A version of this article appeared in the FTFM Asset Services supplement in the Financial Times of October 1 2007
The search for recurring themes in the world of asset services turns up a number of the usual suspects: outsourcing; globalisation; and consolidation. But one powerful theme echoes longer and louder than these three combined, one theme to bind them all. The determined march of alternative investments into the mainstream lies at the heart of much of the soul-searching and repositioning that is taking place in the market.
The tentative steps being taken by traditional long-only investment managers into a parallel universe of quasi-hedge fund investment styles, launching long/short or so-called 130/30 funds, also contribute to the mood music, albeit a little less stridently.
The growing complexity of the investment world poses a number of questions to suppliers of asset services. How do they capture and automate these very varied transactions? How do they price them? How do they manage and automate linked payment processing? How do they handle the paper chain? Hedge fund managers seem able to devise six impossible trading strategies before breakfast, and despite the progress being made in automation, paperwork still abounds in derivatives. The higher the volume, the less use that can be made of old technology.
This has human implications as well as technological ones. As Wilson Leech, head of global fund services at Northern Trust, puts it: “People who are experienced and skilled in handling volatility and high growth within fund structures that are highly complex are in high demand and increasingly difficult to find; all providers are spending a lot of time and money on identifying and hiring staff.”
As asset allocations grow to hedge funds and private equity funds, whether directly or in funds of funds, new issues and challenges present themselves. “As lines blur, we also have to ask whether custodians and prime brokers are heading for a collision, or can they co-exist peacefully,” says Jay Hooley, vice chairman of investor services and global markets at State Street.
Against this backdrop, we are witnessing nothing less than the early stages of a new reshaping of the asset services landscape that is already dramatically different from just 10 years ago, when the US takeover of the UK custody providers was all but complete. “The battleground for survivors now is to handle different types of investment vehicles and instruments,” says Conrad Kozak, global head of the securities company of JP Morgan Worldwide Securities Services. “The industry’s customer base is becoming more and more demanding in terms of the breadth and depth of services they require. On breadth, anyone can do equities and bonds; that should be like switching on an electric light switch. Today you need to be able to handle pooling of assets, the processing of derivatives, hedge funds, private equity and real estate, all the while delivering superior reporting to clients in a way they can actually use. On depth, outsourcing is more and more likely to deliver the solutions, and we are moving further along the functional continuum into the back and middle office, so all that some of our clients will need are their traders.”
Tim Howell, head of HSBC Securities Services, believes the industry is undergoing a fundamental change that will affect its very nature as well as its appearance. Previous change has, he argues, been focussed on achieving scale and in accelerating the extent and pace of automation. The result, he observes, is that the industry is heavily populated with technical experts and engineers who make sure that day-to-operations do what they are designed to do, but it is lacking in higher level management skills. The time has come, he says, to look at the future more strategically, and more thoughtfully, to shift the emphasis away from the plumbing that makes the industry work, and towards the brain that can map out a more inspiring and profitable future.
“I think that asset services is growing up, and that recent market turmoil has underlined the potential for providers to profit from adding more value,” says Mr Howell. “Valuation services, for instance, have come to be viewed as commoditised, but they are not commoditised. The more OTC a product becomes, the more difficult it is to value. When there is price dislocation people start looking to see the true value of asset services. They want to understand how you do valuations, and they want the valuations put in a broader context, rather than an absolute price. This will change the nature of staff the industry needs to employ. More intellectual capital will be required, and ability to import underlying quant skills and the mathematical understanding needed to contextualise a valuation could be a differentiator between different providers. We are not all going to go in the direction of the same one-stop shop.”
Putting its money where its mouth is, HSBC’s asset services unit has established a joint venture with the bank’s global markets division to bring the talents and capabilities of both together across the entire panoply of traded markets worldwide. The bank has also undertaken an exercise over the past 12 months designed to match the DNA of its clients to its own DNA. This has resulted in around 25-30 per cent of alternative funds clients moving to other administrators who are better suited to their individual needs. “The industry is changing, and we are in the vanguard of that change,” he says confidently.
In the meantime, as the integration process begins at the newly created giant The Bank of New York Mellon, there is a consensus amongst custodians that further consolidation is certain. The only questions surround timing and the nature of how the consolidation will unfold; some say there will be significantly more M&A activity, others suggest we will see still more partnerships being formed.
Compared with BoNYM, State Street’s $4.5bn purchase of Investors Financial Services, and Citi’s acquisition of Bisys Group, a hedge fund administrator and mutual fund services provider (purchase completed on August 1, for a net $800m), look like modest bolt-on buys rather than major strategic advances. But the fact is that Citi and State Street have bought in order to extend their existing range of products by buying in capabilities that they didn’t have, but needed.
“The industry is moving away from a pure scale focus to a solutions focus,” says Neeraj Sahai, global head of securities and fund services at Citi. “We had global reach and a wide variety of services but wanted to grow our hedge funds offering and lacked a private equity platform. Buying Bisys plugged a gap and made us number four in that space globally overnight.” Given the underlying commercial imperatives, the moves toward a new-look industry are certain to continue for the foreseeable future.