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Global Custody

Page last updated
February 15, 2003




The explosion ahead
Outsourcing in the securities services industry stands poised for a period of explosive growth.


Over the next five years, our own research indicates that some 25-30% of fund managers can be expected to outsource core administration functions to the new generation of securities services providers, affecting assets worth an estimated $6 trillion. This rapid acceleration of an established trend will generate new business opportunities and continue the transformation of the sector.

Driving The Growth
The appetite for outsourcing has grown and is growing for several reasons:

the high levels of technical spending associated with the creation of the euro, Y2K, progress towards a single European Automated Clearing House, a move to shorter settlement cycles world-wide, and the increased urgency placed on achieving wider straight through processing. In addition, end users are demanding higher standards and higher quality; they want information quicker and they want it better. The underlying fundamentals are today more compelling than ever.

The changes that will take place in securities services processing reflect the consolidation that is already taking place in global custody; that consolidation is essential if the industry is to adapt to the changing market place. Those who do not adapt will not be able to fund the improvements required; this is the principal reason behind the decision of number of banks to quit global custody in the recent past and why more are likely to follow.

Directing The Change
Outsourcing is moving into this exciting new phase with a new momentum. For perhaps the first time in financial services history, the quality of supplier exists in the industry to meet the increased demand for securities services outsourcing.

The change in demand has been matched by a dramatic supply side change which has seen the evolution of a new kind of institution in the banking world, the independent provider of administration and support services. The best of these will offer as their core business a wide range of stand alone or complementary services, from trusteeship and custody to trade execution, automated foreign exchange and internet delivery, allowing asset managers to focus their attention and skills on their own core business, asset management.

The Bank of New York is in the vanguard of this transformation, becoming in the process a provider not only of information and technology, but of the technology and business consultancy services that have assumed paramount importance as the revolution has progressed. If an institution decides that it wants to outsource, it needs to be able to turn confidently to a project team that can advise it on how, what, where and when to outsource. Institutions need to be able to speak to would-be outsourcers in their own language.

Defining The Beast
How is outsourcing defined in the context of modern securities services? Once it was simple: custody and income collection. Today there is a new sphere of complexity, with the definition differing from organisation to organisation. The spectrum ranges from simple global custody to the entire back office function, from trade confirmation to settlement and beyond, encompassing decision support, trading, data management, messaging, accounting, asset servicing and reporting. The pace of change varies too. Some fund managers might prefer to take a measured approach with the aim of outsourcing everything gradually over a period of several years. Others may want to move more quickly.

The leading providers have to be able to deliver the wide range of both generic and tailored solutions to meet individual client-specific requirements in the fiercely competitive marketplace.

Differentiating The Suppliers
The leading providers' commitment to the core function has to be steadfast and unswerving - commitment, which in our case is underlined by our actions and acquisitions over the past few years. Indeed, securities servicing and cash processing now accounts for over 50% of our global revenues.

Customers need confidence that a provider can consistently deliver under changing conditions; The Bank of New York adds value at every stage in the evolving investment life cycle. Product flexibility, technical capabilities and consultancy are the keys. The ability to deliver these under a committed, mutual goal approach with clients has been key to our success.

Depth of Development
The deepening of our relationship with JP Morgan encapsulates the changes that have taken place already in the industry and demonstrates the extent of the potential for future developments. When JP Morgan appointed us to be the back and middle office for its asset management business, it represented the logical continuation of a tale begun in 1995. At that time JP Morgan sold its global custody business to The Bank of New York, while retaining the underlying fund management business. The confidence that has grown in the partnership during the intervening years made our company a logical choice when the bank was looking to outsource its administration.

We now manage all back and middle office functions, picking up the administration trail from the moment of trade confirmation; we also manage the custody process in its entirety, irrespective of the identity of the custody provider itself. We produce accounting and valuations for JP Morgan's client portfolios, which encompasses providing core data to JP Morgan who can supplement and present this to a wider audience as appropriate.

As John Schmidlin, head of Technology and Operations for JP Morgan's asset management business said at the time of the announcement of this arrangement: "We have enjoyed a long-standing relationship with The Bank of New York and believe that its technology, vision, and capabilities are an excellent match with our business objectives. As an investment management firm, our focus is on providing clients with the best possible service and generating the strongest possible returns. Our relationship with The Bank of New York will enable us to do what we do best while fully supported by state-of-the-art technology."

Drawing The Conclusions
Custody has increasingly developed into an information-driven business; the future success of global custodians will therefore depend to a large extent on their ability to build harmonised and integrated links and interfaces between various parties, the investor, the fund manager, the counterparty,the sub-custodian, the clearing agency, the depository and the payment clearing system. This multi-level communication requires major investments in systems and software development and support.

Constant adaptation of systems to meet clients' needs is required, ranging from basic reporting and instruction processing facilities to tailor made solutions. We alone are intending to invest around $2bn in technology to meet the needs of this sector alone over the next five years, in research and development, satisfying client demands and accommodating market infrastructure changes. Clients derive immediate benefits from that investment.

Divining The Future
The rapid changes taking place in the financial services industry make accurate predictions difficult. Even a cursory examination of the experience of the past ten years demonstrates that a decade is more than a lifetime in modern financial services. Since Deutsche Bank took over Morgan Grenfell the landscape has changed almost beyond recognition. Since Swiss Bank Corporation merged with Union Bank of Switzerland it has been clear that no-one is guaranteed an independent existence. Size in itself is no guarantor of survival. A focused and well executed strategy is essential.

Further advances in clearing and settlement procedures and systems will have an equal impact upon custody. The chances are growing that there will be a single pan-European depository and we are already on record as calling for such an institution. Its creation would reduce costs, increase efficiencies and have wider implications for the smaller custody players; if the international depositories introduce open membership, custodians who offer clients nothing more than a core processing service will be exposed and will lose business.

The size and number of major fund managers interested in discussing Outsourcing's possibilities suggests there could easily be $2-3 trillion of readily outsourceable assets. It is thus no exaggeration to say this is a potentially gigantic new market with opportunities for a number of players. Three years ago fund managers were dipping a toe in the water. Today they are taking the full plunge.

We expect there to be no more than a handful of world-wide providers, including The Bank of New York and people like State Street. We believe there will be a number of smaller regional providers focusing on Europe or Asia, with coverage limited to certain markets. It remains our resolute belief that only the world-wide providers are in a position to fund, resource and develop the technology required for successful outsourcing.

Jeffrey Tessler
Chairman, The Bank of New York Ltd in Europe


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