In a tough economic climate, operating scale, processing efficiency and flexibility are the primary goals of custodians in the Asia-Pacific region, according to Graeme Arnott, chairman of the Australian Custodial Services Association (ACSA).
Arnott believes that both local and global custodians in the region are working in a climate of diversification and expansion, with increasing pressure on margins. "We have to be careful that we don't set ourselves up for failure," he said. "A low-return environment means that costs are going to be a greater component of choice for investors and fund managers."
Richard Ernesti, regional head for Citibank Global Securities Services in Asia-Pacific, agrees. "There is an ever-expanding definition of the word custody' and Citibank is no exception," he said. Citibank runs a regional processing center out of Singapore, but is active across Asia-Pacific and is Australia' s third-largest domestic custodian.
ACSA measures Australian custodian activity in global, master and domestic (subcustody) segments, which in June represented about 8 percent, 49 percent and 43 percent of the total market, respectively. Segment size varies with market activity and local custodians have chosen to specialize or diversify their activities according to trends. However, the rapidly increasing proportion of managed assets (estimated to grow to $740 billion by 2010, according to the Austrailian Stock Exchange) means that master custody-where custodians actively insource a wide range of services for funds managers-is a sector growing in both size and complexity, with pressure for more services and lower costs.
This is because Australia's largest local custodians are also the nation's dominant banks, which are diversifying aggressively into the wealth management industry. Westpac's recent purchase of a significant portion of Bankers Trust's (BT) funds management business for $577 million follows the bank's acquisition of Rothschild Australia Asset Management, as well as a 51-percent stake in Hastings Funds Management. The purchases have made Westpac the fourth-largest retail funds manager in Australia, with some $6 billion of assets under management. Westpac's move into asset management is one of many such shifts in recent years and includes National Bank of Australia's acquisition of MLC, Commonwealth Bank's purchase of the Colonial Group and Annex's recent joint venture in funds management and life insurance in Australia and New Zealand, with ING. All seek scale and products to leverage their large retail banking franchises.
Market share is difficult to determine because of offshore holdings, but National Custodian Services claim leadership as the largest Australia-based owned custodian. The firm holds 17 percent of total custody assets and a 39-percent share of master custody. It is closely followed in the master custody segment by J.P. Morgan Chase with 37 percent. However, BT is a client of J.P. Morgan's, and according Barry Dench, head of custody at Westpac, BT's assets could shift to Westpac along with Rothschild's custody business (currently administered by Royal Bank of Canada).
According to Dench, Westpac dominates the domestic custody segment, with an about 27-percent market share, and while the business grew out of the bank's own fund management business, offshore global custodians, broker-dealers and institutions now account for 80 percent of its business. Westpac has so far specialized in domestic custody. Consistently rated as a top performer by its global clients, processing efficiency is a core component of Westpac success, according to Dench. Westpac was the first institution to have a direct interface into Australian depository Chess and is now seeking to be a foundation alliance partner with FundConnect, a processing utility initiated by the Australian Stock Exchange. "We are currently in the evaluation phase with the FundConnect project," Dench said.
Arnott believes transaction processing between wholesale funds managers and custodians is highly automated in Australia and the industry compares well to other developed markets. However, unlisted unit trusts or "investment funds"--particularly retail-are paper-based and problematic for domestic custodians. "They account for 15 percent of the volume but 80 percent of the effort," Arnott said.
While ACSA does not favor FundConnect over competitors Ausmaq or Investment-Link, Arnott believes a single utility would be the preferred option. "The ASX initiative seems to have the most momentum," he said.
Kate Beaurepaire, director of sales and marketing at ANZ Custody Services, concurs. "As an industry, we are all waiting to see one solution rather than have to support three," she said. ANZ's current business focus is domestic custody and according to Beaurepaire, the firm ranks about 6th in overall market share, with managed assets of some $19 billion.
ANZ is revamping its processing capability with a system from Tata Consulting Engineers Ltd. ANZ will focus its attention on domestic clients with new capabilities that will enable them to build their master custody business if that is a direction the bank decides to pursue. "Service levels in that segment are going to increase," Beaurepaire said, "and it will be interesting to see whether providers who are big now will be able to offer more and more services. It's a fine-margin business."
Rationalization is inevitable in light of recent acquisitions in the industry, according to Beaurepaire. "All we have seen is a change of ownership but no consolidation," she said. "It will be interesting to see if there is a move away from one provider doing all aspects to alliances of providers concentrating on core activities."
ANZ could also consider third-party clearing, subject to a viable business case. "We keep a watching brief on a number of issues and will continue to do so," Beaurepaire said.
Cost pressures on fund managers will continue to drive outsourcing, according to Patrick Liddy, head of global Sales, marketing and strategy at National Custodian Services. "Funds managers are doing it hard," he said. They are getting squeezed on their margins and the key place to invest resources is in the front office, not the back office-because the front office is where they make their money, he said. "In this climate they're saying, How can we do this cheaper? Let's consider outsourcing,'" he added.
Liddy believes that his bank's consolidation in wealth management will continue to pressure traditional institutions such as BT and AMP, because National Custodians will now have scale in wholesale and retail distribution.
Global custodians require local and global scale to survive, according to Arnott. "Australia produces some unusual requirements," he said "You can't just take your global assets, systems and expertise and jam it in to Australia. It just won't work. You need enough global for scale but you also have to cope with local requirements-accounting, tax and administration. If you don't have enough assets in a local solution, your global will struggle and you'll end up running a costly business."
BNP's recent acquisition of custodian Cogent from AMP for $357 million is an example of a global custodian balancing its asset base, according to Arnott. Cogent held $51 billion in master custody as of June 2002, and the deal gives BNP a window to local fund managers. BNP announced that it was closing its broking and corporate financing operations on Sept. 19, and would focus its activities on corporate and investment banking through Cogent.
Another major issue facing the custody industry in Australia is the Swift-mandated shift from the ISO 7775 messaging standard to ISO 15022-a migration that was originally set to be completed by Nov. 15 but is now being pushed back due to the establishment of Swift's ISO 7775 Message Users Group [MUG] to support those institutions that are not ready for the switch on Nov. 15. Arnott said generally speaking, the industry is well prepared for the upgrade. "A number of Australian fund managers are going on to Swift for the first time using the new standard," he said.
However, the upgrade may indirectly cause difficulties for larger custodians in Asia-Pacific, according to Citibank's Ernesti. "About 80 percent of my volume customers are ready for Nov. 15 and 20 percent are not," he said. "I am very keen on having all my customers 15022-compliant because I want to keep my STP rate."
Efficiency is the driver for Citbank and STP is a key component, according to Ernesti. "In terms of getting instructions from your customer, the more you have with less manual intervention, the better it is for all. The more instructions without manual processing, the more attractive the pricing becomes," he said. Citibank's focus is on what he calls "the top 350 customers worldwide and their local connections." This group accounts for 89 percent of all investable assets, according to Ernesti. Smaller clients may still be sizable, but they are not as efficient or automated and this inhibits scale.
Ernesti believes that Swift compliance after Nov. 15 could actually create a drop in industry efficiency. Large pension funds in the region may still use the services of smaller investment managers because of their specific market expertise. "If they are not ready for the messaging format, look at the situation that puts the larger players in: either they will have to send faxes or they will have to join a Message User Group," he said. "Citibank is ISO 15022-compliant and a market facilitator, but I have to be a member of that club, which is of the type no one wants to join. The longer you're in it, the more expensive it becomes."
Citibank will expand its broker-dealer services into regional clearing. According to Ernesti, the firm has a number of potential deals in Singapore and is working with regulators at the Hong Kong Stock Exchange to allow brokers to outsource their back-office operations. "Right now, keeping a big back office is expensive. It's tough to get good people and keeping efficiency is difficult. The market is saying, What part of this can we outsource?'" he said. Ernesti believes that while the bank's own custody business is proprietary, "we are intelligent enough to believe that we don't have to build everything ourselves. There are vendors out there that can build linkages to your existing system."
Citibank is working on a number of other initiatives, including projects with the Bank of Korea and Bank of China to improve their respective inflows and outflows of investment funds. Ernesti said global custodians can play an active role in building regional liquidity. "It's in terms of what I have done in other markets, that's how I help liquidity. I transfer my global products into the region, and regulators are now listening more actively," he said.
Arnott said custodians have a role to play in improving or at least measuring the executional efficiency of their fund manager clients. "I predict a bigger percentage will be looking for more value-added services to help them execute their roles as responsible entities, and these include evaluation of the total cost of a transaction; i.e., what was the brokerage and did it move the market," he said.
