A tidal wave of European financial institutions is outsourcing custody of securities to major banks.
In a widely awaited move, the U.K.'s Prudential Portfolio Managers Ltd. is expected to announce shortly - possibly this week - the hiring of external custodians for its 43 billion ($67 billion) in assets.
Mellon Trust, Boston, and Midland Bank PLC, London, are expected to be the winners to handle securities transactions for international and domestic securities, respectively. A spokeswoman for Prudential declined to comment.
Previously, U.K. equities were handled internally, while Citibank N.A. oversaw Pacific Basin assets and Chemical Bank custodied continental European and U.S. assets.
London-based Prudential may be the biggest prize, but it is by no means the only. Other U.K.-based investment houses, such as Sun Alliance & London Assurance Co., Guardian Assurance PLC and AMP Asset Management PLC, have outsourced custody.
And in a significant move, Cologne, Germany-based Colonia Nordstern Versicherung AG recently hired State Street Bank & Trust Co.'s Munich operation to provide global custody for 2.9 billion deutsche marks ($2.1 billion) in non-German assets. State Street will provide a single platform for reporting the investment exposure of 20 Colonia subsidiaries in 14 countries.
"One of the objectives was to control risk of the foreign subsidiaries," said Gerhard Girner, Colonia's head of asset management. Currently, data is reported and evaluated in a variety of ways. With the new system, a consolidated position will be made available online from the perspective of portfolio managers, risk controllers, accountants and Colonia entities, he said.
Credit Lyonnais S.A., Paris, made a similar move. Other European giants, such as NV AMEV, Utrecht, the Netherlands, Commercial Union PLC, London, and Baring Asset Management Ltd., London, are reviewing their in-house strategies.
"If an insurance company with 30 (billion) to 40 billion in assets doesn't think they have the resources to do it, everybody else should be asking the question," said Patric Foley-Brickley, vice president-European sales manager for Citibank N.A., London.
Being one's own custodian "is increasingly anachronistic," said Robert Kay, director, Global Securities Consulting Service, London.
In Great Britain in particular, the expected adoption of the paperless CREST settlement system next June and the threat of increased regulatory activity are catalysts driving many money managers and life insurers to outsource their custody. In continental Europe, the trend is much less developed. But custodial experts see it picking up steam, particularly in Germany, Switzerland, Scandinavia, and the Netherlands.
Focusing on core business
The move to outside custodians is prompted by several events: managers are refocusing on their core businesses; investing has become increasingly global; investment technology has become increasingly expensive; settlement periods are shorter; and regulatory burdens and costs are mounting.
"Banks, operating under the shareholder mantra, will ask: 'Is this our real business?'*" said Martin Brennan, director, Europe, for Barclays Bank PLC's global securities services, London.
Insurance companies also are questioning whether they should continue to oversee their own custody. An oversupply of U.K. insurers is threatening consolidation in the industry, and new disclosure rules and shifting tax preferences are placing insurers at a competitive disadvantage, said Allen Harris, manager, client relations, at Midland Securities Services, part of Midland Bank. That is "causing insurance companies to look critically at what their business lines should be."
By outsourcing custody, firms can cut back both the fixed costs of maintaining internal staff and escalating systems costs, Citibank's Mr. Foley-Brickley said.
The costs of keeping up with the latest technology can be staggering. Assuming one has an adequate system, annual maintenance costs can run œ30 million to 50 million a year, Mr. Brennan said.
It costs essentially "the same level whether you are looking after 25 billion or 2 trillion," said Michael Devine, director of securities services for the Royal Bank of Scotland, London.
Plus, there are all sorts of additional services that major custodians provide, such as investment accounting, client reporting and performance measurement.
Mounting U.K. pressures
British money managers in particular are facing growing pressures to outsource custody. If managers continue to provide custody, they will be forced to bear significant costs and commit resources to join the Bank of England's CREST settlement system next summer. As a result, many are abandoning internal custody.
"The decision was taken that we would not be part of CREST in any way, shape or form," explained Harvey Lightfoot, director of Royal Exchange Trust, a wholly owned unit of Guardian Assurance, which shifted responsibility for about 4 billion in U.K. equities to an unnamed global custodian in July.
But CREST's startup only hastened the process, Mr. Lightfoot added. The firm determined it would save more than 500,000 over a three-year period by using an outside provider, he said.
Also, Britain went to rolling 10-day settlement last year from a twice-monthly settlement date. CREST will move settlement to T+5. Following the Group of 30's recommendations, the system is projected to move eventually to T+3 settlement, requiring much speedier processing of trades.
For Prudential, "this all adds up to a potentially heavy financial commitment and a big diversion of scarce resources from our core activities of achieving superior investment performance and client service," Roger Fishwick, the manager's group treasurer, said in a recent speech.
Sun Alliance executives also determined they wanted to avoid CREST, said John Maunder, director of Sun Alliance Investment Management Ltd., London. Providing custody was beyond the unit's core business, and the firm desired the additional security of having an outside provider, he added.
J.P. Morgan's London operation was hired last year to oversee some 6 billion in U.K. equities. Sun Alliance officials will stick with Bank of New York, which acquired Morgan's custody business earlier this year.
More recently, AMP Asset Management PLC, London, hired Midland Bank to provide custody for 9.2 billion ($14.4 billion) in U.K. equities for which custody previously was performed internally.
In addition, AMPAM has consolidated custody of its 3.6 billion ($5.6 billion) in U.K. fixed-income assets with Midland; custody previously was shared by Midland and Lloyds Bank PLC.
The expected additional costs of converting to CREST settlement system next year precipitated the move, explained Ray Greenshields, managing director.
Increased regulation expected
Regulatory factors also are cited as an equally important factor. Following the Maxwell scandal and the collapse of Barings Bank, the U.K.'s Securities and Investment Board probably will increase regulatory oversight of U.K. non-bank custodians next year. SIB is expected to force firms to meet new requirements in order to do business.
The SIB's review threatens to create onerous burdens on SIB-authorized firms, said Simon Thomas, director, Thomas Murray Ltd., a London-based custody consultant.
The prospect of external regulation, and the introduction of CREST, are prompting Commercial Union executives to examine whether to outsource its 4 billion to 5 billion in U.K. equities, said Oliver Pugh, director of finance.
In addition, financial institutions are interested in transferring as much risk as possible to custodians.
Added Prudential's Mr. Fishwick: "One of our aims is being to transfer custody risk from PPM and its clients to the custodian wherever possible - for example, the risk involved in operating a network of subcustodians, and the risks of failing to pick up a pending corporate action."
Meanwhile, Baring Asset Management itself is close to naming an external custodian for its 11 billion in assets, and terminating Barings Bank. Kevin Lee, operations director, said the move is in part motivated by the crisis at Barings earlier this year, but he noted a decision not to participate in CREST had been reached prior to the bank's collapse.