the senior management team is very good, it is also very stretched – Steve Potter, head of international, admitted in May to spending one-third of his time on FSG – and it should be focusing on solid execution of existing deals, not distant dreams of glory in China or elsewhere. But the sales machine continues to work well, with Biggs now promoted to global head of sales and Winge showing in Europe that she was the right choice as top rainmaker for the region.

RBC

A lot of last-minute attention to devilish Dexia detail has probably knocked a bit of the momentum off RBC, but the JV promises much. RBC has the management team to make it work, and its biggest challenge will probably be to shake off the notorious inertia of Luxembourgers to produce a dynamic organisation that can take on the major players across Europe and Asia. It finally has a toehold in the outsourcing market and it will hope that the JV will give it further sector credibility in 2006.

BBH

Not exactly swimming against the tide, but certainly taking a different tack, to mix metaphors horribly. BBH doesn’t like outsourcing and has come up with compelling products and services that offer alternative routes for thoughtful managers (such as Infomediary). Keeps an intentionally low profile but nothing to suggest that it will have a radical change of heart from its core values of service and innovation in 2006.

SG

A new entrant in 2005, largely because it has relaunched itself and hired one of the market’s most promising managers, Seb Danloy, to run investor services sales. Not averse to spending money on acquisitions, and likes the idea of a lift-out to kick-start its outsourcing plans in the UK, but not at any price. Already a big player, SG could have a significant impact in Europe in 2006.

SNAFU AT FCAM

Another outsourcing deal goes pear-shaped - and Mellon will face the consequences, regardless of who is really at fault

November 2^nd, 2005: You have to feel sorry for JPMorgan, who are turning out to be the unluckiest players in the outsourcing space. A year ago the bank saw a central plank of its outsourcing strategy disappear as F&C Asset Management (FCAM), the result of the merger between F&C and ISIS Asset Management, decided to enter exclusive negotiations with Mellon about outsourcing the ISIS operation. JPMorgan, you will recall, was asked to rebid for this business, having already secured a deal with ISIS before the merger was announced. Mellon had signed a seven-year outsourcing contract with F&C in November 2003.

On November 1^st, after a year of wrangling, F&C abruptly withdrew from its negotiations with Mellon, following a failure to agree satisfactory contractual terms. The ISIS mandate has been pulled, leaving Mellon to look after the legacy F&C business. FCAM says it is going to build a data warehouse to consolidate data feeds from its various suppliers.

Since the summer, when Mellon started to get very evasive when questioned about FCAM, the warning signs have been there. In September, FCAM admitted in its interim statement that the project had fallen behind schedule and that it was going to cost more than originally planned.

Mellon is trying to sound as philosophical as it can about this, maintaining that it was better to withdraw now than when the contract was live. Mellon says that there were disagreements over the scope of services, price and risk, which pretty much covers the entire spectrum of any deal.

Mellon believes that this setback will not harm its credibility in Europe, and that thoughtful buyers will recognise the value of dealing with a clear-eyed, commercially focused partner. Unfortunately, it is probably not as simple as that. With an ironic twist that may help to ease the pain at JPMorgan, Mellon is now tarred with the same brush: it is associated with failure. Convincing clients that the same thing will not happen again is going to be immensely tricky, especially when the market perception of Mellon’s senior outsourcing team is that it lacks weight and depth. The loss of Richard Godfrey, Mellon’s European outsourcing chief, to HSBC last year continues to reverberate, and the transfer of responsibility for the business from Jim Palermo to Jack Klinck cannot yet be judged a success.

Of course there are mitigating circumstances. The sponsors of the original F&C deal are, by and large, no longer involved. Tony Tomlinson, F&C’s COO who was responsible for merger integration, has subsequently retired, whilst Ken Back, the ISIS COO behind the deal with JPMorgan, left following the merger and is now working at Citigroup. FCAM does not list a COO amongst its senior management team.

There is nothing to say that FCAM will not try again and put the ISIS mandate out for tender once more. With its legacy deal with Mellon, it is half pregnant and running in-house and external operations makes little commercial sense. Mellon is confident that its existing deal is locked in until 2010; could another provider step in to handle the ISIS operation?

In the meantime, the FCAM affair should give Mellon pause for thought about its European outsourcing business. It does not have a convincing proposition, just as it does not have a coherent strategy. However it explains away this failure, the fact remains that Mellon needs to work a lot harder to stay in the race with State Street, BNY and the many other contenders who will be quietly enjoying the bank’s discomfort this morning.

TEN GREEN BOTTLES

SWIP might have thought it had real choice, but ultimately it had to stay with State Street

September 28, 2005: So it’s official. We have it first hand from the lips of both Ron Logue, chairman and CEO of State Street, and Chris Phillips, CEO of Scottish Widows Investment Partnership. There is no upfront payment, no weird tariff breaks or other arcane accounting methods to transfer money from provider to client: the renewal of the outsourcing contract, which will now run for eight years, was a straightforward decision based on merit, experience, cost and a year-long analysis of the alternatives.

At the start of that process it must have seemed, to SWIP and others, that there was a real chance that State Street could get the sack. Critically, it had failed to transfer SWIP on to its own technology – the Enterprise solution (not, please note, a platform) – which, by its own admission in filings to the SEC, is a big financial risk. As importantly, the original sponsors of the deal at SWIP – Mike Ross, Susan Ebenston and Bill Main – have all long departed. The current senior management had no skin in the game, as they say. They could dump State Street with impunity.

A few of the smarter providers soon realised that things would not be quite so simple. The Bank of New York, it is rumoured, declined to bid, suggesting that it was not prepared to invest huge lumps of time, effort and money pursuing a lost cause. HSBC, which still believes that SWIP had all but done a deal with it six years ago, was more sanguine, as was Paribas, which kept on going until quite late in the beauty parade. One Paribas executive said earlier this summer that the bank would be disappointed if it did not win the mandate. Désolé!

As other managers would undoubtedly have told Arun Sarwal, SWIP’s COO, your provider has to be truly, truly awful to justify moving somewhere else. Plenty of the things that State Street hasn’t done are fixable, especially if the tariff looks a lot more advantageous than it did the first time around. Logue and Phillips were coy about a precise date to move SWIP on to Enterprise, but Logue mentioned a goal of “within two years”. He declined to say whether there were penalty clauses in the contract if the bank misses this deadline.

All of the usual flute music about a “true partnership” was played at the press conference to announce the deal. Logue even induced a stomach-churning moment by announcing that it was being held in ‘The Partners’ Room’, which he at least felt was significant. But partnership is a word often used by vendors when they have a deal with a client that is much more difficult to break than run-of-the-mill agreements. You will not catch many managers referring to their administrators as partners.

The truth of the matter is that State Street is the market leader, and always has been. It is the least worst of all the options, despite its unique approach to technology which all its competitors think is bizarre. After much rumination, SWIP reached the same conclusion. Perhaps SWIP’s senior management team undertook a rigorous analysis to determine how much value State Street had added to performance, sales and product development, and discovered that it had made a difference. Perhaps – but it might just have taken the simpler option of firstly ruling out bringing it all back in-house, and then evaluating the chasing pack. Who can blame it if it did follow the line of least resistance? In this space, nobody gets fired for hiring – or rehiring – State Street.

ANOTHER FINE MESS

After upsetting software vendors, outsourcing providers still have a lot to learn about the logistics of their business

19th September 2005: The recent acknowledgement by F&C Asset Management, the top-five UK firm, that its outsourcing contract with Mellon is not running to schedule, will hardly have come as a surprise to those in the know. The deal has been complicated by the merger with ISIS last year, and there is no shame in admitting that, in keeping with many such agreements, the best laid schemes “gang aft a-gley”. Mellon has been unnecessarily defensive about the progress of the deal, in part because of the bad publicity surrounding the Schroders/JPMorgan issues earlier this summer.

Everyone accepts that the current model is far from ideal, and that providers have got to get much smarter about cost management, project creep and a thousand other details that may have been overlooked in the negotiation process. All agree that upfront payments should end, but no one can quite bring themselves to take a principled stand when it comes to bidding for the more prestigious mandates. In terms of maturity, the market has not even entered the spotty, hyper-hormonal phase of early adolescence yet.

What is needed is a period of reflection and digestion after the frenzied activity of the last few years. Bean-counters and strategists need to get their heads together and decide how deals will look in the future, based on their experience so far. Those who do not learn the lessons of history are destined to repeat them. 

What is not needed is a further blow to the already fragile economics of outsourcing, yet that is precisely what providers are now confronting. No one, it seems, had methodically thought through the effects of taking over a client’s operating environment, which will often include the technology platform as part of the lift-out. Once they had woken up to the threat to their long-term revenue streams, software vendors retaliated by imposing painful penalty clauses that demand large payments from the providers to continue to use their systems after the lift-out. Every time the provider refuses, the price rises. Vendors know they have got them precisely where they want them – by the short and curlies.

Forgetting the plight of the software vendors is highly embarrassing, not just for the providers but also their clients. Clearly there will need to be some form of compromise: the vendors are being short-sighted by threatening potential or existing clients, whilst the providers have overlooked what is a fairly straightforward commercial dilemma. But the situation demonstrates how far outsourcing has yet to travel before it is a well-established, well-ordered industry with stable, experienced suppliers that know all the potential pitfalls and problems.

Many providers predicted that 2005 would be the year of execution, when they began to deliver on their promises. But it looks more like a year where they learnt that they still have a lot to learn before they can consider themselves to be masters of their craft.

CUSTODY BELLWETHER RINGS TIME ON MODEL

Problems at Investors Bank & Trust underscore the need for a new way of pricing

24 August 2005: For many custodians, transparency is a dirty word. Making money from custody is hard, especially when the tariffs are in black and white, even if they do run to as many pages as the New York phone directory. Skimming a little bit from the less explicitly priced services has always been the custodians’ preferred method of boosting asset servicing revenues. Everyone knows it’s happening, but only the custodians know precisely how and where.

But even the custodians cannot disguise the fact that it is these ‘ancillary fees’ that can make all the difference between profit and loss. Most custodians make more money out of net interest income than they do out of securities processing, which has become the engine that drives revenue from other parts of the bank. Veterans from the time when JPMorgan last sold its custody businesses will remember what a huge hole these deals punched in the bank’s treasury turnover, which dropped off dramatically after the loss of so many clients with cross-border investments. JPMorgan’s custody operation may have been a dog, but even that didn’t stop it from fetching profits for the dealing room.

Is this a sustainable business model? Last year, State Street discovered that dependency on market-related earnings was a two-way street, with credit agency Fitch downgrading the corporation’s long-term rating after a poor third quarter. More recently, and perhaps more worryingly, the success story that was Investors Bank & Trust Company (IFIN) came to an abrupt end when it had to downgrade it EPS forecasts for 2005 and 2006.

Here’s what IFIN had to say about its second quarter performance: “A number of factors have contributed to the company’s revision of its historical target for annual growth in diluted earnings per share. Key factors that are driving the change in expected diluted earnings per share include:

a flatter than expected yield curve;

narrower than expected reinvestment spreads;

weaker than expected market-sensitive revenues, including fees linked to both the equity and foreign currency markets; and

continued investments in headcount and technology to support new and existing clients.

These factors are expected to be partially offset by continued strong growth in the company’s core service fees, which are driven by sales to new and existing clients and consistent growth in the company’s assets under administration. The company’s pipeline for new business remains medium and the company continues to bid on and win mandates from new and existing customers.”

An 18 pct drop in IFIN’s share price on the day of the announcement clearly demonstrated what investors thought of Investors. But, leaving aside the concerns of analysts and traders, IFIN’s pure model of custody and administration is the best indicator of how the market as a whole is performing. If IFIN is suffering, it is immediately apparent because it has nowhere to hide its pain. Most other banks do – but that doesn’t mean they aren’t hurting too.

That pain is being compounded by a much closer scrutiny of ancillary services. Ever since the UK’s London Regional Transport pension fund called in a specialist consultant, Record Treasury Management, to undertake an audit of FX rates charged by its custodians and managers in 2001, the heat has been turned up. Data Explorers, Amaces, Thomas Murray and others are all asking uncomfortable questions – not, you understand, to get custodians to reduce fees, but to bring about greater openness and transparency.

Some custodians, notably HSBC, are benefiting from this. HSBC won the BBC pension fund mandate at least in part because of its innovative FX pricing model, which others either wouldn’t or couldn’t match. A lot of its competitors are simply not ready to come clean over pricing. 

But IFIN’s stumble should be a timely warning for all custodians, especially those trust banks that do not have the luxury of corporate lending relationships and investment banking revenues to fall back on. The whole pricing model on which asset servicing and investment operations is based is an anachronism that needs a complete overhaul. The banks’ experience with outsourcing has already shown that the current economics simply do not add up, and that is bad for them and their clients. IFIN has had to put its hands up to the problem, whilst others try to disguise their issues or hang on and hope that it will all come right in the end. It is time for a serious dose of reality. As The Bank of New York says, a 9000 Dow would certainly sort the men out from the boys…and how many suppliers have prepared themselves for that eventuality?

THE EMPEROR’S NEW CLOTHES

Schroders calls time on the ill-fated outsourcing deal with JPMorgan, raising fundamental questions about the custodians’ project management skills

4^th July 2005: Everything you ever wanted to know about relationship management, project management, communications management and senior management can be learnt from studying the Schroders outsourcing deal with JPMorgan. Here you will learn all the textbook errors that resulted in Schroders pulling the plug after five highly frustrating years, condemning JPMorgan to a place in outsourcing history that will make its life difficult for years to come.

Every custodian should study the case thoroughly and ask themselves two questions: am I safe from the same fate, and do I want to stake my entire reputation on a model that looks increasingly flawed? True, the Schroders deal involved ineptitude on a grand scale (and not just at JPMorgan), and it is difficult to imagine other projects going so badly sour, but these two partners do not have the premium on poor management skills. Other custodians and their clients are equally likely to make the same kind of mistakes, trundling down blind alleys in expensive and poorly planned diversions that could all end in tears.

Any custodian enjoying the agonies of JPMorgan needs to see a therapist. The Schroders decision, which seemed all but inevitable once Markus Ruetimann took over as head of operations and IT last October, spells trouble for all providers. The concept of total outsourcing, which managers have increasingly bought as the right solution, has taken a huge knock: Schroders no longer believes that JPMorgan – or any other provider – can deliver the benefits that it was looking for five years ago.

This will give other managers pause for thought. Schroders had always said that it wanted to be at the leading edge of outsourcing so that it could dictate its own terms and conditions. It is not the only pioneer to discover that its theory was fatally flawed because its provider failed to live up to its promises. The demise of the Schroders transaction means that other managers should also take a long hard look at what benefits really accrue from outsourcing. As importantly, they need to ask much more searching questions about their providers. There is no point structuring a complex deal with a custodian that then proves utterly incapable of managing the complexities of a huge IT and operational project, especially if that provider is always struggling financially. How many custodians can truly claim to have the expertise necessary to complete these projects on time, to specification and within budget? As of July 1^st, there is one less on that already limited list.

In its statement, Schroders said that the two partners’ operating models “are no longer sufficiently aligned to justify the continuation of the project”. Yet there never was any alignment: from the start, JPMorgan miscalculated the magnitude of the transaction and failed to put its best people on the project. Even after five years, the joint project teams were going in different directions.

What is likely to happen is that Schroders will now cut a series of smaller deals as well as maintaining a strong in-house operational capability, spreading its risk to avoid further car crashes. Custodians have been saying for ages that the era of the big deal is dead, and that component outsourcing is the future, even as they tried to sign up more total outsourcing mandates. It may not be good news for consultants, but these smaller deals, overlaid with smart communications technology, may represent the pragmatic alternative.

Schroders does not mark the end of the affair. The market still has to hear what Scottish Widows Investment Partnership decides to do with its State Street contract, which expires next year and which is now in the last stages of review, and whether The Bank of New York can rescue its relationship with Merrill Lynch Investment Managers, which has so far refused to move on to the bank’s strategic platform.

All of a sudden, exit strategies have become the most important issue for the buy-side. Schroders has shown that it can be done, although it is really only taking back its own staff and systems, along with a cheque for GBP20m. Others may be emboldened to follow suit. JPMorgan’s failure may well be seen as a crucial inflection point in the history of outsourcing.

DANGEROUS LIAISONS

Properly managed, RBC Dexia Investor Services could cause real problems for competitors

17^th June 2005: Have you ever noticed how almost every investor services provider claims to be a ‘leading’ player? In exactly the same way as all fund managers appear to be top quartile performers, custodians see nothing wrong about claiming leadership positions for themselves. It is the same as mission statements that talk about being a ‘premier’ provider in ‘chosen’ markets. What does that means – and who cares anyway? Directors do not get fired for failing to comply with the mission statement, and mandates are not awarded on that basis either.

The condition is highly contagious. In the announcement of the deal between RBC and Dexia, we were introduced to the two holders of leadership positions: “The combination of a leading global custodian known for best-in-class client service with a leading European player in global custody, fund administration and transfer agency services creates a unique proposition for sophisticated institutional investors worldwide,” it said.

You get the picture. But, leadership claims aside, the deal is significant for RBC, Dexia, clients and competitors. For the first time, two successful providers on opposite sides of the Atlantic have struck a deal that simultaneously acknowledges that neither party can go much further on its own whilst creating a vehicle that has a lot of gas in the tank. On paper at least, RBC Dexia Investor Services fulfils the key merger criterion of being greater than the sum of its parts.

For the last 10 years – since the disgraceful behaviour of JP Morgan when it was still pitching for business on the day the bank sold the custody shop – investors have fretted over commitment. The whole point about RBC Dexia IS is that both banks like the business enough to do a deal that demonstrates unequivocal commitment. Nothing has been held back, and a lot of very senior people, from José Placido downwards, have staked their futures on it. When your own career is on the line, and you agree to forego the obvious comforts of working for a big bank in favour of a specialist provider, you are sending a very clear message.

Just in case anyone doubted the rationale, RBC spelt it out from the very top. “Both RBC and Dexia are committed to this business and look forward to seeing RBC Dexia IS succeed as a strong global competitor,” said Gordon Nixon, president and CEO of RBC Financial Group. “We believe this joint venture is the best way for us to ensure that we can continue to grow to meet the complex needs of our clients effectively.”

Nixon and Placido know that the new firm has all the elements to make a real impact, rather than operate at the margins. Nearly two-thirds of the pro forma revenues of the merged group come from just two markets – Canada and Luxembourg. Yet it will now have a presence in 15 markets, and it needs to turn that better coverage into better business. Neither party was ever going to be able to do that on its own.

RBC insiders, who worked for nearly two years on the deal, say that they looked at every other possible option, and kept on returning to this structure as the best way forward. It is hard to see what else could have been a better solution for either of them, especially as Dexia reportedly did not want to treat with a US bank. Competitors need to think very carefully about the full impact of this deal, and how attractive the combination may prove to clients that are eager to look at alternatives to the US hegemony. HSBC, BNP Paribas and ABN AMRO Mellon are already proving that there is room for a slightly different approach, as long as the products and service stand up. To succeed, RBC Dexia IS will need to be similarly distinctive.

OUTSOURCING: THE DIRECTOR'S CUT

1st June 2005: Here's a question for you: what qualifies as an outsourcing transaction? Having trawled through the archives back to 1999, I can still find no clear, definitive answer. We all think we know one when we see one, which is how I have compiled the list of deals below. Most of these transactions have involved the transfer of staff from client to provider, as well as a significant chunk of operational responsibilities over and above custody and reporting.

What I want now is feedback. Does the list fairly reflect the market since 1999? Are any significant deals missing? Should any be excluded? And what other information would you like to see in the database?

Once I have some answers from you, I will turn it into a separate database for the website.

TIME FOR A BLOOD TRANSFUSION?

25th April 2005: It cannot have taken the branding gurus very long to come up with the new name for the merged trust and investor services businesses at JPMorgan: Worldwide Securities Services. Until fairly recently, this was the style adopted by Citi, clumsily abbreviated to WWSS. At least JPM has settled on a single W.

But that is about the only thing that looks good about the decision to try and squeeze two businesses into one model. Cost-cutting is the name of the game at JPM, and the merger of these business units was inevitable after the bank decided not to replace Tom Swayne as head of investor services. Looking at first quarter results, the focus on cost has served the treasury and securities services business well: compared to the previous quarter, non-interest expense dropped from $1,146m to $1,065m, whilst net revenue grew from $1,413m to $1,482m. Investor services saw net revenue jump by 12% to $508m.

But the promising numbers do nothing to explain why these two units, which have almost nothing in common, should be merged, other than as a cost-saving exercise. Even Mike Clark, the newly anointed head of WSS, could find nothing of substance to say in the official press release, relying instead on flute music. “We are exceptionally well positioned to offer clients the most complete and innovative arsenal of products and services,” he gushed. “As clients respond to changes in the industry and regulatory environment, we will be able to anticipate their needs and help them react even more quickly to the ever-changing demands. This array of services will be the winning hand going forward.” Quite why an asset management firm considering outsourcing, for example, will be better served by WSS that it was by IS has not been articulated.

JPM does not have the winning hand at the moment. Although its bean-counters have managed to engineer a rise in assets under custody to $10.1trn, it continues to lag behind State Street and BNY in most areas. Both of its main competitors are leagues ahead in outsourcing (although they have yet to prove that this is a good thing financially). State Street leads the way in Europe, whilst BNY has a much stronger hand across the three main client constituencies: broker/dealers, institutional investors and corporate issuers. Despite its formidable firepower as an investment bank, JPM is an also-ran in the transition management space, where State Street has become the world’s largest provider. In terms of product innovation, JPM lacks focus and undoubtedly suffers from the big bank syndrome that has led to the death of so many other universal bank providers over the last 10 years.

Part of its problem is staleness. The new management team looks remarkably like the old management team, only with different titles. As old wood is chopped out (and some notable names appear to have been pruned from the new structure), it is vital that JPM recognises that fresh thinking and a different perspective could work wonders. The merger of these units was an opportunity for Mike Clark to inject some new blood, but he has failed to take it. Continuity is all well and good, but WSS needs a radical shake-up that is driven by the changing business models of its clients rather than the cost-cutting demands of senior management.

For inspiration, JPM should look to HSBC, which has reinvented its securities services business over the last two years, bringing in a full slate of aggressive, hungry senior and middle managers who are not afraid to challenge the status quo. The result? More business and a new respect from clients and consultants that would previously have ignored it.

At the moment, JPM is very big but it is also very clumsy. It has stumbled over its entry into hedge fund administration, fumbled its UK transfer agency plans and faltered over integrated execution services, to name but three examples. Reorganisations will not fix that problem. A radical shake-up of personnel, and attitudes, just might.

PERCEPTION IS REALITY - PART THREE

25th April 2005: Truly the final word on this subject. Here is a recent e-mail from a PR firm that used to represent one of the world's largest global custodians. My response was very brief.

Richard

Haven’t spoken for ages, and I’m afraid I don’t have your most up-to-date number.  Hope all’s well with you. 

I wondered if you would have a few minutes for me to pick your brain.  We’re putting together a pitch for a securities services company, and I just wanted to get your views on them and what’s going on in the custody/securities services world these days.

If you’re happy to do this, if you could let me have your number I’ll give you a ring.

Many thanks and regards.

PERCEPTION IS REALITY - AND HERE'S THE PROOF

23rd March 2005: Call me mean, but I cannot resist publishing these extracts from an e-mail I received recently. The sender - whose name and firm, so far, I will keep anonymous - has started a new job with a PR firm, as you will read. His hope, clearly, is that if he buys me lunch he can get lots of free information. I'm sure that precisely the same arrangement would hold good if I wanted to use his firm for PR - a spot of lunch and no charge, old boy.

"Our mutual acquaintance (name supplied) suggested I contact you, based on my admission of ignorance on the finer points of the custody industry. I am an experienced writer on corporate treasury and related areas of banking, but have recently joined (name supplied), a PR firm that represents (name supplied), and would greatly value your insights as consultant and commentator to the industry. As head of media relations at (name supplied), my role is currently ill-defined, but continued improvement of industry knowledge does fall within my remit. As such I'd like to discuss current trends and basic principles of custody over lunch some time in April (11-13 and 18-22 are currently free).

PERCEPTION BECOMES REALITY

Failure to manage external relations effectively suggests deeper problems with custodians

17^th March 2005: Why is public relations important? It is a question that few custodians or other service providers ask themselves often enough. Good PR is not just about getting your press release into a trade publication or having your director interviewed by a cub reporter who would rather be working for FHM or Vogue. PR says a huge amount about the culture and values of the firm. For better or worse, it projects those characteristics into the public arena, so that we can better understand the way in which a firm is likely to behave.

CHASING RATINGS

2005 scores remain static, but that's no reason to give up on trying to get better

March 7th, 2005: The supporters of Millwall Football Club, based in east London, have long enjoyed a reputation for being amongst the beastliest of all, which is some accolade. In response, these fans have adopted a chant: "Nobody likes us and we don’t care". Cruel competitors have been suggesting recently that State Street might like to use the slogan, after its spectacular crash to the bottom of this year’s R&M custody survey.

A CUT TOO FAR

The focus on costs at JPMorgan Chase has led to a bizarre decision about Investor Services

28th January 2005: Heidi Miller has a reputation as a cost-cutter. Very few people can honestly say that they know her – or Jamie Dimon, her mentor and the president and COO of JPMorgan Chase – primarily as managers who grow businesses. Dimon has recently raised his target for cutting costs to $3bn, which suggests that he, and his management team, have little time for anything else.

Miller, who runs the Treasury & Securities Services business at JPMorgan Chase, certainly has the opportunity to cut costs. The business units have traditionally been run on separate lines, each with their own infrastructure of finance, marketing, operations and IT. This duplication is expensive and counter-productive: what few cross-selling opportunities exist are likely to fall between the cracks as the units exercise their independence.

Getting simple things done – like cash management and investor services working together – is no cake walk, as any Citibanker will tell you. But Miller and her elite squad of enforcers will not allow turf wars to develop, and are already chopping furiously.

In their haste to make a difference and satisfy whatever targets they have been set by Dimon, Miller’s team seem to have forgotten about the bigger picture. How else can you explain the decision not to replace Tom Swayne, head of investor services since 1999? In that period, assets under custody have almost doubled, and now stand at over $9trn. Yet Miller has decided that a dedicated head of the business is no longer required.

Instead, Mike Clark, who already runs the institutional trust services business, will add investor services to his responsibilities. Clark is being given the sort of build-up that leaves you wondering why he isn’t already CEO of the entire bank, such are his apparently outstanding qualities. But even with the best will in the world, it is hard to see how Clark can be anything more than a part-time leader, whose main role will be to squeeze out duplication and overlap rather than grow the business.

The message that this sends to the market is pretty damning: the business simply doesn’t deserve its own leader. Last year JPMIS reported record revenue and saw a 20% growth in assets under custody. It is a vast global business. While there will always be significant opportunities to cut costs in any business of that scope and scale, doing away with the overall unit head isn’t the most sensible option.

This myopic decision comes just a few weeks after the outsourcing business was merged back into the core securities operations group. Again, this move looks motivated more by cost than commercial logic. Now there is no one sitting at the top table who will be fighting exclusively for the rights of Investor Services. And, even though Swayne’s senior management team has also been lavished with praise, there was apparently no one good enough to replace him. Is that the impression that Miller wanted to give to clients and prospects?

This decision has been poorly informed and may cause serious damage to the perception of JPMIS. As long as cost management continues as the driving force in T&SS, JPMIS will lag behind BNY and State Street in terms of product innovation and speed to market. Without a clear strategy for its outsourcing business, which should be the engine of growth, there is a danger that the business will only win low-value assets which swell the books but fail to generate superior returns. It doesn’t look as if the T&SS senior management has yet resolved that equation.

MEASURING THE BANG FROM THE BUCK

All assets are created equal, but some are more equal than others, and custodians should record them more openly

January 24th, 2005: Is it time to recalculate the way in which we measure the relative strength of custodians? Players like JPMorgan Investor Services have long argued that the traditional yardstick – the value of assets under custody – is no longer relevant in an environment where asset administration and asset servicing are becoming two separate disciplines.

THE POWER OF LATERAL THINKING

A PUNTER’S FORM GUIDE TO 2005

NORTHERN RAISES THE STAKES

Deal to buy FSG from ING is fully priced and will take a lot of work to justify

November 30^th, 2004: What can you buy for GBP260m nowadays? If you’re Northern Trust, you can pick up a business that few people even knew existed, such is its insignificance in the administration industry. The announcement by Northern that it is to buy Baring Asset Management's financial services group (FSG) for approximately GBP260m ($480m) took many by surprise, not only because of the price but also because FSG hasn’t been heavily featured as one of the top players in the alternative administration space.

When the deal is completed, Northern Trust will have a fund services group with approximately $63bn in funds under administration, $28bn in custody and $32bn in trust assets. Perhaps that explains why it has such a low profile.

As Northern would probably argue, there are few benchmarks against which to judge the price of a business that you really, really want. Northern needs the alternatives experience of FSG: it has a hedge fund capability, as well being able to handle private equity and property investments. MassMutual, which has bought the asset management business of BAM and which has signed a multi-year deal with Northern, represents 20% of FSG revenues. No other clients have been mentioned, although there are apparently ‘several hundred’. Based on total assets of $123bn, that means they are each going to be pretty small. Half are in the UK, and none is the size of MassMutual.

For such a small business, FSG has a lot of staff (770), and Northern has already said that there will be headcount reductions. 400 of the staff are in the Channel Islands, with the rest split between London, Dublin and the Isle of Man. Although Northern hopes to shed most of the staff through attrition, it will inevitably have to pay some to go, adding to the final bill.

There is a lot of head-scratching around the industry about the deal. Without good benchmarks, it’s tough to say that Northern has overpaid, but that amount of money should not only buy you a lot of expertise and technology; it should also get you chunky clients. BNP Paribas paid less to buy Cogent in 2002, whilst The Bank of New York paid GBP400m to buy RBS Trust Bank in 1999, with GBP400bn of custody assets and a long-term deal with Merrill Lynch about the Mercury business.

More recently, HSBC managed to buy an entire bank – Bank of Bermuda – for USD1.3bn. For this, HSBC got fund administration, trust, custody, asset management and banking services, as well as a very strong presence in the hedge fund business. It also picked up over USD130bn in assets under administration and a network spanning 16 financial and offshore centres. State Street paid roughly the same to acquire Deutsche Bank’s global securities services business, with over USD2trn of assets under custody.

Whilst every custodian accepts that you have to have a servicing capability for alternatives, and buying, rather than building, has proved to be the preferred option for all the top players, the price for FSG seems to be at the very top end of the range. Interestingly, not a single analyst queried it at the presentation Northern made to announce the transaction. Other marginal firms, like Fortis, with strong capabilities in this area will be heartened by the deal.

Historically, Northern has been a canny and highly selective purchaser. It bought Ulster Bank Investment Services in 2000 for EUR13.5m, and paid an initial USD100m for Deutsche Bank’s global passive equity, enhanced equity and passive fixed income businesses in 2003. But its steady growth as a custodian has been entirely organic. This deal suggests that Northern does not believe that it can afford the time and effort involved in building its own fund administration business – and, with limited availability of viable targets, it was prepared to pay a premium to secure its platform. Now it needs to think smartly about how it is going to feed the new machine from its own client base by intensive cross-selling. Northern rarely makes mistakes, so this transaction will be watched with close interest by all its competitors.

LOSING THE PLOT

August 16^th, 2004: Europe’s central securities depositories are a sensitive bunch of flowers. Their trade association, ECSDA, did not approve of my news article of 11^th August, from which readers might have inferred that ECSDA’s response to the European Commission’s communication on clearing and settlement was awfully similar to Euroclear’s response. Perish the thought, says ECSDA (which, incidentally, is not a subscriber to the website – so three guesses as to which of its members might have alerted it to the story?).

Here’s what ECSDA had to say:

QUOTE:

Att: Mr. Richard Greenstead (sic)

cc: Mr. Giovanni Sabatini

Dear Sir,

I have read through your text on the ECSDA response to the Commission Consultation on Clearing and Settlement - the Way Forward. You seem to claim that the ECSDA response is a copy of the Euroclear document.

Having participated in drafting the ECSDA response, I have to disagree with your text and with your suggestions.

I am the chairman of the ECSDA working group (WG2 - Public Policy) responsible for drafting the response for the approval of the ECSDA board of directors. All members of ECSDA, i.e. CSDs and ICSDs are represented on the board. The working group itself includes members from 14 different CSDs and ICSDs, encompassing also members representing some of the CSDs of the countries that acceded the EU on May 1, 2004. The ECSDA response is the product of common efforts of the working group.

The principles of the response were debated at length and approved on the ECSDA Board of Directors upon my presentation. The wording of the response was agreed between the members of ECSDA and finally confirmed, as is customary in such cases within ECSDA, by the Chairman of the ECSDA Board, Mr. Giovanni Sabatini of Monte Titoli. Thus I think your suggestions are unfounded.

In general, the views presented in the ECSDA response represent the concerns the ECSDA members have in respect of the Commission Consultation. Having familiarized myself with a number of responses by the ECSDA members, I have noticed that they tend to include similar notions. I send for your information the response submitted by HEX Integrated Markets on behalf of the Stockholm Stock Exchange, of the Helsinki Stock Exchange, of the Finnish Central Securities Depository, and of a number of Baltic entities. I think you will find that the emphasis in our response corresponds to the ECSDA response.

Yours faithfully,

Janne Lauha

OMHEX

HEX Integrated Markets/ Legal

UNQUOTE

Europe’s depositories are a strange bunch. They want to have everything their own way, and have completely lost touch with reality or the reasons for being in business. Possibly spurred on by the more commercially minded members, ECSDA announced last year that "the management of CSDs are responsible to their boards of directors who in turn are responsible to their shareholders". The concept of user-owned, user-governed structures is, apparently, so twentieth century. Clients come last in the brave new world of depositories.

They want to have banking licences and compete with their clients, but they want to be protected by the regulators so that custodian banks are put at a disadvantage. They also don’t like criticism. ECSDA should stop being an apologist for the more extreme element of its membership, and start concentrating on fixing the numerous shortcomings of its members’ operations.

SPARE THE ROD AND SPOIL THE CHILD

The European Commission tells Clearstream it has been naughty, but doesn’t send it to bed with no supper

June 3^rd, 2004: Of the many bizarre decisions that spew forth from the European Commission on a daily basis, the judgment that Clearstream was guilty of price discrimination and refusal to supply hardly registers on the radar. A few eyebrows may be raised in surprise that the EC did not levy any fine, or impose any punishment, and will struggle to understand that one of the reasons for this leniency was that "there has been a wide-ranging debate on clearing and settlement within different institutions and fora (sic) in order to better define the role of the different protagonists in the industry".

The decision, which the EC is keen to stress does not favour any particular business or regulatory model, and "is not directed against Deutsche Börse’s business model or any other", confirms the view that the Commission is clueless about the mechanics of clearing and settlement. The Commission admits that "there is no Community case law or jurisprudence dealing with the competition analysis of clearing and settlement", something it knew when it started its ‘ex officio’ inquiry. Deutsche Börse has therefore escaped financial penalties that can reach 10% of a company’s annual worldwide turnover, and has not been forced to change its behaviour. Can other national CSDs therefore get away with similar tactics, secure in the knowledge that a precedent has been set and the only punishment is a limp slap on the wrist after a dilatory inquiry?

Depositories like Clearstream Banking Frankfurt are monopolies and, in the words of the Commission, "unavoidable trading partners". As a result, they need to be closely regulated and monitored. European depositories strongly object to this. The European Central Securities Depositories Association told ESCB-CESR that it should mind its own business in several areas. "The ESCB-CESR standards should avoid using competition-style language (such as "dominant position") and should not set standards for institutions which may occupy such a position, since to do so might have specific national and European competition law implications," it warned in a letter in November last year.

In the same letter it told the regulators that depositories are not answerable to users, regulators or the market as a whole. "The management of CSDs are responsible to their boards of directors who in turn are responsible to their shareholders. Each CSD must therefore structure its business and services in way which delivers value to its customers and/or value to its shareholders (if the CSD is part of a group which is listed on a stock exchange). We do not believe that it is appropriate for regulators to act as shadow directors, deciding on which business activities a CSD should, or should not, pursue."

Although Alberto Giovannini and his team have told the Commission (twice) what is required to make cross-border clearing and settlement more efficient, it is still floundering. A framework clearing and settlement directive, as proposed in the Commission’s second Communication, will struggle to make it through against the distraction of European elections and a new set of Commissioners. The ESCB-CESR proposals for regulatory standards have proved to be politically motivated and have alienated a huge constituency of powerful banks that will not meekly accept the changes. Now the Competition Directorate has fumbled its first opportunity to set a strong anti-trust policy in the industry. Does anyone now seriously believe that the Commission has the necessary expertise to deliver a better C&S infrastructure?

AUSTRALIAN NOTES FOR GENERAL CIRCULATION

March 22nd, 2004: The Australians may not be much good at rugby union, but at least they still know how to throw a good party for a visiting Englishman. At a custody conference in Sydney in February, I gave a speech on global custody's past, present and future. You may find it mildly amusing.

Thirty years of global custody

GETTING BETTER ALL THE TIME

January 20^th, 2004: So, let’s just get this straight, shall we? Deutsche Bank sold its global securities services business to State Street. The German bank had claimed to have some €4trn of assets under custody but, for reasons that are probably only comprehensible to Frankfurt bean-counters, State Street saw nothing like that number in increased assets when it completed the transaction last year. Where did all those securities go? Did somebody lose them down the back of the sofa?

Stranger still was the deal that saw Deutsche Bank – yes, the same one that sold its business to State Street – acquiring Dresdner Bank’s custody operation, some six months after we all thought it was getting out of the business. Might this represent just the tiniest inconsistency in the bank’s strategy? And, let’s be honest, would you rather be in the low-value, low-margin sub-custody market or the high-value, high-margin global investment operations business? No cigars for Deutsche’s strategic directors in 2003, then.

Other banks were slightly less befuddled in 2003. HSBC started to deliver on its potential. It is in the middle of a deal to acquire Bank of Bermuda, which most of its competitors seem to think is a pretty smart move. It has a first-class sales and relationship team in place. It stole the highly coveted accounting and performance measurement mandate for the Universities Superannuation Scheme, the UK’s third largest pension fund which has over £18 billion of assets, from under the noses of more fancied suppliers. And it may be on the verge of winning a vast outsourcing deal from a UK fund management house.

JPMorgan Investor Services will also be pretty pleased with itself. Having acquired the services of Dick Feehan, who is equally skilled as a trencherman and rainmaker (often exercising both skills simultaneously), JPMIS has scooped up some substantial mandates and is finally nearing a result with its agreement with Schroders. Whether or not the deals get publicised, JPMIS has also bagged one or two plump mandates that fell out of the State Street/GSS transition.

For State Street, much of 2003 was a living hell. Staff were climbing over each other to take voluntary redundancy, right up to the top of the organisation. The GSS acquisition cost a lot of time and money, and it isn’t over yet. David Spina, the chairman, had major heart surgery. But…despite all this, State Street is not a quitter and it remains a class act. The deal with Investec shows that it is still a primary contender, with rumours that there are other deals in the pipeline. 2004 will be so much better – well, it couldn’t get much worse, could it?

Jeff Tessler left his post after six years running The Bank of New York in Europe, and he made a pretty good job of it. BNY globally is looking remarkably fit and healthy again. The Pershing acquisition is a much better fit than GSS would have been, and integration seems to have been relatively painless. It has a new outsourcing mandate in its back pocket, and is on a very short shortlist for the much-debated AXA mandate. Don’t rule out further acquisitions, too: BNY never stops looking.

One of BNY’s challenges will be to make sure that Citigroup doesn’t buy everything first. Having publicly stated that securities processing firms are on its list of acquisition targets, Citi could buy some likely contenders and treat the price tag as a rounding error. Its outsourcing deal with Standard Life Investments still looks good, although it could go pear-shaped if the parent decides to sell the asset management business. But Citi has now cemented its position as a premier league player and more is expected of it in 2004.

Mellon’s outsourcing mandate with F&C brightened up what was otherwise a rather quiet 2003. ABN AMRO Mellon, in particular, seems to have lost some of its early momentum, and there are interesting rumours about the destination of a supposed outsourcing mandate for ABN AMRO Asset Management. In keeping with every annual review about Mellon since the year dot, it also has to be said that its European fund services business doesn’t look very European.

Perhaps Mellon should talk to Northern Trust, which has bitten the bullet and decided to build a Luxembourg business from scratch. Northern had a great 2003 and is winning mandates all over Europe. It is also beginning to make greater strides in outsourcing, having recently reached the final two in a contest against HSBC for a major UK manager’s hand in marriage.

Royal Bank of Canada also has great hopes for its outsourcing business, although it appears to have been thwarted in its bid to do a deal with Edinburgh Fund Managers. Bringing Tony Johnson back from Bisys was a great move, because the loss of Paul Stillabower to HSBC was painful. But Johnson cannot do it all on his own: RBC now needs some transformational players and some transformational deals in 2004 to stay in the hunt.

Congratulations to BNP Paribas, which had spent almost the whole of 2002 whinging and moaning about Euroclear. Now it has got that out of its system, it has been winning lots of business all over the world. It still needs a top-line outsourcing contract: can it snatch AXA away from BNY and State Street? If it does, it will be a major coup: if it doesn’t, where does it look next? Fortunately, it has one or two senior managers who are smart enough to craft a sustainable strategy that takes the bank further away from its mystifying belief that it should not compete with the Americans on their level, but should try and do things ‘the European way’. Worked really well for Deutsche Bank, didn’t it?

Brown Brothers Harriman has been careless. It lost David Bilbé unnecessarily so it is back to square one in Europe. With Andrew Tucker now in London, the bank needs to sort out a credible European strategy and implement it. 2003 saw it, at best, treading water.

So, for most banks, 2003 was a year of improvement. But will that be enough to keep them all safe from takeover in 2004? The answer, as yet, is no clearer than Deutsche Bank’s custody strategy.

SINGAPORE SLUNG

October 28^th, 2003: So, who exactly was that infamous network manager who, having returned to his hotel at 0345 after a refreshing night out with other professionals, found himself rescued by hotel staff after he had bounced up and down in the lift between his floor and reception for 45 minutes? And who was the US custody banker whose e-mails kept being returned undelivered because the bank’s new, highly prudish software system objected to references to Charlie Cock?

Sadly, these were isolated highlights of what was otherwise a very dull week in Singapore. Sibos has been turned into a technology show, where vendors predominate and banks have been relegated to the outer fringes of the exhibition hall. Gone are the glorious days when Deutsche Bank had a stand as big as the Bismarck, triumphantly emblazoned with the slightly dubious motto: Ein Bank, Ein Europe. Of course, ABN AMRO still has a stand that is slightly larger than the Ajax football stadium, but others had given way to vendors with names that were unpronounceable – all of which were probably owned, in some way or another, by IBM or SunGard.

Panel sessions covered depressingly familiar themes, whilst delegates snoozed away the effects of too much Tiger beer or planned their evening party schedule. One bash of note was the Northern Trust knees-up, held in an Irish bar called Father Flanagan’s, where a hardy group of grizzled network managers and sub-custodians quaffed Guinness and watched the Rugby World Cup. Credit to Northern: instead of the usual flashy canapés and nibbles, there was not so much as a pork scratching on offer. This was not a do for the faint-hearted.

The end of conference party was held at the Singapore Turf Club, just a grenade’s throw away from great friends and neighbours Malaysia. Swift had done its best: three horse races, hundreds of bars, enough food to maintain a small nation for a month, a very loud ‘pop’ band, fortune tellers, stilt-walkers (gosh, aren’t they just too, too hilarious?), foot massages (disgusting for onlookers), pinball machines and more bars. But the bars soon ran out of big beer glasses, forcing journalists to order six wine glasses of Tiger at a time. The hardships we face…

And at the end of all this, what had been achieved? Was STP more real than it had been before 5,000 hungry and thirsty bankers descended on this control freak’s paradise, where no one crosses the road before the green man lights up? Would asset managers see the error of their ways and spend lots of money on automation projects? After representatives of both BGI and JPMFAM laid into custodians and broker/dealers – Mike Brown of BGI professed himself to be ‘tired of talking about all this stuff’ – it seems unlikely.

But that is not the point. Sibos is not there to solve any problems. If it were, only a few back-office staff, blinking as they adjusted to natural sunlight, would attend. Sibos is all about…well, eating, drinking and whatever else floats your boat. That’s what I was told, anyway, and it has always served me well. Atlanta, here we come!

UNLESS I’M VERY MUCH MISTAKEN…

August 11^th, 2003: Who would have predicted that two worthy, if rather dull, UK-based asset managers would administer a much needed shot of adrenaline into the arm of the sickly outsourcing sector? Having both recently announced their intentions to outsource, subject to due diligence and the right size of cheque being handed over, Standard Life Investments and F&C Management have made some miserable bankers very happy. Yes, there is life in the sector after all, following a pretty disastrous 2002 in which there were no deals of any note.

The overdue revival in the sector, however, was not widely predicted. In fact, it was hardly predicted at all. Many of the industry’s finest minds spent 2002 and the first quarter of 2003 explaining to anyone who would listen why total outsourcing was so last year. Here are just three examples of what some big custodians were saying up until SLI and F&C came to the rescue:

• ‘We hear occasional interest in lift-outs, but nothing like it used to be. These are very risky deals for the custodian, whilst larger managers are not yet convinced that the model works.’ Clive Bellows, head of global fund services for Northern Trust in London (December 2002)
• ‘We do see a trend towards component outsourcing. We won’t see many more large-scale deals, although some smaller managers may continue to outsource everything. It’s a question of striking the right balance.’ Ron Logue, president and chief operating officer, State Street (December 2002)
• ‘The up-front costs of a total solution are just too great. In some ways, total outsourcing is like the first fish to leave the sea and try and walk on land. It’s just too big a jump. Component outsourcing is a more reasonable path to a total solution with a single provider.’ Mark Austin, head of European strategy for JPMorgan Investor Services (March 2003)
• ‘Managers will look at specific purpose solutions, with low start-up costs and relatively few complications. The ‘Big Bang’ solution, where an asset manager gets rid of the whole back office, has passed its time.’ Tom Abraham, head of outsourcing, Citibank (March 2003)

Two people called it right. At the end of 2002, Jeff Tessler, executive vice president and head of Europe for The Bank of New York, said: ‘The fund management industry is under severe revenue pressure. They are adjusting to the new environment, and driving out operating costs. They know the benefits of outsourcing, and they will come back to the market.’

In March, this viewpoint was endorsed by John Campbell, managing director of State Street’s European investment manager solutions group. ‘The market is actually moving towards total solutions,’ he said. ‘Managers were outsourcing components, but their strategic plans have changed. I’m confident we’ll see more lift-outs and total solutions.’

So perhaps, after all, there is a correlation between the strategic vision of a firm and its long-term success, as BNY and State Street share the market leadership position in the outsourcing sector. It’s a funny old game, this forecasting, as Dan Quayle rightly pointed out. ‘I hate making predictions,’ he said, ‘especially about the future.’ Quite.

SHOOT THAT PIGEON!

May 8, 2003: Nobody makes life more complicated for themselves than the people who organise clearing and settlement. Why have one bond clearing system, when two would be much more fun? Hey, let’s build a matching system that no one wants and doesn’t conform to market practice, and see how much time we can waste and money we can burn! Got nothing better to do - why not try and convince the market to spend $8bn on T+1 in the middle of a bear market? And wouldn’t it be neat to get together a few of the usual suspects and build a European central counterparty – how hard can it be?

There were probably good commercial reasons for all these seemingly brainless ideas, but there was very little common sense applied to them. As a result, a whole industry now exists to tell the market how to dig itself out of all the holes it created. And, in the true spirit of capitalism, you even get a choice: if you don’t like what CPSS-IOSCO says, you can plump for G30 Mk II, or Giovannini Mk II, or ISSA. That’s one more triumph for the free market.

In this case, more equals less. Whereas everyone read the original G30 report of 1989, many have yet to get round to its successor, let alone Giovannini’s latest effort. There is simply no impetus to do much of anything at the moment. The mood was summed up by a particularly frank, if dim, IT director of a custody bank, as quoted in last month’s Wall Street & Technology, who said that, at his firm, ‘STP is dead and gone’. He went on: ‘I think that saying you have an STP strategy is a fashion statement. I think that my firm would deny that we are not working on STP initiatives but, to be honest, those resources have been reallocated.’ Pity the poor clients at that shop.

This is pretty grisly. The failures of T+1 and GSTPA are being used as an excuse to avoid investment in STP projects, although vendors must also take their share of the blame for selling solutions that actually delivered more problems than they solved. Or, in the case of Reuters, not selling any solutions at all, but merely setting up a big unit, talking about it, designing some knock-out PowerPoint presentations, and then closing down again. No wonder everyone is so wary of more investment in STP products.

But that shouldn’t stop developments that truly reduce errors, cut costs and mitigate risks. For a custodian to admit that it isn’t working on any STP initiatives is little short of heresy, especially for an industry that has spent so much time and money convincing its clients of the merits. Right now, when even the dullest fund manager recognises the need to cut costs, is precisely the time for custodians to be rolling out better, smarter, cheaper ways of doing business, not when markets are booming again and nobody cares about the back office.

No one wants to get burnt again by investing large amounts of cash into useless infrastructure projects. But that is no excuse for inactivity, or the temporary diversion of reference data projects, this year’s must-have fashion accessory. STP – Sack The Peasants? Shoot That Pigeon? – should still be very high on the list of market priorities. That a custodian should say that it isn’t even on the list should ring some very loud alarm bells.

BEING RIGHT MAY NOT BE ENOUGH

February 27th, 2003: Fairness and clarity are commodities in short supply in the securities services business, so it is particularly appropriate that a lobby group composed of European custodians should call itself Fair & Clear. These custodians - agent banks from 10 European countries, including BNP Paribas Securities Services, Citibank, Den norske Bank, Sanpaolo IMI, Intesa BCI and KAS Bank – claim to control 80% of European securities settlement volumes. Even if the claim is vague and unsubstantiated (all securities, or just equities?), it is still a market share that is worth protecting, which is why Fair & Clear is so exercised by the growth of Euroclear, and why it is telling the regulators to sharpen up their act.

Neither side has a premium on virtue or straight talking. In its position paper issued this month, Fair & Clear makes some interesting, but not altogether sound, arguments. For example:

• It claims that ‘it is indisputable that Euroclear Bank enjoys exclusive arrangements made available to it as a result of its close connections with CSDs and its special role within the Euronext markets’, but provides no evidence – and Euroclear Bank certainly does dispute the allegation.

• It accuses Euroclear of cross-subsidisation between the ICSD and NCSDs, again without proving its case.

• It says that the conclusion of the 2001 CEPS report on European securities settlement - that some 35% of the total costs of cross-border settlement are generated by local agents – was based on a figure provided by Euroclear, and therefore not to be trusted. But that figure was verified last November by the Association Française des Professionnels des Titres, which is the French custodians’ trade association – and one of the members of the team that worked on the report was from BNP Paribas.

• It cleverly, but rather disingenuously, compares Euroclear Bank’s revenue per transaction against NCSDs with purely or largely domestic volumes, whilst the ICSD settles in over 30 markets.

But these shortcomings should not detract from the central tenet of Fair & Clear’s complaint, that Euroclear is unfairly mixing and matching its utility and commercial activities. Fair & Clear says that Euroclear’s plans for a single settlement engine and the internalisation of trades are no more than a grand design to end up with a private monopoly.

Fair & Clear is unimpressed with Euroclear’s assertion that it is user-owned and user-governed, as opposed to the commercial models of the shareholder-driven agent banks. ‘What Euroclear fails to recognise is that agent banks deliver value to their shareholders first and foremost by keeping their customers – which they can only hope to do by responding to their needs and delivering superior services at competitive prices,’ the position paper says. ‘Agent banks’ customers have consistently negotiated service enhancements and lower prices year-on-year. As customers, they are free to make new demands on the agent banks at any time.’

Fair & Clear compares this model with governance at Euroclear. ‘By contrast, users of Euroclear must submit themselves to a more cumbersome process in order to have their say,’ it asserts. ‘They must be selected by Euroclear Bank as a member of a market advisory committee, wait for the committee to convene and organise support from other users (who may be competitors) before getting their case heard by management, which makes the ultimate decision to accept or reject a proposal. Further, fees have been non-negotiable.’

Interestingly, broker/dealers and global custodians have kept their counsel on this issue. They like lower fees, and that is what the Euroclear group is delivering. Do they care if some marginal players in France or the Netherlands lose business, or close down their custody shop, as a result of fine pricing by Euroclear? No they do not. You can be sure that, in keeping with any smart management team, Euroclear’s senior executives spend a lot of time with their board members, reminding them of the rebates and tariff reductions that have already been delivered or are in the pipeline. For many of them, the governance and cross-subsidisation issues simply do not matter.

So what will the outcome of all this activity be? There are several possible scenarios:

• The European Commission will take action. Euroclear will either be broken up (split between the Bank’s commercial arm and the NCSD utility business, for example), or the banking licence will be withdrawn. Neither of these looks likely. Euroclear Bank will probably be able to prove that it has arm’s-length relationships with the NCSDs it owns, and no one will ever be able to substantiate allegations of cross-subsidisation. For the banking licence to be withdrawn, the EC would also have to strip Clearstream of its licence, hugely upsetting the Germans, which is something the European Commission, like the rest of us, would rather not do. Also, new banking consortia would have to be assembled, as used to be the case with Cedel, to manage the financing and credit aspects of the two ICSDs.

• The European Commission will take no action. This one is also unlikely, given that so much work has been commissioned (if not read, let alone understood) on the vexed subject of European clearing and settlement.

• The European Commission will take some action that will turn out to change nothing (except, possibly, the cost of doing business). If it is true that the EC worries most about individual investors, and the costs and risks to which they are exposed, then it will be very difficult to argue that the consolidation of NCSDs is anything other than a benefit. But the EC may feel duty-bound to introduce some new element of regulation, or other interfering mechanism, if only to show that it is decisive and powerful. No doubt, Euroclear already has a compromise solution prepared which would serve to achieve this purpose, whilst allowing it to continue pretty much as before.

The more Mario Monti and his team delay, the more difficult it will be to unwind anything that they think needs unwinding. That obviously works to the advantage of Euroclear which, based in Brussels, has a well-oiled political lobbying machine. Fair & Clear, on the other hand, is a mere beginner at the process and may well suffer for it. Do not expect radical change of the type that Fair & Clear is demanding, however compelling its arguments. That is not how real life works.

HOW WAS IT FOR YOU IN 2002?

January 6^th, 2003: Was 2002 an exciting year for global custody? Believe it or not, I say yes. Of course, it was dominated by the sale of Deutsche Bank’s securities services business, but that was by no means the only milestone. Here are a few pointers as to who did what to whom, and how the runners and riders fared.

WINNERS

The Bank of New York – one of the first serious sell-side back-office outsourcing deals (ING Barings) followed by the custody alliance agreement with ING, which included a €90bn slug of ING assets. Congratulations also to Jeff Tessler for persuading head office to sit on their hands whilst the Deutsche book was up for sale.

State Street – for them, the Deutsche deal was just right, beefing up the historically underpowered European business whilst adding €350bn of DeAM custody assets into the bargain. Also, the bank managed to mop up interesting TA assets in the UK (M&G and Schroders), got into the fund distribution business through Cofunds, bought a hedge fund administrator (IFS), took a whopping third of the US public funds market, and successfully managed the Scottish Widows conversion.

JPMorgan Investor Services – some interesting developments with front office products (e.g. trade cost analysis through Plexus and Inalytics), but mainly because they managed to persuade Dick Feehan to return to the fold and add some quality bloodstock to the EMEA sales effort.

PODIUM POSITION

Citibank – carelessly lost Francis Jackson, top product manager, but finally started to realise that fund managers don’t buy custody – they buy solutions. Citi has made serious breakthroughs by signing up distribution agreements with managers, a strategy that has brought them some big names (e.g. Pioneer, Britannic, Invesco).

Mellon – OK, so the fall-out with Clydesdale was uncharacteristically clumsy, and they wouldn’t pay the asking price for the Deutsche book, but another stellar year in Europe (and Canada). In 2003, though, they will have to do something about their lack of any substantial fund administration business in continental Europe: so far it has been all talk, no action.

HSBC – Mike Martin, the new director of Global Investor Services, could be just the tonic for this sleeping giant. With a new sales director in the pipeline, a more coherent strategy for Europe, and a very strong fund admin business in Edinburgh, this is the custodian to watch for 2003.

Northern Trust – typically understated year for Northern, which continued its long run of success with UK local authorities and also dipped its toe in the fund administration/outsourcing waters for the first time. A class player that continues to punch well above its weight.

STILL RUNNING

Brown Brothers Harriman – but running on the spot in 2002 as far as Europe goes. Having installed heavy hitter David Bilbé in London, they have failed to give him the ammunition he needs to make a difference. It isn’t at all clear what their true commitment to Europe is, and the relocation of Andrew Tucker to London is a puzzling development.

KAS Bank – rebranded but that’s about it. The bank has been putting together a Euronext solution and has made some impact in the UK pension fund sector. It will have breathed a sigh of relief when 4.9% shareholder BNY signed an alliance deal with ING.

Royal Bank of Canada – did someone turn the lights out? Despite some top-quality staff, RBC’s profile remains subterranean. That doesn’t mean it’s going to withdraw from the market, or has lost interest in Europe, but it’s a strange way to run a business.

LOSERS

Clydesdale – they ditched their name in favour of the bland and unmemorable National Custodian Services, and lost the key Mellon account, representing half of their assets under custody. Until the Australians release more authority to the UK, the prospects don’t look good.

BNP Paribas – They have completely lost the plot as a result of Euroclear’s expansion, and spent most of 2002 whinging about the unfairness of life when they should have been extolling the virtues of Cogent and their brilliant European network. No one likes their idea of a European securities services alliance, either. To cap it all, they somehow managed to miss a €9m hole in Cogent’s Australian books as a result of alleged fraud in the securities lending area.

All custodians – for investing in the GSTPA initiative.

NO GAIN, LOTS OF PAIN

London, 6^th December, 2002: For a group of firms that promote themselves on their ability to handle client assets, the shareholders in GSTP AG should be feeling exceptionally embarrassed by their total inability to look after their own cash. Managers, broker/dealers and custodians recklessly poured money into a project that always looked unnecessary, without ever holding out the prospect of making any returns for these investors. It seemed that every participant was asked to suspend commercial judgment and plain common sense, simply because GSTPA’s strongest proponents didn’t like the Americans. That is not a sufficient business case to build what amounted to an engine block without wheels or a fuel tank.

For the shareholders, the financial pain is spread pretty thinly, so no one firm will lose too much sleep. But the same cannot be said of the some of the providers to the project. SIS Group, owners of Swiss depository SegaInterSettle, has said that it will write off CHF40m ($27m), and other members of the axion4 consortium, such as SWIFT, will also need to provide for their losses.

The failure of GSTP should force managers of utility services, such as national CSDs or financial networks, to take a very hard look at their strategic raison d’être. Is it right that a CSD should become so heavily involved in a cross-border trade processing initiative, risking such a huge chunk of its participants’ money? SIS, for example, has always harboured international ambitions, yet has failed to make any impression beyond its own borders. Its involvement with the TFM looks like a desperate roll of the dice in a futile attempt to become a player on the global stage – but, had it not been SIS, other CSDs were also keen to gamble their shareholders’ cash. CREST, DTCC and Canada’s CDS were all involved in consortia that reached the final stages of the TFM selection process.

This collective madness is truly worrying. T+1 and the TFM have proved that the securities industry not only lacks strong leadership, but also a common goal. Managers do not share the views of brokers or custodians on how the market should be reformed, yet these pet projects continued to be funded until it was clear that they would never leave the hangar, let alone the airstrip. Without consensus about infrastructure improvement, every further initiative will go the same way.

This is the warning that should be ringing in the ears of those who want to build a pan-European solution for mutual fund processing. Without the buy-in of fund distributors, no solution will ever work, and those distributors are notoriously difficult to convince of the need to invest in automation. Further muddying the waters is NSCC, part of DTCC, which has announced that it is going to teach the Europeans how to do it by exporting its US platform, FundSERV, even though the international track record of the US clearing and depository firm is one long list of failures (e.g. International ID, IDC, EuroCCP). The seeds of expensive disaster and duplicated effort are already there.

The lessons of 2002 demonstrate that, above all else, focus is key. That is why the ETC project worked so well. The Industry User Group kept to a very narrowly defined project plan, excluding those, like custodians, who wanted to get involved but who would have diffused that focus. Until all the market players understand that, they will keep on paying for the pain without ever experiencing the gain.

AUF WIEDERSEHEN, PET

London, September 24^th, 2002: Scroll down to the bottom of this page and you will find an article written nearly four years ago – the first on this website – about Deutsche Bank and Bankers Trust. The angle of the piece was that, for the combined custody business to be successful, the BT senior management should be put in charge: Scary Mary and her bright young things were much more impressive than the leaden-footed plodders from Eschborn.

Sadly, we were never given the opportunity to discover whether that would have been the case. Although Mary Cirillo briefly ran the business - to give what she did the most generous interpretation - it wasn’t too long before there was a mass purge of practically all the BT staffers who looked as if they might be vaguely competent. To say that the people who ended up running Deutsche’s securities services business lacked strategic vision would be putting it mildly: they simply didn’t have a clue about integration and expansion.

Now State Street is volunteering to clean up the mess that remains. It is a bold, but highly risky, move by the Bostonians, who have yet to prove that they fully understand the European market. They are most comfortable in the US, where they now service some 40% of the public pension plan market, but that is a low-margin business, short of the global assets that generate such juicy FX and cash management earnings. State Street needs to be bigger in Europe, and Deutsche offers it one of the last high impact opportunities. Under different leaderships, State Street and BNP Paribas would probably have made a better combination, but dogma, politics and history have combined to ensure that such a deal would never happen.

The Deutsche business comes with plenty of unwanted baggage, such as a vast new operations centre in Edinburgh and a very fat layer of middle management. Those close to the negotiations say that Deutsche’s top dogs made it perfectly clear to potential bidders that there would be significant redundancy issues attached to the sale, even though the business has been stealthily cutting headcount for some time. This will be tough for State Street, which has a well-earned reputation as a caring employer: it disliked laying off 375 staff earlier this year, and will not enjoy the heavy culling necessary to get Deutsche’s operation into shape.

It also knows, even though it won’t yet admit it, that the profile of its senior management in Europe needs significant upgrading. Parachuting in Americans from the mother ship has never looked like the smartest idea, but now it will have to accept that a European business of this scope and scale needs a European head – or, at the very least, a predominantly European senior management team.

It took Mellon two years to see real benefits from its alliance with ABN AMRO, and three years for The Bank of New York to flush out all the service, technology and operational gremlins from RBS Trust Bank. Now State Street, which has no prior experience of acquiring and integrating a global business on this scale, proposes to enter that long tunnel in an effort to become the most global of the global players. Even BNY balked at the prospect, preferring to focus its attentions on the pioneering sell-side deal with ING. State Street’s seniors, and shareholders, must hope that the bank doesn’t choke trying to digest a typically large, and very fatty, German würst.

STP LITE - SAME TASTE, LESS GAS?

London, June 29th, 2002: Democracy doesn’t work. If you want the trains to run on time, you need a dictatorship. Allowing everyone to ‘have their say’ merely ensures total atrophy of government and maintenance of the status quo. Committees, working parties and review groups all contribute to analysis paralysis.

You do not need to be an extremist to hold these views, especially if you have had any involvement with the ill-starred T+1 project in the US. Under the aegis of the SIA, a large group of seemingly intelligent people came together to plan this major enhancement, supported by armies of sharp-pencilled consultants and eager software vendors. Some 17 sub-committees were formed, as well as the main committee overseeing the whole project.

The result was very much as might have been the case with any project run by a democratically elected government: every special interest and lobby group enthusiastically ground their own axes, whilst the heavy jellies meant to be leading the charge were too busy with their personal and political agendas to concentrate on the job in hand. No one was surprised when T+1 imploded earlier this month.

Of course there were mitigating circumstances, and it would be wholly unfair to blame the collapse exclusively on the shortcomings of SIA members. But a significant reason for T+1’s failure was the simple fact that there was never a truly compelling case for its introduction. The SIA and its consultants failed to identify the cost and risk benefits that had convinced the market of the merits of moving to T+3 in 1995.

Now that T+1 – considered by some to be the real catalyst for STP – is off the table, how will the market persuade self-managed pension plans and specialist managers, for example, to embrace same day affirmation and electronic allocations? Differential pricing would be one avenue, although both broker/dealers and custodians are reluctant to charge a premium for manual processing, for fear that their competitors will not.

This, surely, is an opportunity for the market to come up with creative, co-operative solutions that enable the small guys to keep on trading without having to invest in major technology upgrades. What’s needed is ‘STP Lite’, a concept that was partially pioneered by TradingLinx before it went under, where there is a cheap and basic plug-and-play option for money managers who cannot afford anything else.

Neither Omgeo nor GSTP are there yet, and they will need to be prodded hard by their clients and shareholders to get them to develop entry-level services. With SDA rates in the US still running at lower than 20%, broker/dealers and custodians have a huge incentive to fund the development of better transaction processing interfaces for the buy-side.

T+1 has demonstrated that fund managers will sit on their hands and wait for someone else to invest in improvement, however much grief it causes the rest of the industry. Bearing that in mind, there is absolutely no point in hoping that managers will react differently to the new STP agenda. Instead, their service providers should come up with imaginative alternatives that circumvent all the buy-side cost and resource excuses.

THE RUNAWAY TRAIN

London, May 10th, 2002: You will need to be a very dedicated student of the history of mismanagement to find a better example than the Global Straight-Through Processing initiative. From the outset – when it pompously imposed itself on the IDC/G15 working party – its representatives have proved themselves to be arrogant, myopic and out of touch. The only thing they have managed to do consistently well is to spend millions of dollars of other people’s money, much of it going to management consultants who have far too much power and far too little responsibility.

With no clients, no revenue and no product, GSTP continues to behave as if it had some divine right to control the matching business. Rather than work to fix the TFM’s shortcomings, it has tried to manipulate the SIA’s institutional trade processing model so that it fits the TFM, rather than the other way round. Because most of the people in the US controlling the debate on T+1 and STP are heavily compromised, there is every possibility that GSTP will get away with it.

The one small saving grace of GSTP was that it was an industry initiative, owned and run by its ultimate users. This was a conscious decision, taken to ward off those nasty commercial interests like Thomson ESG, who were only interested in making money. That, apparently, is simply not acceptable. Yet now GSTP has sold a stake in itself to SunGard, which by all appearances looks like a profit-driven commercial vendor – and one, incidentally, that has expressed serious interest in becoming a virtual matching utility, in competition with GSTP and Omgeo.

What, precisely, was the point of firing axion4, the consortium that was originally hired to build and operate the TFM? In April, GSTP said that it ‘will assume direct responsibility for the operation of the utility, migrating from axion4’. One month later, it is getting rid of that ‘direct responsibility’. If there has been a thought process behind this, a lot of people are wondering what it is. Were other vendors invited to pitch for the business? What is the precise nature of the agreement? Will SunGard be represented on the GSTP board? Typically, these are questions that have been left unanswered.

GSTP has come to represent everything that is rotten about the securities industry – a toxic brew of vested interests, double-dealing and management ineptitude. The deal with SunGard merely confirms the long-held suspicion that this is an initiative with all the characteristics of a runaway train. How much more money, time and effort need to be wasted before these people come to their senses?

WHERE THERE’S A WILL THERE’S A WAY

London, March 11^th, 2002: Europe’s finest securities players have just missed a golden opportunity to save lots of time and money. In the constitution of the European Securities Forum (ESF) there is a ‘sunset clause’, mandating that it be wound up in April of this year unless otherwise decided. But, instead of the membership invoking the clause, and putting the wretched beast out of its misery, they actually decided to keep on going. "The ESF will enlarge its membership to reflect more fully the nationalities of the EU," they said. "It will accordingly invite the other major investment banks in Europe to join." They also said that London may not be the most suitable location and this would be discussed with the new executive chairman.

There are lots of clever people in the securities business, many of them based in London. But this decision reminds us that clever people can also be unbelievably stupid. What is ESF for? In December it reminded us of its plans "to enhance its role in pursuit of a pan-European capital market through consolidation of clearing and settlement, and appropriate and enabling regulation". Successes to date on this front have been non-existent. Last year ESF tried and failed to engineer a pan-European central counterparty (EuroCCP), wasting a good nine months of members’ resources. It also reacted adversely to Deutsche Börse’s plan to take over Clearstream, saying that it favoured a merger between Clearstream and Euroclear. That merger might have been the ideal outcome, but money spoke much louder than principles. Cedel shareholders, many of them members of ESF, have managed to overcome their objections to vertical silos, helped by a fat cheque from the Germans.

Having achieved a 100% failure rate on its major objectives, it is now aiming both barrels squarely at its own foot. Its current membership is pretty representative of the world’s major players, so who exactly are "the other major investment banks in Europe" and what will they bring to the party? And the idea that it could be based anywhere but London is quite astonishing: should it be in some hotbed of cross-border securities trading like Lisbon, perhaps?

ESF has failed because its members never had the will to make it succeed. It became a talking shop where increasingly junior people would turn up to talk about increasingly unimportant matters. A broader membership makes that more, rather than less, likely. Having already punctured a huge hole in the ozone layer with its hot air, the last thing we need is more of the same, only in a dozen languages.

For a lobby group to have any credibility – and therefore influence – it has to say what it means and mean what it says. ESF says that, "it continues to believe strongly in a horizontal structure which separates governance of clearing and settlement from trading platforms", yet its members voted otherwise when the Germans came calling. Only JPMorgan and UBS publicly demurred.

Once reorganised, ESF says that major policy decisions will be endorsed by a new Advisory Council of up to 10 "very senior individuals" from members to maximise their strategic impact. But neither that, nor a new executive chairman, will necessarily help the Forum to establish itself as a body worth listening to, if its members pay absolutely no attention to those major policy decisions. In the US, the Securities Industry Association has built a model that works: in theory, there is no reason why it can’t happen in Europe – except, of course, the absence of a collective will to make it so.

WIN SOME, LOSE SOME

London, January 7^th, 2002: What a wonderful way to start the year: State Street loses one of its most valuable executives to Brown Brothers Harriman, an institution that is as close to royalty as we have in this business. After a storming seven years, during which he transformed State Street’s London business from a niche player into a heavy hitter, David Bilbé will be hoping to weave the same magic with BBH, which has been an effective but rather quiet player in Europe.

There are a few similarities between Bilbé’s new and old masters, the most striking being that they both missed out on the great British unit trust bonanza of the late eighties and early nineties. They each have huge strengths in the US mutual fund business and, for different reasons, are somewhat conservative when it comes to international operations. Both are also strong technologically (even though they both insist on sending press releases by fax, sometimes several times).

That is where the similarities end. Regardless of the perception that it is determined to shoot itself in the foot, State Street is a big player in Europe, with clients from most of the major investment markets. It has had a European transfer agency business for 10 years, and has been in London for more than a quarter of a century.

BBH, by contrast, is just at the very beginning of its European adventure. It has operations in Luxembourg, Dublin and Zurich – but, until last year, it had no securities lending or treasury desks in London. It finally launched its OEICs depositary and unit trust trustee subsidiary, BBHISL, in January 2000. This is hardly what you’d describe as trailblazing. That is not BBH’s style.

But it does recognise that the time has come to step up a gear or two. Europe is the theatre of war, and BBH needs a four-star general to lead the assault. Bilbé’s track record is impressive – which makes it all the more bizarre that he was moved from his business development role at State Street to a fluffy, wholly unsatisfactory strategic assignment. State Street’s loss is BBH’s gain.

THE ART OF THE POSSIBLE

12^th November 2001: There is a growing lobby against the concept of T+1, driven in no small part by the feeling that the benefits simply do not outweigh the costs and efforts involved. A succession of industry ‘experts’ have begun to question the validity of the US approach, which will inevitably be mirrored by other markets, most notably Japan and Canada. Interestingly, the Europeans seem far more relaxed about the whole issue, possibly because they have worked out that there are other, cheaper ways to mitigate risk and improve efficiency.

But T+1 and its shortcomings are not where the real game is at. Connoisseurs of securities industry politics are much more interested in the continuing dance of death between Omgeo and the GSTPA, a struggle that has moved well beyond commercial considerations and has instead become some kind of macho arm-wrestling contest between a very small group of players who seem determined to ignore the best interests of their clients. On the one side sits Omgeo, which appears to have decided that its massive client base justifies its image as the school bully. On the other is GSTPA, still gamely pretending that it has an independent future as well as some kind of unique market value.

Every sane person knows that the two entities will have to merge sooner or later, yet serious discussions are being held up by personal, rather than professional, considerations. Some senior people in Omgeo – largely from the DTCC camp – want to bury GSTPA, arguing that it has no intrinsic value and any money it might pay to effect a merger would be accounted for purely as goodwill, a commodity in short supply. This position is used to disguise the level of personal animosity felt by some of the Omgeo managers towards GSTPA.

But the big cats who have been consistent boosters for GSTPA – many of whom are also Omgeo clients and even golf partners of the very people now trying to bury them – will not give up so easily. No one wants to admit that they were wrong to try and take on DTCC and Thomson Financial; this is not about money, which is too trivial even to mention, but about face-saving. For GSTPA to come to the party, the top industry bananas need to believe that their actions will be recognised by the industry as altruistic and honourable.

As with the achingly tedious Clearstream/Euroclear schism, the gulf between GSTPA and Omgeo has more to do with settling scores than any fundamental commercial concerns. And, as so often happens, the clients come last. Much as they might complain, however, they really have no alternative but to continue to use Omgeo and finance GSTPA.

Insiders suggest that Jill Considine, head of DTCC, has an ambition to enter politics. But the way in which she and her senior managers are conducting themselves over some kind of accommodation with GSTPA suggests that they all have a lot to learn about the art of the possible.

THE NEXT BIG THING

London, 3^rd September, 2001: For compulsive committee joiners, this year’s fashion has been European central counterparties. The European Securities Forum has devoted much of its time and energy to the subject, sadly to no avail. In July, ESF admitted defeat, citing ‘profound obstacles of law, regulation, technology, national and commercial interest, and frankly cost, which make immediate progress towards a single EuroCCP unlikely’. It also accepted that ‘the move by some trading platforms to public flotation, dependent in part on income streams from clearing and/or settlement services, has raised the stakes, and at the same time the barriers to a single EuroCCP’.

Putting aside the obvious observation that it seems remarkable that ESF took nine months to work this out, the failure of the EuroCCP initiative means that its members have to find other fish to fry. The most generous interpretation of ESF’s progress to date would be to say that it has had a limited impact. On its two key priorities – CSD consolidation and EuroCCP – it has largely failed. It played no significant role in the DBC/Cedel merger, or Euroclear’s mergers with Sicovam, Necigef and CIK. Neither has it advanced the discussions between Euroclear and Clearstream, both of which seem fully occupied on other projects.

What, then, will ESF and its members get their teeth into next? Many observers believe that, without direct intervention from the European Commission, there will never be any incentive to improve clearing and settlement practices in Europe. Lamfalussy’s Wise Men have already suggested that, if the private sector proves incapable of delivering such improvements, there will have to be a ‘clear public policy orientation’. The Eurocrats in Brussels being notoriously keen on such incursions, they will need little prompting to begin the process.

Having discovered rather late in the day that publicly held companies do not enter into altruistic projects that help the market but not their shareholders, ESF must now urgently turn its attention towards steering the Eurocrats in the right direction. Pan-European harmonisation of securities processing will be notoriously tricky – just think of issues like insolvency, tax and stamp duty – and the overfed Commissioners and their advisers will struggle to understand such intricacies. Left to its own devices, the European Commission will come up with proposals for reform that no one likes. ESF could help it to avoid such a disaster, whilst lobbying for change that keeps Europe competitive.

This mission requires a completely different set of skills, as well as a much heavier commitment from ESF’s members. It needs to broaden its membership to include the CCPs and CSDs, and to acquire the necessary expertise to begin a sustained campaign in Brussels that will deliver the results it has so far failed to squeeze out of individual players. Regulation is the next big thing – ESF’s members can either shape it, or be shaped by it.

SMOKE WITHOUT FIRE?

London, May 17^th, 2001: Very few people in the clearing and settlement world have evoked such strong feelings as André Lussi, the suspended president and CEO of Clearstream International. The reaction to the announcement that he has ‘stepped aside temporarily from his responsibilities’ ranged from disbelief to delight. Lussi is respected as a tactician, but that does not make him hugely popular. Some, like Tom Perna at The Bank of New York, think he has been wilfully obstructing a merger between Clearstream and Euroclear, despite his public protestations that he supports the concept. But will his suspension make such a merger any more likely?

On the face of it, the answer is no. It is common knowledge that Deutsche Börse, which owns half of Clearstream, will take this opportunity to try and buy the other half. It had, reportedly, already made such an offer just before the furore over Lussi erupted. Does this strengthen its hand in the negotiations? Much depends on the attitude of the big German banks, which have a great deal to lose if Deutsche Börse ends up controlling trading, clearing and settlement in Germany. There is a feeling that this would be just another step in Deutsche Börse’s effort to control European markets: once it owned 100% of Clearstream, the argument goes, it would be in a much stronger bargaining position with Euroclear, which has neatly tied up clearing and settlement for Euronext.

The big European players do not like this plan. The European Securities Forum issued a particularly blunt statement about it:

‘We have seen reports that Deutsche Börse is seeking to gain majority control of Clearstream. At first sight this seems a move in the wrong direction. This is because we believe that a vertical silo of trading, clearing and settlement in a single group leads to higher costs for market users and investors. As explained in our Principles, which embody the views of ESF's 28 member banks, vertical silos tend to lead to cross-subsidisation of trading platforms by earnings from clearing and settlement. Vertical silos can thus prevent the major cost savings and economies of scale, which could be achieved through horizontal integration of Europe's clearing systems and through consolidation of settlement. We continue accordingly to favour a merger between Clearstream and Euroclear. However we need to see the details of such a proposal before reaching a considered view.’

It would be entirely forgivable if Clearstream’s other shareholders decided that enough was enough, and pushed through a deal with Euroclear, despite negotiating from a position of weakness. But those shareholders should stop and reflect before rushing into the arms of the Belgians or the Germans. In all likelihood, the investigation of Clearstream by the Luxembourg authorities will reveal nothing earth shattering and, even if it does, so what? How many of Clearstream’s shareholders and clients have had their hands burnt in money laundering scandals? How many chief executives stepped down as a result? And how many found themselves so weakened by the revelations that they had to merge with their closest rival? The business isn’t going to go belly up on the strength of these difficulties, so why panic?

André Lussi has made a lot of enemies, and they are now queuing up to kick him when he’s down. They conveniently forget that it was his vision to create a European clearing house, and that much of the depository consolidation to date can be attributed to his efforts to get the concept off the ground. Lussi launched his blueprint for the clearing house on May 14^th, 1999. It is an irony that, almost two years to the day since that launch, his removal from office, however temporary, may be the catalyst for real consolidation.

THE SWILL-BUCKET

London, 8th March 2001: Hats off to Mellon, which is understandably very pleased about its good showing in this year’s R&M Consultants custody survey – up from 11^th to 7^th with a 20% increase in its overall score. Mellon’s dramatic improvement in its service quality shows what can be done when a custodian, however large or small, decides that things have got to get better.

Some of Mellon’s competitors could do worse than to pop round and have a chat about how to achieve this. Citibank, for example, continues to perform woefully, but that has become a bit of a non-story. But the overall results suggest that most custodians had a pretty mediocre year, with eight of the thirteen recording reduced scores in the overall rankings.

Perhaps the only real shock of the survey was the savage way in which respondents – especially pension funds – marked down Chase (now rather foolishly known as JP Morgan Investor Services). In the pension fund category, Chase dropped from 2^nd to 8^th, losing almost 10% of its previous year’s score. Insurance companies like them little more, relegating them from 4^th to 8^th. Amongst several unflattering assessments of Chase’s performance, one seemed to sum up many of the frustrations: ‘Chase offer a reasonable core product as a result of "factory processing" in Bournemouth but this can lead to inflexibility. The Chase proprietary systems are dire, they are the bane of our IT department and of limited benefit to the users. The service for the Luxembourg funds is appalling.’

But the real lessons of this increasingly influential survey do not come from a snapshot of a single year’s experience. To be fair to Chase (I know, it doesn’t sound right, does it?), its long term performance in this and other surveys has been very good, and all the signs are that it will recover from what is probably a blip. The above respondent’s complaints about Bournemouth are a bit rich, because everyone knows that it’s a factory – that’s the whole point. And, if you didn’t already know that Chase’s technology is off the pace, and has been for years, then it serves you right for using them.

What the table below demonstrates is how consistent Chase has been over the last seven years, and how close it is to Northern Trust, which is about a sixth of its size. Over the period, Chase is the best performer amongst the biggest players, though the margins between top and bottom remain pretty thin. But the fact remains that it scored worse this year than it did in 1995, along with BNY. They may claim that this is because client expectations are much higher than they were back then – but who encourages that process? If the custodians continue to puff their products and capabilities to such an extent that their clients will almost inevitably be disappointed in the delivery, then their marketing efforts will indeed be nothing more than ‘the rattling of a stick in the swill-bucket of capitalism’. Mellon may turn out to be a useful role model of how it should be done in future.

Source: © R&M Consultants Custody Surveys 1995-2001. For more information, contact R&M Consultants on 44 (0) 1428 684649; e-mail  richard@clientalkback.com

SPONGERS

London, 26^th January 2001: Sometimes you wonder whether it’s all worth it – or at least I do. Last week I received a call from a guy at JP Morgan Chase, wanting to know if I would tell him the names of subscribers to this website from his organisation, because he didn’t want to subscribe but would just use someone else’s user name and password. He was a bit surprised when I declined to do this.

He’s not alone. At the last count, about 20 firms have tried to get access to the system without paying. One enterprising fellow from Citibank in New York even gave a false company name for the invoice, forgetting that the address would give him away.

Not the most heinous of crimes, but there is no shame from some of the world’s biggest companies. Consider these two messages, e-mailed to me last year:

"Hello Richard.

First, I present mysefl.
I'm a manager of Arthur Andersen in Barcelona (in the Financial Sercices
Industry).
Now, I'm doing a study on Custody & Settlement to advise the players of de
Financial Industry (mainly banks, savings banks and Stock Exchange) what are the
advantatges ang disadvantatges of being with a Global Custody (Deutsche Bank,
Bank National of New York, Societe Generale, Dresner, Chase,...) or with a
International Settlement System (Euroclear or Clearstream).

I have read on the "Financial News (13-19 November 2000)" your article about:
"Custody & Settlement - BNY and State Street are moving up the value chain: Top
Players extend their range".

I would be gratefully if you could give me your opinion about our preliminary
conclusions. I tried to sumarize them in the next scheme:
(Embedded image moved to file: pic28527.pcx)
Your opinion ....:

I would be gratefully if you could give me your feed back about those
preliminary conclusions and if you want to complete the advantatges and
disadvantatges, with your deep knowledge about Custody & Settlement.

Thank you very much for your atention."

"I am currently doing research on the global custody industry and can't find
one specific piece of information. Andy Stephenson from Globalcustody.net
advised me to contact you, as he was not able to help me on this point.

I would like to identify the banks/custodians that expressed their intention
to sell their custody business. Would you by any chance have material on
that subject or, if not, could you please let me know where I could find
this type of information. Any help or hindsight that you have on this would
be greatly appreciated.

Thanks.

Best regards,
(name supplied)
CREDIT SUISSE FIRST BOSTON"

Sadly, these are not isolated incidents. Consultants, bankers and headhunters frequently call in the certain expectation that I will give them my time, and expertise, for free. Well, why shouldn’t I? Wouldn’t they do the same for me? I’m convinced that, if I rang CSFB and asked them to handle an IPO for me, they’d never dream  of asking to be paid for it.

The strange thing is, the worst offenders are the consultants, who should know better. But they think absolutely nothing of ringing or e-mailing to try and get something for nothing, even as you can hear the meter ticking on their desk. Is it ignorance, arrogance or a complete dislocation from the real world? Don’t bother to send me your answers – I already know!

ANOTHER FINE MESS

London, 2^nd January, 2001: Welcome to the third millennium (yes, I’m one of those irritating pedants who thinks the rest of the world got its sums wrong). In this brave new world, where bandwidth and processing power are everything, it’s reassuring to know that we are not so far removed from good old-fashioned incompetence and mismanagement. I refer, of course, to Lloyds TSB Securities Services (LTSS), and the revelations last November about the dreadful lapses of control that led to it being fined GBP100,000 by its regulator, IMRO.

The charges against LTSS almost beggar belief – I say almost, because a lot of people had long suspected that there were serious operational and technological holes in the business. When the decision was made to close down LTSS, rather than sell it, those suspicions were further raised. IMRO’s report confirmed them.

At roughly the same time as LTSS was apparently leaving bearer stock all over the place, along with the keys to the safe, The Royal Bank of Scotland was also exercising its rather relaxed method of accounting for client assets, which subsequently led to a very impressive fine by IMRO of GBP250,000. RBS managed to sell its business to The Bank of New York, but you don’t see many of the RBS custody managers at the top of BNY’s organisational structure in Europe. Isn’t that a surprise?

Although we can laugh at all this with the benefit of hindsight, these stories should set alarm bells ringing with custodians’ clients. Both LTSS and RBS pretended to be well-run shops, but now we know better. They were pitching for new business, and talking up their operations, at the very same time as they were breaching regulations left, right and centre. Are they the only two custodians ever to have been guilty of such a crime? I hardly think so – and let us not forget the jumbo USD60 million fine that Bankers Trust had to pay in 1999 after it was found to have falsified client records and siphoned unclaimed client balances into its P&L account.

It is difficult to tell when a custodian is having problems. They are all exceptionally good at presenting a serene, assured face to the outside world, even as the back office is imploding. Right now, one major global custodian is widely reported to be suffering very badly, both in operations and client service, but you would never guess it from their demeanour.

These things tend to catch up with you eventually. It is no coincidence that most of the worse-run custodians have gone out of business: when a bank says that custody no longer forms a core element of its strategy, it really means that it has failed to make it work because its senior management couldn’t get to grips with it. And, even today, with all the shiny new technology at their disposal, there may yet be custodians that cannot design and implement adequate controls over client property. It is a sobering thought that custodians may be able to send accounting data to a client’s WAP phone or personal digital assistant, but that won’t be much use if they don’t know the precise amount, nature and location of the client’s holdings.

IT’S MY (COUNTER)PARTY AND I’LL CRY IF I WANT TO…

London, October 23^rd,2000: By now, we should be used to it. The big investment banks don’t like the way things are going, so they puff out their chests and wave what they consider to be the ultimate big stick: the threat to do for themselves whatever it is that they don’t think is getting done properly elsewhere. At other times it has been bond and FX broking, alternative exchanges and STP; now it is the central counterparty. Frustrated by what they describe as ‘disappointing progress with an alternative approach by the European Securities Forum to persuade existing service providers to come together to create a single CCP for Europe’, the big boys have decided that they should show them how it is done.

Were it not such a criminal waste of time and money, it would be laughable. These banks have an extremely limited understanding of how to build and run a fully functional clearing house that offers both netting and a central counterparty (CCP) across all financial instruments and markets, yet they are proposing to produce ‘a detailed blueprint, hopefully (sic) by the end of the year’, with an RFP to follow. Many of the houses involved have already demonstrated, through ventures like electronic crossing networks, iX, GSTPA and the Clearstream/Euroclear merger talks, that they are poorly equipped to handle any issues connected to infrastructure development. They are accomplished bullies, but less experienced at making positive and constructive progress.

The list of established central counterparties in Europe is short - LCH, Clearnet, Eurex and ESCC – but, between them, they cover a pretty impressive range of markets and asset classes. Two weeks ago, ESF chairman Pen Kent admitted that the talks between them were going nowhere. This is hardly surprising, given that Clearnet is now concerned primarily with satisfying its obligations to Euronext, whilst LCH works on its CCP projects with the London Stock Exchange and with virt-X.

It also appears as if no one from ESF read the interview with David Hardy, chairman of LCH, in the spring edition of Global Custodian magazine. Asked is he foresaw the emergence of a single European clearing and central counterparty provider, he replied: ‘I cannot imagine that any one of the three large players in Europe - Eurex/DTB, Clearnet and LCH - would make a play for either of the others. We are too different at the moment. LCH and GSCC have formed a successful alliance (ESCC) because we have similar structures and roughly the same user base, and neither of us is looking to compete with the firms or trading platforms which own and use us. Clearnet, by contrast, is a 100% subsidiary of the Paris Bourse. Eurex, similarly, is part of the Deutsche Börse. Unlike them, we are not the captive of any trading platform or settlement organisation. So it would be very difficult for us to come together unless our structures move closer to one another.’

The unknown quantity in all of this is DTCC, which has been having discussions with some of the ESF members about the design of a CCP. It is obviously keen to make some sort of move in Europe, having already become involved through ESCC, and has suggested in the recent past that it is willing to consider further alliances like the one with Thomson Financial. Apart from the fact that it knows all about netting and clearing, its main attraction might be that it has no particular affiliations to European exchanges.

The hope is that this whole episode is nothing more than the usual bluff and bluster we have come to associate with these firms. A year ago, many would not have known how to spell central counterparty, let alone have a clue as to what one did, but now they are all experts. Their approach to what is an incredibly complex problem is accompanied by the strong sound of feet being stamped and toys being thrown out of the pram. Is that any way to run a business?

IF YOU THINK WE'RE BAD...

London, September 26th, 2000: What effect has CREST had on UK custody? Judging by the recent results of the esteemed Global Custodian agent bank survey, the answer is very little. Whilst CREST has completely revolutionised market practice - with lower fees, dematerialisation, better registration turnarounds and a more effective way of handling securities lending, inter alia – it seems that the custodians offering a UK service have been wholly incapable of taking advantage.

The editors of the Global Custodian survey have often sought to find mitigating circumstances for the poor performance of UK agents, referring to the ‘challenges’ and ‘idiosyncrasies’ of the market, but that shows a generosity of spirit that is sadly misplaced. The simpler truth is that the UK agent banks have never made much of an effort to deliver a proper service and, now that HSBC is the only game in town, the clients’ ratings continue to decline. In a remarkable effort, The Bank of New York’s UK operation – largely based, one assumes, on RBS Trust Bank – recorded the lowest scores in the entire survey of 24 markets.

HSBC has recorded lower scores for each of last five years, and has not been a top-rated custodian since 1995 (as Midland Securities Services). Its 2000 score of 4.69 compared to the global average of 5.11. HSBC’s custody managers are good at bleating about the difficulties of the market, but apparently less proficient at pushing through change. They like to talk about their dominant market share, but cannot translate that into anything approaching the influence such a position should command.

In a staggering act that suggests HSBC is either supremely arrogant or extraordinarily insensitive – or, quite possibly, both – it has recently despatched reprints of the Global Custodian survey that so clearly points to its long-term degradation of service levels. In any other country, this would not be used as a marketing opportunity – ‘If you think we’re bad, look at the competition’ – but the UK is different. For a market that is meant to be one of the world’s major international financial centres, the UK’s custody capabilities should be the source of great shame. The survey suggests that the strongest emotion is studied indifference.

TURNING UP THE HEAT

London, August 17th, 2000: Chase’s spectacular – if long trailed – capture of the Schroders’ outsourcing mandate is the latest in what is becoming quite a flurry of activity for a business line that has often seen more talk than action. At the start of almost every year for the last decade, custodians have predicted that outsourcing will be the next hot thing. But, in the UK at least, it has never been anything more than tepid. The fall of Schroders, however, may signify the beginning of something substantially warmer.

American custodians have long maintained that outsourcing is a way of life in the States, but that is being slightly economical with the actualité. Whilst it is true that mutual fund companies like to outsource daily NAVs and shareholder recordkeeping, their lead has not been followed by many institutional fund managers – until, of course, the massive JP Morgan Investment Management deal, for assets valued at around USD321 billion, which went to The Bank of New York last year.

Before Schroders, this year’s big deal had been State Street’s agreement to acquire the entire back office operation of PIMCO, the fixed income specialist, including taking on 300 staff in Newport Beach, California. The PIMCO transaction is critically important for State Street as, if they get it right, they can franchise their expertise all over the world. It will probably take between eighteen to twenty four months before we know whether they have succeeded.

Saloon bar wisdom suggests that, once you take on a big outsourcing contract, you put yourself out of contention for any others. But that has now been challenged by BNY, which has recently agreed terms with Julius Baer for another deal. Some question the ultimate profitability of these contracts, but that probably misses the point: in outsourcing, critical mass is key. That is why State Street is so excited about the potential of the PIMCO deal: now they have the infrastructure, everything else they do will be at marginal cost.

In the UK, outsourcing has fizzled more than fizzed. Most people forget that the largest deal of all remains the Mercury/Warburg contract (now enduring as MLM/BNY), and even fewer remember that Cogent put together a comprehensive service for Aberdeen Asset Management a couple of years ago. The UK deal with the highest profile is Prudential’s arrangement with the Mellon/HSBC alliance, although that appears to be under threat as M&G has the capacity – and the reported willingness – to take it all back in-house.

Schroders has been wrestling with its decision for many years. In part, the debate caused the unexpected departure of John Lambert, their highly talented operations director, who was unable to agree with various parts of the strategy and approach. Schroders was always very keen on transferring risk as part of the deal, but it is unlikely that Chase will have taken on everything Schroders was looking for.

Custodians know that the ability to provide outsourcing services will be critical in the battle for market share in the European mutual funds sector, but few are properly qualified and structured to offer them. Chase, State Street and BNY are the only players yet with any significant business. Deutsche, Citi and Mellon all have the necessary components. Outside that group, it is difficult to think of a custodian with the scope, scale and product range to sell outsourcing effectively, although Brown Brothers might just do it.

As we have known all along, this is going to be a seller’s market, where demand significantly exceeds supply. Custodians will rightly be choosy about whom they take on as clients, but that doesn’t necessarily mean that tariffs will escalate – after all, the big custodians are pretty much interested in the same group of clients and will compete fiercely to win them. The cost of this concentration of power amongst a few players is not so much in the fees, as it is in the time it will take to strike a deal with a provider. For some, that delay could be the difference between survival and death.

THE MEN AND WOMEN IN GREY SUITS

London, July 7th, 2000: For two weeks of the year, every man, woman and child in Britain becomes an instant authority on tennis. Whilst public courts remain steadfastly empty, front rooms the length and breadth of the country are filled with temporary devotees of a game that almost none of them plays. After Wimbledon, the country quickly returns to its more usual antipathy towards any sport that doesn’t feature a football in it.

Part of this ritual involves bemoaning the fact that there are no ‘characters’ in the game any more. We all loved the old characters like Nastase, Connors and McEnroe, according to tennis pundits, and wish there were more of them today. For many of us, this is utter tosh, but it is a contention that is routinely peddled, as if the game had once been full of these lovable rogues and being boring was the exception rather than the rule (just think of Lendl and Borg and you’ll realise what rubbish that is).

But now, to my horror, I find myself thinking exactly the same thing about the custody business. Let’s face it: few businesses are as intrinsically tedious as global custody. There are not a lot of laughs, or intellectual challenges, in tax reclaims and corporate actions. You don’t get much of a thrill from settling through Euroclear. And on-line portfolio reporting is hardly in the same category as the swimsuit edition of Sports Illustrated.

The business is largely rescued by the people who run it and work in it. Over the years, there have been some highly colourful individuals, from Derek Stubbs to Dick Feehan. Many attended the Chase finishing school under the headmastership of Colin Grimsey, the Big Daddy of the business and a man with a definite joie de vivre. In a world of actuaries, accountants and trustees, these people managed to have fun and make the tedium considerably more bearable.

Where are their replacements? Sadly, it seems that the next generation of custody managers, who are now cutting their teeth in the hinterlands of regional insurance company mandates, are already substantially more serious than their predecessors. Custody is a big business, they seem to be saying, and is no laughing matter. The days of wine and roses are behind us.

Well, not quite. It is encouraging to see that Richard Warner, who worked with Grimsey at Chase and taught the rest of the industry how to run an agent network, has landed on his feet at Dresdner, where he will team up with another heavy jelly, Steve Lomas. Both have contributed huge amounts to the business, but have also managed to retain a great sense of humour and a very well developed ability to enjoy themselves. There are others like them, but it is a diminishing breed – and that worries me. If all the managers become as dull and drab as their products, what will there be to write about?

BRINGING UP BABY

London, 6th June 2000: Last July I wrote about the strange behaviour of some of the people connected with GSTPA. I suggested that better communication, and a more open approach, would be of considerable help in winning people over to a project that was, after all, nothing more than a long winded series of PowerPoint presentations and progressively chunkier membership invoices.

Naturally enough, the response of those at the top of GSTPA was to continue as before – that’s the sort of influence I have. But I am surely not alone in observing that many of those industry figures who are apparently in charge of the project seem immune to criticism and hugely arrogant. The attitude has always clearly been that there is no alternative.

Except that now there is. As outlined in the article below, the Thomson Financial/DTCC deal offers some real choice to the market. The combination offers something different, and something tangible. Its clients will not be asked to cough up huge gobbets of money to pay for a system that is being built from scratch. And, of course, the big US players have the most to gain from a link-up between the two, as it will draw together the US trade allocation and affirmation processes for the first time.

So how do you think GSTPA has responded to this? In a press release, it said that it ‘applauds the recent announcement by DTCC and Thomson ESG, on the creation of a new commercial venture for the US marketplace. We look forward to interoperating with this new entity as it focuses on the US market and its T+1 solution. We look forward to meeting with the leadership of this new venture to pursue discussions on interoperability for cross border processing whenever appropriate, and extend to them our very best wishes for success as they seek to form their new enterprise.’

The response beggars belief. Having read and re-read the press release, and having reviewed my interview notes, I could find no reference from anyone at Thomson Financial or DTCC to the joint venture being focused on the US market. So I went back to Thomson to be sure. They appear to be as baffled as I. Why would GSTPA say these things?

There is no easy answer to that question. The broker/dealers – especially the big ugly Americans like Merrill Lynch, MSDW, Goldman Sachs and SSB - have been the noisiest and nastiest proponents of GSTPA. They have the most to gain from improvements in trade processing, and they are prepared to throw a lot of money at the problems. Whilst they pay substantially more for their membership of GSTPA than their fund manager clients, broker/dealers also dominate the executive committee. GSTPA is their baby. And, as everyone knows, proud parents do not like to be told that their baby is about as attractive as Edward G Robinson.

The Thomson/DTCC proposition puts them in a difficult situation. They are clients of Thomson, and clients and shareholders of DTCC. Because of the ridiculous politics surrounding the contract awards for building the TFM and the network, neither Thomson nor DTCC was given a slice of the pie. Now they want to set up their own party, and they have the critical mass and the products to do it. Broker/dealers simply do not know how to react. Of the four I called when researching a recent story for Financial News – UBS Warburg, Merrill Lynch, MSDW and Goldman Sachs – not a single one had anything to say either on or off the record. Even allowing for the fact that their press offices are largely staffed with sufferers of post-lobotomy stress disorder, this would suggest that no-one has yet come up with a good reason to continue chucking major wedge at GSTPA. Whilst we all know that broker/dealers are not rocket scientists, even they can surely understand that you do not throw good money after bad. And if they don’t, they should contact me about some really good swampland for sale in Florida…

THINKING THE UNTHINKABLE

London, 29th April, 2000: Less than one year ago, Thomson Financial won a major victory in the US when it forced an end to the market rule (known as 387) which effectively gave the Depository Trust Company a monopoly over the provision of electronic trade confirmation services. The battle was long and bloody, and neither DTC nor Thomson emerged with too much credit from it. But it served to prove a point: the allocation and confirmation process in the US needs streamlining and consolidating.

That, in part, is the motivation behind the decision of Thomson Financial and DTCC (as it became after merging with NSCC last year) to create a new joint venture. This business will effectively take on all the assets of Thomson Financial’s ESG (Electronic Settlements Group) and the non-depository functions of the DTC, which is now a DTCC subsidiary.

Streamlining apart, there are plenty of other solid commercial reasons for the deal. Neither Thomson Financial nor DTC are involved in the consortium currently trying to work out a way to build a solution for GSTPA: Thomson declined to bid, whilst DTC was mysteriously passed over for final selection after being heavily tipped as a leading contender. Some suspect that the Europeans lobbied strongly against DTC’s inclusion, muttering darkly about American imperialism.

But, if you combine the product strengths of Thomson and DTC, you come up with an extremely powerful franchise, and one that makes the GSTPA blueprint look redundant. For example, Thomson Financial has global reach but no links with custodians, whilst DTC has precisely the opposite profile. Put the two of them together, and you have answered the question posed by Howard Edelstein, the president and chief executive officer of Thomson Financial ESG: ‘How do you bring together and integrate the whole community of users?’ The major weakness of Thomson’s new platform, Intelligent Trade Management (ITM), is that it lacks links to the custodians. With DTC, that problem is solved.

DTC has domestic concerns, too. It is increasingly worried that the market won’t get to T+1 unless there is a fully integrated clearing and settlement process. Linking to ESG makes that task all the more straightforward. ‘The market has been telling us that we (DTCC and ESG) should be working much more closely together,’ says Bob McGrail, managing director and head of new business ventures for DTCC.

The deal looks brilliant on paper – but that’s all it is at the moment. Nothing is likely to happen formally until the third quarter, and there is a risk that the cultural gap will be just too hard to bridge. You’d be hard pushed to find two organisations more diametrically opposed when it comes to their approach to business, but both sides are adamant that they can make it work as a commercial venture that adopts the best practices of each partner, rather than settle for compromise.

But the biggest question is one that neither DTCC nor Thomson can answer. If the joint venture works, where does that leave GSTPA? Some of the biggest shareholders and clients of DTCC are also proponents and sponsors of GSTPA: will they seriously consider continuing with a project that is unlikely to deliver anything vastly superior to what Thomson and DTCC will have by the end of this year? Will pragmatism overcome pride? DTCC and Thomson have set a very important precedent, setting aside their past differences to create what may become the first genuine global trade processing platform. To get to this point, they have thought the unthinkable: can the GSTPA executive committee do the same?

THE YELLOWBRICK ROAD

London, 30th March, 2000: ‘Hurrah! Hurrah! The wicked witch is dead!’

That was reportedly the message that zipped around Deutsche Bank’s internal e-mail system when it was announced that Mary Cirillo, head of Global Institutional Services, had decided to leave. Scary Mary had not exactly built a solid fan club for herself in the brief time she ran GIS; in failing to make tough organisational and business decisions, she allowed the ship to drift whilst competitors steamed ahead.

Few will therefore feel anything but relief that Hermann-Josef Lamberti, the impossibly youthful main board member who runs Global Technology and Services, has acted so decisively to re-invigorate the team that runs GIS. In comes Jim Zeigon, erstwhile head of Global Services, Chase’s equivalent of GIS. One of Zeigon’s first tasks will be to decide what to do with Deutsche’s US custody business, a legacy from the BT takeover. Deutsche has apparently talked to potential buyers about the idea of swapping this business with something in Europe, but cannot yet find a willing counterparty. Zeigon will know that Deutsche’s real strength is in Europe, and that it needs to streamline itself to capitalise on that.

He will also have to confront the question of Dresdner Bank’s German custody business. Described in the latest Global Custodian agent bank survey as an ‘agent banking icon’, no other bank has achieved and maintained Dresdner’s level of service consistency. Run by the charismatic Steve Lomas, it has a formidable reputation – but will that be enough for Deutsche? Both Euroclear and Clearstream would love to get their hands on the business, even if other custodians might not be so interested.

Zeigon will have some useful insights on this, and other, issues from Juergen Marziniak, the prodigal son who returns to the bank after only two years at Cedel/Clearstream. Marziniak has some points to prove and some bridges to build. As head of Global Securities Services, he will be powerful enough to do both, but his top priority must be to nail down, and articulate, a coherent strategy for his business. He will also be hoping that his new team – largely Deutsche people whom he already knows – will unite the business. He and Lamberti can hardly be blamed for excising so many BT people, after their divisive and negative behaviour following the takeover.

There has rarely been such a strong collective market will for a business to succeed, to the extent that even some of Deutsche Bank’s competitors hope that it can come good in the custody market. Frankly, there is no other European bank capable of challenging the hegemony of the Americans. But, during all the time that Cirillo was in charge, it looked as if that was nothing more than wishful thinking. Lamberti and Marziniak can make it happen. How much do they want it?

NODS AND WINKS

London, 29th February, 2000: Things have come to a pretty pass when the most interesting thing in the market is the battle between those two champion bores, Clearstream and Euroclear. Most of the time, we’d all prefer it if they simply got on with their jobs and kept their own counsel. International central securities depositories are not the most exciting entities – why else would they be based in Brussels and Luxembourg? – and the less heard from them, the better.

But they simply will not go away. The nagging debate about merger, consolidation or, most promisingly, a war of attrition that would make the Somme seem like a summer garden party, continues to rub a sore under the saddle of the market. Everyone has an opinion about the merits of each option, although very few want that opinion aired publicly. One member of the pusillanimous European Securities Industry Users’ Group ticked me off the other day for suggesting that it was…well, pusillanimous. Behind the scenes, it was suggested, ESIUG is working hard to reach a satisfactory outcome to the impasse that now exists between the two ICSDs. What it says in public is necessarily bland and non-committal.

ESIUG is a body that shouldn’t exist. All the members are big clients of both Euroclear and Clearstream, and yet they are apparently unable to get the ear of their account managers. Whatever happened to listening to clients? Surely the relationship management teams of both ICSDs – and their bosses, and their bosses’ bosses - should be fired. The existence of a user group almost always means a breakdown in communication between supplier and buyer.

That is a side issue, however. What is truly important is what will happen over the next twelve months. There seem to be only three possible scenarios:

1. Clearstream and Euroclear will merge and live happily ever after.
2. Clearstream and Euroclear will merge but will not live happily ever after.
3. Clearstream and Euroclear will not merge or live happily ever after.

Option 1 is seen as the most likely outcome by those who genuinely believe that, at some time in their life, they have been abducted by aliens. Option 2 is favoured by people who regularly change the oil in their cars and read instruction manuals before using a new appliance. Option 3 is my personal favourite, but we can all dream.

The odds on options 1 and 2 were shortened considerably last week when André Lussi, Clearstream’s ceo, declared that he was ready to take early retirement if it helped to bring the two together. That will come as some relief to those who thought he was implacably opposed to a merger, but then he probably believes that Clearstream has the upper hand in any negotiations. That may be a miscalculation, according to some observers. There are those who feel that the real-time capabilities of the Euroclear/Sicovam axis give it a very weighty advantage, especially as Clearstream is still operating on ‘continuous’ batch processing whilst it waits for a new technology platform. These people smile knowingly and suggest that Lussi has been fatally weakened by the loss of the Sicovam deal – but also add that Luc Bomans, head of Euroclear, is equally damaged by his recent stewardship.

There are, in fact, too many people nodding and winking about the outcome of this three-act farce. Since Lussi’s premature announcement of the European Clearing House last May, how many things have changed for the better as a direct result? If the answer is less than a lot, then who is to blame? And how long do clients have to wait? Don’t send the answers to me – send them to Brussels and Luxembourg.

THERE TO BE SHOT AT

London, 21st January, 2000: What is Clearstream? If you believe the spin – and it is very persuasive – the transformation of Cedel/DBC into Clearstream will be little short of revolutionary. Clearstream wants to sweep away the tired old battles between Euroclear and Cedel, and the traditional NCSD/ICSD dichotomy, to create a global clearing and settlement platform that encompasses all markets and all instruments. That is one of the main reasons why it decided not to call itself the European Clearing House: Clearstream’s employees are citizens of the world, not just Europe.

This is heady stuff, but very little of substance has actually changed as a result of the rebranding. Whilst the board has been spruced up, and the tariffs for German custody cut (and how disappointed the market would have been if that had not been possible following the merger with DBC), the staff, management and systems are the same. And Clearstream, from ceo André Lussi downwards, cannot yet resist the temptation to have a pop at Euroclear, especially on issues like price reductions and volume of business. The cultural adjustment to market leader is clearly going to be tough.

But, despite its slightly naff new handle, Clearstream has a real chance to do some good for the industry. There is no doubt that Euroclear is in a frightful mess, devoid of strategy and lumbered with a commitment to drop JP Morgan as operator and convert to bank status. Pursuing that path is surely the worst of all alternatives, as it strongly suggests that Euroclear’s board can think of nothing better to do than imitate its rival. It may be the sincerest form of flattery, but it isn’t exactly a compelling reason to invest in the business when it asks for the proposed EUR1 billion of capital.

Given the right conditions, and its stated commitment to look forward, Clearstream could steam away from Euroclear in terms of product, service and clients. There are significant holes in its offering – one of which is its ‘continuous’ settlement platform, which compares unfavourably with Euroclear’s real-time service – but most can be fixed. Its current momentum will surely enable it to attract brighter sparks, such as Terry McCaughey, to join it and improve the proposition. Once Euroclear loses the Morgan connection, from where will it get its new blood?

The critical question is this: Can a leopard change its spots? Clearstream has been second in a two-horse race for so long that its managers are used to playing the underdog role, and very effective they are at it. Now that has all changed, and it will be the target, as was evidenced by Euroclear’s highly effective swoop on Sicovam. As expectations have been raised, Clearstream is there to be shot at. If it spends too much time defending itself, it will lose all the momentum it has spent the last eight months building. That would not be simply a personal tragedy for André Lussi and his team; it would also be a bitter blow for the market.

VIVE LA DIFFERENCE!

London, 23rd November, 1999: The French have always known how to manage more than one lover, so it should come as no surprise that, whilst the Paris Bourse flirted with Cedel, it was also making eyes at Euroclear. Even as André Lussi, the CEO of Cedel International, bravely declared earlier this month that he expected the French to sign up to his vision of a European Clearing House, they were making other plans.

Euroclear executives could hardly control their glee as they announced the formation of an alliance with ParisBourse and Sicovam. For this they must be forgiven, as it has endured a pretty bad year in terms of public relations and missed opportunities. By launching the European Clearing House and merging with Deutsche Boerse Clearing, Lussi and his lieutenants have given Euroclear the runaround. It was enjoyable whilst it lasted, but Euroclear is now fighting fire with fire – and not a moment too soon. After its ill-conceived proposal for a hub-and-spoke model in Europe, Euroclear looked as if it was bereft of ideas to combat Lussi’s grand plans, even stooping as low as to play PR games over the future direction of Monte Titoli, the Italian depository.

Now Euroclear has a story to tell and a base from which to do business with other European depositories and, more importantly, European exchanges. Several have already expressed an interest in the netting alliance formed with Clearnet, and Euroclear has lost no opportunity to stress the importance of netting facilities for the alliance of eight European exchanges. Cedel has made similar noises about the alliance of exchanges, suggesting that the European Clearing House is a viable alternative option as a clearing and settlement platform. The battle for the exchanges’ business is likely, therefore, to be as fierce as that for Stalingrad.

Luc Bomans, managing director of Euroclear, admitted that the hub-and-spoke model was dead, saying that this alliance was ‘a step beyond’ that concept as it incorporated both netting facilities and finality of central bank money settlement. He also suggested that Euroclear’s recently announced participation in the European Securities Clearing Corporation, a netting service for government bond cash and repo trades, would be enhanced by the deal with Clearnet, which specialises in equities.

The immediate question is whether Monte Titoli will follow the French and go with Euroclear. The Italians have been playing their hand very cleverly, waiting to see what the French would do before committing themselves but keeping their options open. At the same time, someone is going to have to talk seriously to CRESTCo, the UK depository, to find out precisely where it stands. Euroclear and Cedel both know that the participation of CRESTCo is pivotal to the success of a pan-European clearing house, and yet Iain Saville continues to cling to the ECSDA Eurolinks model.

In the longer term, the real question remains unchanged by recent events: can the market support two clearing systems? The European Securities Users’ Industry Group says that it wants ‘a single integrated process in Europe for clearing and settlement of equity and debt transactions’, but what precisely is meant by the word ‘process’? ESUIG’s reaction to this latest development will tell us more on that front. In the meantime, the boys from Brussels will enjoy their latest coup, and why not? – seducing the French as the Germans and Luxembourgers look on must be sweet indeed for the Belgians.

DROPPING THE PILOT

London, September 6th, 1999: Modern times have added to Benjamin Franklin's two certainties in life: death and taxes. We know of at least two others: software will always be delivered late, and people who run market cooperatives will, given the opportunity, make commercially illogical decisions. The first additional certainty needs no proof, as we have all grown used to it. The second gathers credence with almost every new development in the Euroclear/Cedel battle for European domination.

Euroclear's recent decision to jettison JP Morgan as the system operator flies in the face of logic. Euroclear is a well run and profitable business, virtues from which its participants directly benefit. True, it has recently looked sluggish when compared to some of the nimble footwork of Cedel, but it remains a model to which many other market cooperatives should aspire. JP Morgan makes a lot of money from its contract (more than USD250 million last year), but it earns it: not only does it run the system, but it also provides vital credit facilities to ensure continued liquidity. So why would anyone in their right mind want to drop a bank that has performed so well for thirty years?

If you have to ask that question, you don't understand the workings of a cooperative, or the dynamics of the fight between Euroclear and Cedel. Cedel has made Euroclear look very silly this year, not just through the DBC merger but also through its pre-emptive launch of real-time processing. Euroclear's chief executive, Luc Bomans, has been consistently outflanked by Andre Lussi, his counterpart at Cedel. Euroclear has no dance partner at the European settlements party, and seems unlikely to get one until the Cedel/DBC/SICOVAM deal gets underway. Bomans is a man under pressure, both from his shareholders and his clients.

Very conveniently, Euroclear has been letting it known in the market that there were significant rumblings of discontent about an American house running the system, and that the Morgan connection was inhibiting Euroclear's ability to forge alliances in Europe. This line has been spun so effectively that, when the announcement of Morgan's withdrawal was made last week, few were really surprised or paused to query the logic behind it. Attention shifted from the shortcomings of Euroclear's senior management, which have been patently obvious this year, to the big bad Americans, who must be sent home (albeit with a munificent pay-off).

But someone needs to ask some more questions about this. Why does Euroclear need to look like a carbon copy of Cedel ? What is wrong with having an American running the system, if it does the job well? Is Euroclear really saying that only Europeans can manage the process? Or is there another agenda in play, one in which Euroclear and Cedel have to look the same because the market wants them to merge and Morgan is an impediment to that?

Whilst Bomans may be busy on job protection schemes, it should not be assumed that Andre Lussi is much more secure in his position. Cedel's financial position isn't great, and the money-swallowing capability of the new settlement platform, CREATION, is legendary. The DBC deal didn't come a moment too soon for Lussi, who even had to resort to bringing in outside partners (TIBCO and Perot Systems) to help with financing the project. As if this were not enough, some believe that Juergen Marziniak, Cedelbank's chief executive, is lining himself up to replace Lussi. He has certainly made some less than flattering remarks about Cedel's previous product strategies, and seems to be positioning himself as a credible alternative if the DBC deals goes pear-shaped or a merger with Euroclear ever gets off the ground.

And will that merger ever happen? If commercial logic were the only factor, it would make an enormous amount of sense and the market would force it to happen. But, as we know to our cost, commercial logic is often the first victim in situations like this. It would be foolish to believe that we have seen that final twist in this tortuous process of consolidation.

AND THEN THERE WAS ONE (PART 2)

London, July 30th, 1999: Earlier this year (see article below, March 24th) I suggested that, following the sale of RBS Trust Bank to BNY, HSBC was the only British player left in the global custody business. This was a harsh and cruel judgement on Lloyds Bank Securities Services (which had a little period towards the end as Lloyds TSB Securities Services), but it turned out to be fair. By then, LBSS had already stopped bidding for new mandates from UK institutional investors and was only taking on UK agency business for overseas banks. Its managers ascribed the rationale for this strategy to the difficulties it was having with Laser, the much-trumpeted operating system that never worked properly.

Lloyds' decision to withdraw from the business is hardly a shocker, although some clients are apparently rather surprised. (Perhaps if they read this website rather than Rubberwear Monthly or Trainfanciers' Gazette they would learn more about the business.) One sympathises with David Watson, the head of LBSS business development, whose main function over the last twelve months appears to have been to deny rumours of an impending sale.

At least he was right about that. It's impossible to know at what stage the board of Lloyds decided that it could not sell the business - or any part of it, such as the apparently prestigious trustee function - but last year there were approaches from other custodians that might have included cash on the table. These were all rebuffed. The directors have subsequently watched as Trust Bank was sold for a premium of about GBP200 million over net assets. Did they do a good job for their shareholders?

Full credit to State Street, however, for its dogged persistence. David Bilbe, managing director of State Street's investor services business in the UK, has been pursuing a deal with Lloyds for a long time, but could never really get senior management attention. State Street was never likely to wave its cheque book around, as it knew as well as anyone else how fragile the business was. But Bilbe believed that a deal - possibly involving a degree of private-label processing - was both feasible and attractive. Once it had successfully cleared the euro hurdle, and Wayne Kitcat had moved on, Lloyds were ready to talk.

It isn't entirely clear what State Street will end up with. No money has changed hands, and no commitments have been made about client transfers. Undoubtedly there will be some financial inducement for Lloyds' clients to move to State Street, probably in the form of a waiver of transfer costs. Beyond that, the clients will have to decide whether they like the look of State Street - and, as importantly, vice versa. Many of the smaller pension fund clients, for instance, will have to find a new home because State Street just isn't interested in that type of business. Additionally, it seems unlikely that State Street will want to take on the overseas banks and turn itself into a UK agent.

All of which is lovely news for HSBC, for whom Christmas has come early. Terry McCaughey now runs the only UK shop capable of taking on these clients. But it would be surprising if he decides to abuse this enviable position by ratcheting up his tariff; it is much more likely that HSBC will be looking at overall corporate banking possibilities, especially where it can poach valuable franchises from Lloyds. With local authority business, for example, HSBC makes at least twice as much money on the banking side as it does from the custody mandate.

But, even though it will shortly become American, Trust Bank isn't going to go away and leave the field open for HSBC. If its managers have any sense (yes, that's a hostage to fortune, isn't it?) they will already be sending out their crack sales team to all points, reminding punters that they still have a choice. Whether investors will be prepared to transfer their assets to a custodian in the midst of a huge transition is open to doubt, however.

Is it healthy that the UK, one of the world's most important international securities markets, has only one indigenous global custodian? To many, the answer is no - but the UK banks have been largely pathetic in their attempts to compete with their bigger US cousins, so this outcome has been inevitable for some time. We are constantly reminded that we're operating in a global market, with global players with global needs. Who cares about the nationality of the suppliers? The reactions of the Lloyds clients will give us a better understanding of the answer to that question.

SOMETHING NASTY IN THE WOODSHED?

London, July 23rd, 1999: What is it about GSTPA that makes everyone behave so oddly? Let's face it, at the moment GSTPA is nothing more than an idea - albeit a very expensive idea. But no-one knows if it's going to work, let alone precisely how it's going to work. The vendors, who are the ones who must make it work, haven't yet been consulted about the model, although some will shortly be given their chance when the RFI and RFP are sent out. Whatever your thoughts about vendors, their morality and their standards of personal hygiene, they do know a bit about systems, and GSTPA is a giant system (in the language of the great and the good, however, it's a solution).

What we have so far are a few doodles from a big consultant and a lot of PowerPoint presentations from the venerable Dr Kirby (still vaguely reminiscent of a teddy bear on speed), executive director of GSTPA. We also know that fifty institutions have paid their money and signed up for membership, and we can surmise that a fair few are very sceptical but still want a seat at the table just in case it works. And, of course, we have the usual selection of motormouths and rentaquotes whose entire professional lives are seemingly devoted to committees and talking-shops. We have grown used to them, if not exactly fond of them, and life would not be the same without them.

But, even if the emperor has not yet visited his tailor, GSTPA has already aroused some strong passions. Right from the birth, when GSTPC effectively replaced the G15 committee convened by IDC, there have been rumblings about its independence and impartiality. People suggested that, in order to get IDC/G15 buy-in, GSTPC undertook to focus exclusively on cross-border issues and leave the US clear for DTC (one of IDC's parents). DTC was in the process of launching TradeSuite, its electronic trade processing platform, and was finally conceding ground to Thomson ESG over the confirmations business over which it had previously had a monopoly. The last thing it needed, so people say, was GSTPC/A to tread on its turf.

True or not, that suspicion has never been completely removed, although the rumours have evolved. Now there are new accusations of a conspiracy theory, again involving DTC: this time it is said that the DTC/SWIFT alliance, which has submitted an expression of interest to GSTPA, has already got the deal in its pocket. 'Rubbish,' say members of the GSTPA executive committee. Well, maybe...but this is the essential conundrum of the project. SWIFT and DTC are just too important to the industry for GSTPA to discard. They have to be part of the solution, as does Thomson (although there are many who feel that GSTPA could quite properly be renamed ABT - Anyone but Thomson, such is the apparent antipathy towards them within the organisation).

Perhaps this would explain the following examples of extraordinary behaviour (or it might just be me and my brand of after shave):

• DTC agrees to a phone interview about T+1/GSPA - and then fails to turn up without explanation or apology;
• DTC declines to be interviewed for an article in Financial News on T+1/GSTPA in the US;
• In response to nearly every question about the GSTPA timetable, however innocuous, KPMG's Steve Crosby says: 'I'm sorry, I can't comment on that';
• Two members of the GSTPA executive committee preface their interviews with warnings about the consequences if I 'twist' their words or 'spin' the facts (even though one of them subsequently tries to 'spin' the facts to me).

There is a misplaced sensitivity that may come simply from a natural, and entirely understandable, suspicion of journalists. But it's hard not to think that what we are seeing is only what GSTPA wants us to see, and that there is an entirely separate, and largely secret, agenda in play (of which, incidentally, Tony Kirby himself may well be unaware). There are certainly any number of vendors who feel the process has already been tainted and that political expediency will ultimately overcome commercial logic. But the use of hostility and a surly silence is not the way to dispel that notion and nail the rumours. A charm offensive, and clearer communication, would definitely help.

GSTPA needs to succeed: if it cannot carry the continuing support of the market, and convince all the players of its strict impartiality, it will fail. Its executive committee needs to appreciate that mere strength of intellectual argument is not the basis of success. You have to win hearts and minds, even in a business like this.

THE NEW REALITY

London, June 29th, 1999:  On a trip to New York and Boston five years ago, I interviewed most of the major American global custodians - State Street, Chase, Citi, Brown Brothers, BNY, JP Morgan - and was unsurprised to learn that they were all doing very well and were hitting all their targets. None of them had any discernible weaknesses or areas for concern; in fact, when I raised a small issue with one custodian, a particularly shrill and aggressive woman screamed and leapt from her seat to challenge me (she is still employed by the same custodian, even though she seems to be closely related to Hannibal Lecter, albeit substantially less charismatic).

On a similar trip last week, something very strange happened. Instead of the usual 'we-have-all-the-answers' attitude, I was struck by the extent to which the custodians have moderated their tone. Some admitted to mistakes, others to gaps in their product line; a few even asked me what I thought they should be doing (a sure sign of desperation). Oddly, consolidation has not left the winners feeling particularly confident about the future. They fret about the internet - one said that, if they didn't get it right, it would consume them - they agonise over market share, they keep their fingers crossed about Y2K, and they feel the constant pressure of very tough corporate financial targets - SVA, ROI, ROE and all those other esoteric acronyms so cherished by the pointy heads.

The bullish optimism of 1994 has been replaced today by a much more attractive pragmatism. Custody can be profitable, but you can also burn yourself very badly if you get it wrong. A sustained bear market, for instance, would wreak severe damage on revenues based on portfolio market values, whilst the loss of eleven currencies in Europe has already had a negative effect on FX revenues. Last year the Asian crisis showed the perils of securities lending. This is not a business for the faint-hearted; it is also no longer a business for snake-oil salesmen. Ten years ago you could find any number of highly paid custody sales people with no experience or expertise: today they have largely gone. There is too much at stake to let the cowboys loose.

Today's senior managers know all this, and know how tough the market is. And it is an undeniable fact that the remaining big hitters are under so much scrutiny - from clients, consultants, regulators and, yes, even journalists - that they simply cannot bluff their way out of trouble. When a custodian has a problem, everyone knows about it. That is the price of a mature, and very tight, market.

Maturity, in fact, is the word that most immediately springs to mind when thinking about these players, which is as much of a shock to me as it probably is to you. These guys have grown up. They have learnt painful lessons, and they have withstood tremendous change over a relatively short period - just as one does in adolescence. The global custody business has finally come out of the bathroom, its face clear of zits and other childish blemishes, and it finally knows how to behave in public. What a relief that will be to all its friends, relatives and neighbours.

FLAT COLA WARS

London, May 17th, 1999: There has always been something vaguely farcical about the competition between Euroclear and Cedel. It doesn't have the same fizz or intensity as the rivalry between, say, Coke and Pepsi; in fact, many of the jibes they routinely trade through the press appear manufactured and somewhat laboured, such as Cedel's tedious insistence on referring to 'JP Morgan/Euroclear'. With such trifles do spin doctors amuse themselves.

But there is no mistaking the very genuine outburst of hostilities between the two ICSDs that erupted this month. To the casual observer it looked as if Euroclear had fired the first shot with the release of its white paper, 'The hub and spokes clearance and settlement model'. Euroclear executives made it abundantly clear that, to make the model work, there would need to be a merger between itself and Cedel, positioning the proposal as an altruistic move for the good of the European market.

Problem is, Euroclear and altruism are not natural bedfellows (in the same way as quick and drink, or fun and run, are mutually exclusive). What looked like an opening salvo was actually nothing more than a rather desperate reaction to the impending announcement of Cedel's marriage with Deutsche Boerse Clearing. When Euroclear got wind of this deal, it felt the need to launch its own 'vision thing' - thus the white paper.

That the contents of white paper were so fuzzy, and its central arguments so nebulous, should therefore come as no surprise. Euroclear didn't have time to make it any better, or to hire external consultants as it had done with its 1993 white paper, 'Beyond G30'. But it should at least be given credit for the fact that it managed to respond at all, so lumbering has the organisation become. To many in the market - including its shareholders and clients - Euroclear seems bloated, smug and unimaginative.

If proof were needed of this, it came with the announcement that Groupe SBF, the holding company of the Paris Bourse and SICOVAM, had signed a memorandum of understanding to join new Cedel once it has been legally established. As late as the Wednesday before the Friday announcement, one Euroclear board member was confidently predicting that SICOVAM was going to sign a deal with his outfit, not with Cedel. Even after the news had been released, Euroclear was expressing bewilderment about why SICOVAM had chosen to go with Cedel/DBC.

Reports suggest that, under Sir Andrew Large, the relatively new chairman, Euroclear is starting to improve. As one insider said: 'Under Breuer (the previous chairman), meetings were efficient but not terribly effective. Sir Andrew has changed all that.'

The question, however, is whether the change will be soon enough. Cedel has spectacularly trumped Euroclear with its DBC deal, and any future talk of a merger between the two ICSDs would probably see Cedel as the senior partner. Whilst nothing has yet happened which will deliver significant benefits to institutional investors, there are the beginnings of a very important shift in the balance of power in Europe. Six months ago, a Franco/German alliance would have seemed impossible - so what are the odds now of it succeeding? Mesdames et messieurs, faites vos jeux!

AND THEN THERE WAS ONE

London, March 24th, 1999: 'Those who cannot remember the past are condemned to repeat it,' said George Santayana. If ever proof were needed to validate this, executives at The Royal Bank of Scotland (RBS) can provide it in abundance.

In the securities services business, RBS has made a habit of coming second. In the UK share registration (transfer agency) business, it tried - and failed - to compete with the market leader, Lloyds Bank. By 1997, its registration business was a big black hole, swallowing up resources at an alarming rate without producing much income in return. Its much vaunted system, SHARES, was inadequate, whilst the dematerialisation of the UK market deprived it of a central part of its service offering. Clients began to wonder what they were paying for, and RBS didn't have a good answer. Fortunately, it found a buyer with a lot of answers, and the business was sold to Australian specialist Computershare last year. The irony of the story is that RBS has retained a stake in Computershare, presumably because it knows what a good business share registration can be if it is managed properly.

Even as their registration business was heading south, RBS executives were busily trying to create another franchise in securities services. Having made a disastrous decision to buy the Vista securities movement and control (SMAC) system in the early nineties, Royal Bank's trust and custody business began to spiral out of control. In one of the more bizarre manifestations of the management style, Mike Devine, the American drafted in from Chemical as director of securities services, chose to appoint Jackie Edwards as head of custody. Edwards, another American, was a teccie, with no track record in operations, sales or client service, but her inexperience was no barrier to such a critical senior role. Under their leadership, the custody product lurched from one crisis to another.

By 1996 the wheels were starting to fall off. That year's influential R&M Custody Survey showed RBS as the worst rated custodian in both the overall and pension fund categories. The decline appeared terminal. But the hour before the dawn is always the darkest, as they say: just as it looked as if there was no way back, an escape route presented itself. SBC Warburg was looking for a buyer for its custody and investor services division (CISD). SBC didn't like the business, and Mercury Asset Management (MAM), CISD's biggest client, didn't want to buy it.

Although several banks were interested, few can have been as keen as RBS. In CISD they saw salvation: here was a business with strong managers, good systems and a very loyal client in MAM. RBS quickly became the preferred partner for CISD; as its Scottish head, Gordon Lindsay, said at the time: 'We were looking for someone with a real commitment to the business and an excellent name. RBS fit the bill on both counts.' Thus was born RBS Trust Bank.

Perhaps the story of Trust Bank's birth would not have been quite so tragic had it not been for the meteoric rise of Midland Securities Services (MSS). MSS, which was on its deathbed at the end of the eighties, staged an incredible recovery following the intervention of parent HSBC and the appointment of Terry McCaughey as its director in 1993. As RBS suffered, MSS prospered: McCaughey appointed a new management team, many of whom are still in place today, and ensured that Vista - yes, the very same - worked properly. MSS started to attract back clients who had left it during the bad old days, and its assets grew exponentially. Today, MSS is close to becoming the first UK custodian to have USD1 trillion in assets under administration, and is now the only British player left to challenge the Americans' domination of the global custody market.

At the time of the formation of Trust Bank, several commentators noted that it was really a reverse takeover. CISD managers got all the top jobs; the business was run on CISD systems; and Mike Devine, who had been pencilled in as joint managing director, never took up the post. And therein lay the problem. The two cultures were at opposite ends of the spectrum, with RBS as the owners but CISD very firmly in charge as the managers. The Trust Bank chairman, John Trueman, appeared to be little more than a figurehead, and his management team certainly enjoyed the freedom, basking in the knowledge that the omnipotent MAM supported them. Who can blame them if they were slightly arrogant?

Trust Bank reported into Iain Robertson, who was then head of corporate and institutional banking for RBS, and has since been promoted. He was also responsible for the share registration business, so RBS shareholders, clients and staff might be wondering whether Robertson's stewardship of securities services represented the best deal for them. Insiders suggest that Johnny Cameron, Robertson's successor in the CIB job, got conflicting messages from Robertson and George Mathewson, chief executive, about the RBS commitment to Trust Bank, which can't have helped him a great deal in his negotiations with The Bank of New York (BNY) and other contenders.

But all that is history. BNY has bitten the bullet and, after six months of discussion, it has produced the cheque book and offered in excess of GBP400 million (USD640 million) for a business with GBP400 billion of assets and an annual pre-tax profit of GBP17 million. Its most immediate priority will be to stabilise the old RBS client base, especially those Scottish institutions that have supported the bank through thick and thin. The Mercury contract looks pretty watertight, and it's inconceivable that BNY would have done the deal unless it had the strongest possible assurances from Merrill Lynch, Mercury's owner.

Beyond that, BNY will be sharpening the pencils - and the knives. It will ruthlessly cut costs, for which it is rightly famous, but more importantly it will integrate the business into BNY. The 'two tribes' mentality will disappear, as will those still keen to promote it. It happened with JP Morgan, and it's going to happen with Trust Bank. But it is sad to report that Trust Bank couldn't carve out a viable future as the UK's second largest custodian. There was always room for two serious players in such a key market, and one can't help feeling that, with different owners, things might have been very different. BNY is unlikely to make the same mistakes.

PARTY ANIMALS

London, March 17th, 1999: Banks think differently from the rest of us. At its splendid annual drinks party last week, Midland Securities Services boss, Terry McCaughey, announced that the MSS name was to disappear. The boys and girls in the marketing creche have decreed that every business now has to have HSBC somewhere in its name - so it's bye-bye MSS, and hello to something snappy like HSBC Global Investor Services. All the hard work that's been done by McCaughey and his crew to rebuild the reputation and values of the brand will be lost at the stroke of some young shaver's e-mail edict.

But how ungracious for a party guest to carp over this decision. The MSS bash has become one of the more important events in the London social calendar. As McCaughey wryly observed, every year there are client mergers and yet more people attend the party. This year the elegant Lutyens room in Midland's head office was full to bursting, with many of the great and the good from the custody business there.

The question on everyone's lips was not, surprisingly, whether McCaughey tints his hair, but who will end up making a bid for RBS Trust Bank. Amongst the chattering classes, this was the hot debate - poor old Trust Bank has already been written off as an independent operator. But, whilst most people agreed that RBS would have difficulty finding an alliance partner, there was no consensus about who might want to acquire the whole business.

As minimalist canapes were proffered and nibbled, attention turned to the ABN AMRO/Mellon alliance. Few appeared to have any real sense of what the deal might mean for clients, and how the two institutions would work together. Some suggested that the alliance offered ABN AMRO an opportunity to withdraw gracefully from global custody; others thought that it showed how little progress Mellon has made in penetrating European markets. Whatever the truth of the matter, the partners haven't yet done a very good job of explaining the whys and wherefores of the deal.

Midland is a forgiving host, as was evident by some of the people it allowed in, but even some of its own staff were surprised to see Jim Day propping up the bar. Day, a former Midland employee, is from the old school of custodians - a school closed down for its consistently poor performance. Seeing him at the party must have brought back some painful memories to those Midland staff - and their clients - who remember what life was like before new management sorted out the mess.

A much more welcome experience was to meet Stewart Crawford and his team from snappily branded HSBC Fund Administration Services (and surely some mistake here - no mention of 'global' in the title?). Stewart was looking and sounding supremely confident about the prospects for his shiny new business, which he expects to start earning fees this year. His positive karma was only momentarily shaken when some unkind soul asked him what he thought about the health of WM, his old employer - recovered, he wisely avoided a direct response and talked instead about the weather in Scotland.

On the subject of ebullient souls, Tony Solway of Henderson was looking as fit as a fiddle, helped by a recent trip to the ski slopes. Enlivening proceedings with his usual bonhomie and racy anecdotes, he explained that his late arrival was to be blamed on the imminent new brand launch for Henderson Investment Services - apparently he was licking the stamps and envelopes for the invitations. He swapped bad hair stories with McCaughey before leaving unusually early, presumably to catch the last post.

For more refined conversation, one had only to turn to Ham Lynch and Peter Gibbons of Brown Brothers Harriman. After an incisive discussion of the major issues affecting world equity markets, Ham raised a minor objection to a recent flyer for this website, which said: You want incisive analysis, not flaccid waffle. Ham protested that he was, in fact, rather a fan of flaccid waffle. All who know Ham know better than to believe this.

The MSS party was a useful snapshot of the British investment administration scene - some guests on the way up, a sprinkling who are already there, and a few very much on their way out. You could learn a lot about the business simply by studying the guest lists for the last five years. In fact, there's probably a business school already offering an MBA in exactly that.

WHEN THE FAT LADY SINGS

London, February 4th, 1999: Listen carefully and you may just be able to hear an unfamiliar sound - is that the fat lady singing? She may only be warming up before her grand entrance, but there's little doubt that this is the gala performance.

What, you may ask, is he babbling on about? It's quite simple, really. For years we have lived with too many custodians, most of which have distinguished themselves only by their inability to look after their clients effectively. Like a comet with an extremely long tail, the industry has a nucleus of competent providers followed by a trail of duller detritus. Realistically, buyers have always had a fairly limited choice if they wanted a global custodian with a half-decent service, and the industry's perpetual fixation with asset growth, rather than asset quality, has only made the service problem worse.

That said, there are some shops which have largely concentrated on getting the product and service mix right, and - guess what! - they are the ones most likely to be around long into the next millennium. The surprise, though, is that the roster of winning players may include one or two institutions which, until now, have been considered as little more than makeweights.

One such custodian which immediately springs to mind is Mellon. In the past, competitors (and, it must be said, one or two journalists) have dismissed the concept of Mellon as a serious international custodian: the fashionable view was that Mellon would be acquired before it had time to trouble the big providers. But recent events suggest that the new management is just as determined as Frank Cahouet, the former chairman, to remain independent: by selling off peripheral businesses, and cementing a global marketing alliance with ABN-AMRO, the powerful but sleepy Dutch custodian, Mellon has thrown down the gauntlet. It may even be in acquisitive mode, now that it has some fresh capital to spend.

The same comment could equally be applied to Royal Trust, another contender standing on the cusp between greatness and obscurity. With rationalisation of the Canadian banking market stalled by the government, and US custodians winning substantial public and private mandates, one option for Royal Trust is to expand internationally. In Europe it has already built up a significant operation, but it lacks the critical mass and blue-chip clients to be considered a major force. An acquisition could change all that.

But what would it - or any other asset-hungry custodian - buy? The days of mega-acquisitions are behind us, as whole banks, such as Bankers Trust, are bought and sold, rather than simply the securities services businesses. That is why, in effect, the fat lady may be limbering up. We may be nearing the end of the long march towards a stable custody market. If there is to be further consolidation, it will probably happen primarily in specific markets - and the UK still looks like one of the hottest.

The UK has three serious custodian banks - Midland, RBS Trust Bank and Lloyds - and one near-invisible player, Clydesdale. HSBC's commitment to Midland Securities Services appears to be pretty solid, so no custodians are going to waste much time pursuing that one. But Lloyds and RBS Trust Bank both give off less than convincing signals about their staying power. Lloyds is dogged by persistent rumours of its imminent exit from the business, to such an extent that its custody managers have learnt to greet such speculation with a resigned shrug and a weary smile, as if to say: 'What can I tell you? As far as I know, it isn't true.' In a brave effort to change the spin, they have discreetly let it be known that the Lloyds board has already rejected polite overtures from other banks. To date, the tactic hasn't worked and there is still a general belief that its custody and trustee business has a limited shelf life.

Whispers also surround RBS Trust Bank. To date, this operation has failed to achieve its full potential as the only British custodian capable of offering more than core custody products. Whilst it has extensive fund servicing capabilities, and all the experience it needs through its relationship with Mercury Asset Management, it has made little impact as a leading provider of outsourcing and administration facilities. History suggests that The Royal Bank of Scotland, its parent, will not wait forever: when the share registration business misfired after a substantial amount of investment, RBS offloaded it. Will it be more patient with Trust Bank?

There is, of course, one global institution where the decision to keep or sell the custody business hasn't yet been made - or at least, made public. Deutsche Bank's purchase of Bankers Trust wasn't driven by its need to have a big global custodian, but it's interesting how often the German bank's senior managers have mentioned its commitment to the custody business since the deal was announced. Are such words genuine, or are they just trying to keep the troops happy before they sell it off? Publicly, Deutsche is very bullish about its custody operation, and there is little doubt that it would pose a formidable threat to the big boys if it were to integrate the Bankers' business and make a go of it. It would be both refreshing and highly desirable to have a European bank in the premier league of custodians and let's face facts - Deutsche is the only contender. We will know soon enough if it has the stomach for the fight.

MARY HAD A LITTLE DOG

London, January 4th, 1999: When did you last hear of a takeover in the banking sector which resulted in employees of the acquired company securing senior positions in the organisation? It doesn't happen very often, a fact which seems to defy commercial logic. Why bother to buy a business if you're then going to dispense with one of the key assets?

But the projected deal between Deutsche and Bankers Trust suggests that there is some hope, at least within securities services. Mary Cirillo, the heavy hitter parachuted in to Bankers Trust from Citibank to run the asset servicing businesses, has joined the roster of proposed top bananas at the merged company. Cirillo has been like a much-needed dose of prune juice at Bankers, slimming the business whilst applying much tougher commercial disciplines. One of her first actions was to make it very clear that all custody clients would be subject to a minimum tariff, regardless of asset size. Some believed that she was house cleaning before putting the custody book up for sale; others saw it simply as an overdue reaction to years of chronic underpricing by Bankers.

Whatever the truth, the result of her management has been a securities services organisation that is no longer regarded as a second division player with a single tactic. In the UK, Bankers has been quieter in 1998 than the previous year, but that's no bad thing. It has a blue-chip client list - including British Airways, Railpen, Tate and Lyle and BP - and shouldn't need to be engaged in an underbidding war. Clients appear to love Dick Feehan and Francis Jackson, the senior rainmakers in London, and the business appears to have sustained a middle-management purge especially well.

Not everything has been good for Bankers overseas, however. In years to come management schools will probably turn the story of WM into a case study of how not to run a business. It is a story of big, bad Americans, greed and Scottish intransigence, spiced up with a shot of incompetence. Others can write the history; for our purposes, it is sufficient to say that WM is a very large, pustulating boil on Bankers' backside. Cirillo and her new German buddies will have to lance it.

She will also have to deal with the little problem of what to do with the custody business of Deutsche. This is a pedigree Dachshund. To the disinterested observer, it has no leadership, no strategy and no franchise (cf. Morgan Stanley, RIP). Global custody is increasingly the preserve of the Americans, and there is no evidence to suggest that the introduction of the euro will tip the balance back towards Europe. Deutsche has made progress in very limited areas, such as Asian sub-custody, but it can't even establish itself as the leading sub-custodian in its own market.

It has also been damaged by a rolling series of management conflicts, the most striking of which was the battle between Juergen Marziniak and Peter Grafunder. Marziniak won that one, but his triumph was short-lived and he moved on to Cedel. (For the record, Grafunder stuck it out and now runs the back office for Deutsche Asset Management). But, for all his faults, Marziniak gave Deutsche some much-needed direction and was a very public face for the organisation; how many could say the same about his successor(s)?

Will Cirillo be under pressure to hang on to the Deutsche custody staff? Will she be forced to use the Deutsche brand in Europe? Or will she be given a free hand, which is what she really needs if she is to make the combined business a global force? In Europe her lieutenants have served her well, and they should be rewarded with the top spots, but acquisitions don't always work like that. If Deutsche is serious about global custody - and it has repeatedly mentioned it as a key component of the deal - it must let the Bankers people run the show. As a famous friend of the Germans, Margaret Thatcher, once said: 'There is no alternative.'