SACRAMENTO, Calif. - State Street Bank & Trust Co. delivered its second early knockout blow to other global custody banks by avoiding competitive bidding and signing a new contract - at reduced fees - with a huge public fund client.
The deal with the $62.5 billion California State Teachers' Retirement System comes only three months after the $100 billion California Public Employees' Retirement System accepted a similar offer from State Street Bank.
Coming to the end of a five-year contract, State Street offered the California Teachers an 18% reduction in custody fees - $1.75 million per year vs. the current $2.15 million per year - to sign a new contract with no bidding. Fund executives accepted after pension and custody consultants called the bank fee proposal very competitive.
(When the California Employees' fund earlier signed with State Street, it cut its projected global master custody costs 40%.)
Global custody consultants and banking officials see fierce competition for global custody contracts as part of a trend that is resulting in reduced competitive bidding in the United States.
James J. Darr, executive vice president and director of U.S. financial asset services at State Street, denied in June that the bank was pursuing a strategy of discounting services to avoid bidding after signing the contract with the California Employees fund. He said that deal was "very specific" to the fund.
The new deal resulted partly from California Teachers' officials asking State Street about getting a contract like the employee fund, said Mr. Darr.
But he agrees with some consultants that because of fierce competition among major global custody banks, a "de facto" situation has developed where cut-rate fees sometimes knock banks out of competition before bidding even starts.
Some global custody banks appear to be launching "pre-emptive strikes" to avoid competitive bidding, said Ben Abesamis, a vice president and manager with consultant Callan Associates, San Francisco.
While not referring specifically to the latest California deal, Mr. Abesamis said he is aware of a "proliferation" of similar strikes in global custody in the past year.
The moves often take the form of discounting fees to induce clients to stay with a particular custody bank. "Pricing is the key to gobbling up market share," Mr. Abesamis said.
Global custody bank executives know that if there is a competitive bidding situation, one bank is likely to launch a "first strike" and sharply undercut the fees of others to get the contract, he said.
Client retention has become a "big, big thing nowadays" because there is an "oligopoly" of only about six major global custody banks, said Mr. Abesamis.
Although price-cutting is fierce, it could go on for another two to five years, he said.
Sometimes the fight is over the prestige of having a particular client or over fear that losing an existing client will make other clients wonder why the account left, said Mr. Abesamis.
Yet another critical factor in price-cutting is that banks are selling their core custody and reporting services as a price leader, said Mike Costa, a practicing director with Alliance of Fiduciary Consultants, Parsippany, N.J., a financial services consulting firm.
In recent years, core custody and reporting fees have fallen about 40% to 1.5 basis points or less from 2.5 basis points.
But once a client is signed up, the banks sell ancillary services,
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and fees might end up costing a pension fund as much as 10 to 20 basis points, said Mr. Costa.
Banks are charging competitive fees for those ancillary services, but "they are not cheap," said Mr. Costa.
State Street Bank has built a "very fine" number of ancillary services, and its consulting product is among the best of consulting firms, said Mr. Costa.
Banks will cut core fees in hopes of "growing the relationship" by getting the client to take value-added services, agreed Steve Appell, a senior vice president with Northern Trust Co., Chicago.
But hoping to sell value-added services to the client is "taking a bet" and "not all bets pay off," he warned.
A caveat in the State Street contract with the California Teachers' fund is that State Street continue as a lending agent for the fund for all portfolios on which it now lends.
The new contract also calls for an additional fee estimated at $800,000 for emerging market transaction and holdings. When the last contract was signed, the fund had little or no holdings in the emerging markets, where transaction and holdings costs are higher than the domestic market.
The original argument for competitive bidding by public funds is comparison of services and fees, because among global custody banks, technological advances come quickly, said Mr. Abesamis.
But a fee evaluation report done by Global Securities Consulting Services Ltd. for California Teachers' found the fee proposed by State Street is "fair and highly competitive in the current market circumstances."
Fund staff is also "very pleased" with the service it is getting from State Street, said James Mosman, the fund's chief executive officer. "State Street is known for their data processing infrastructure and their ability to service large international accounts," he added.
Although CalSTRS got an 18% fee reduction compared to CalPERS' 40% reduction, the fees aren't really comparable, said Mr. Mosman. The employees' fund contract, he said, has an escalator clause in it, while the teachers' fees are capped.