Some asset owners are taking a closer look at the fees they pay custodians. But some consultants say bringing them down might not be easy — and in many cases, clients could ultimately see fee increases.
Pension funds and endowments have hired or retained custodians over the past two years with stipulations for lower fees. They include:
- The $137 billion New York City Retirement Systems, which hired State Street Bank & Trust Co. as master custodian in July, in part, because it provided the lowest fees;
- The $1.1 billion Wake Forest University endowment, Winston-Salem, N.C., which this past summer chose Northern Trust Corp. as global custodian because of lower fees; and
- The $6 billion Arkansas Public Employees Retirement System, Little Rock, which retained BNY Mellon Asset Servicing as global custodian in spring 2012 after the firm agreed to cut its fees by $2 million over the course of the five-year contract.
At Wake Forest, cost was important in the selection of a new custodian, but as important was “what we paid historically for the services our previous custodian had provided,” said James Dunn, chief investment officer. State Street was the previous custodian; its contract had expired.
“The old custodian offered us a good deal,” he said, but Northern Trust's fees were lower, and although it did not have the lowest fees among those who submitted proposals, Northern Trust was chosen for overall value of services, Mr. Dunn said.
Custodial costs are on the minds of other asset owners. In a Callan Associates Inc. survey of 49 pension funds and trusts in April and May of this year, 13% of those surveyed said renegotiating custody fees was the biggest anticipated change with respect to costs to be made over the next two years.
Clients of Mercer Sentinel Group, Mercer's custodial consulting business, have been asking about fee renegotiation, said Arti Sharma, Toronto-based principal and head of the custody practice. But many custodial clients who now are only looking at reducing their custodial fees have timed it poorly, she said. Fees had been declining since 2005 until recently, when they flattened — the same period that asset owners focused more on external money management costs than their custodial arrangements.
Among pension funds, “custodians had been treated like a poor cousin. They recognized their importance but always kept them kind of at the bottom,” Ms. Sharma said. “Now, those clients are saying, "Maybe I should take a look at this cost since I haven't done so in five to 10 years.'”
Virgilio “Bo” Abesam-is, San Francisco-based senior vice president at Callan, said as more asset owners invest in alternative asset classes, they will seek better deals from their traditional custodians. “Custodians' pricing methodology was built on traditional asset classes,” Mr. Abesamis said. “But the evolution of public and corporate funds in the past 10 years has been more into alternatives, which is not under traditional custody. ... Why pay custody fees for non-custody work?” he said, adding those traditional revenues “aren't coming back.”
Ms. Sharma agreed the traditional fee model for custodians had been “broken.” But she and Colin Rainbow, senior investment consultant at Towers Watson & Co., Reigate, England, see a different trend ahead — one in which added regulatory and staffing responsibilities lead custodians to increase fees. Also, custodians' revenues from foreign exchange and securities lending “have dried up,” Ms. Sharma said.
“Custodians used to know they would get X percent from securities lending and X percent from foreign exchange, so they could massage fees to make them more attractive,” she said. But because of recent lawsuits over foreign exchange against custodians like State Street and BNY Mellon, those fees as well as fees for securities lending are far more transparent now.
Mr. Rainbow said: “Some clients might be successful at reducing fees, but a number will not be.” Custodians have given “keen” fee deals to larger asset owners in the past, “but they won't get the same kind of fee deal today.”
However, large asset owners could see better deals from custodians eager to keep their biggest clients.
“For prestige clients, one or two custodians might pitch a good fee deal to them. They won't be a high profit margin for them but because of the client's size, it's still a good deal,” Mr. Rainbow said. “Smaller clients may find that they renegotiate to get reduced fees but end up paying even more money for what the custodian is providing. In these cases, the custodian ends up driving the negotiations.”
Ms. Sharma said smaller institutional investors' relationships with large custodians have become less personal — more like “calling an 800 number — you get who you get.” That — plus some of “the ridiculously high fees” Mercer Sentinel has seen in some cases from large custodians — are pushing those asset owners to more regional custodians like U.S. Bank Institutional Trust & Custody, Wells Fargo Institutional Trust Services and Huntington Bank.
Mr. Rainbow said that along with regional custodians, the increase in the number of alternatives administrators is creating “stiff competition” for larger custodians. And Callan’s Mr. Abesamis said even though large custody banks have added alternatives administration services, “that’s not making up for the lost custody fees. We’re in the new normal.”
At BNY Mellon, Samir Pandiri, New York-based CEO of asset servicing, said the firm more than a year ago re-evaluated its overall pricing “to ensure that we fairly capture the cost of serving (clients). Naturally, there are economies of scale in the wide range of services we deliver to a large public pension plan that don’t exist with smaller clients. In all instances, we continue to price aggressively and competitively, both to win new customers and retain existing ones. Our success as a business depends on that.” n