(June-2002) As safe as being in custody

The Australian custody industry continued to enjoy solid growth over the past year, even though the value of many overseas investment markets fell. According to the Australian Custodial Services Association (ACSA), total assets held under custody and administration by its members rose by 13 per cent to $1.1 trillion in calendar 2001.

But despite this growth, the trend towards consolidation that has gripped the industry over the past few years shows no sign of abating, with French group BNP Paribas the latest to join the fray after announcing that it had bought Cogent from AMP last month.

Other moves have included the sale of BT Portfolio Services to JPMorgan Chase in 2000 and the Royal Bank of Canada’s (RBC) purchase of Perpetual’s custody business last year.

These deals have surprised no one and according to Bryan Gray, JPMorgan’s Australian and New Zealand sales executive, they have sent “a message to the market that custodians could not continue with the downward pressure on fees”.

Sarah Carne, a consultant at Frontier Investment Consulting, says: “To be profitable, custodians need to have scale. This means they need a large client base over which to spread the ever increasing costs of technology. Plus, the reduction in corporate super funds has reduced master custodians’ client-base opportunity.”

Looking forward, these rationalisation moves are unlikely to dry up. Carne believes that a number of custodians will be reviewing their presence in the Australian market over the medium-term. “And, those custodians that determine that master custody is off-strategy are likely to exit. The commonly held view is that there is scope for only three large master custody players in Australia,” she says.

At present, there appears to be only four serious master custodians looking after the super fund market - National Custodian Services (NCS), JPMorgan, Commonwealth Custodial Services (CCS) and Cogent.

According to NCS general manager Tony O’Grady, the super market remains attractive because its future is underpinned by the super guarantee, which rises again in July this year, as well as the growth in the industry’s assets over time.

Not all players would agree, including State Street which exited the master custody business in 2000 and RBC Global Services which recently said its was also withdrawing.

RBC managing director Graham Putt believes that the master custody market is “fairly settled” and that little movement can be expected because super funds generally stick with existing providers after they review them.

Other players also note that the super fund market is shrinking, as corporate funds outsource to master trusts and industry funds amalgamate into larger funds.

As a result, a number of Australian custodians view fund managers and master trusts as more vibrant areas for future growth.

Some master trusts do their own custody, but there are many that are outsourcing in order to enhance their communications and member investment choice offerings. Also, the master trust business continues to attract a steady stream of new entrants.

Likewise, while many large fund managers still do their custody in-house, small to medium fund managers increasingly need to outsource to improve their economies of scale.

“In the US, outsourcing was embraced earlier and now Europe and Australia are starting to catch up,” says Putt.

But while the flow of corporate funds rolling into master funds may decrease the corporate super client base, the growing size of remaining corporate and industry funds provides new opportunities in areas like non-super products, retail registry and online accessibility, areas that are fast emerging as the new battlegrounds for existing master custodian players.

Indeed, it is becoming harder for custodians to differentiate themselves through technology because most use the same platform, which means that custodial services have become almost commoditised.

The trick now is for the custodians to find their own niches or to offer value added services which can improve their margins. As O’Grady notes, custody is the ticket to the game, but the winners will be those who can do all the add ons.

Cogent managing director Alexis George adds: “Clients are looking for that little bit extra. Prices have been set for typical services and now the different players are looking to find extra revenue streams.”

The key is to find ways to support super fund clients who are under pressure to keep up with members’ rising demands and the bells and whistles offered by master trusts.

JPMorgan, for example, is focusing its efforts on more tailored services, providing value added reporting and differentiating itself through Internet enabled technology.

To make its mark, NCS has added various features which assist funds wanting to offer member investment choice and to move to more frequent pricing.

And, to differentiate itself, CCS has developed some unique reporting tools for super funds offering Socially Responsible Investment. CCS senior manager Rob Brown says his group has also developed a pack that helps super funds with their compliance, and it has put in place a dedicated team to assist with transition management and transition reporting.

Service providers like JP Morgan, which are part of global groups, are also looking at how they can leverage off their international networks. And, local banking players, such as NCS, are looking at how they can provide a total service to super funds, making use of other parts of their groups.

Indeed, O’Grady confirms that NCS is working on integrating services like banking, cash management and administration with its custody services to create a single package for clients.

In addition, smaller players, like Permanent, are trying to carve their own niche in areas neglected by the bigger players in the market (see right box).

But before they get too carried away with value adds and niches, CCS’s Brown believes that Australian custodians need to first get their core capability right.

“Most master custodians offer pretty much the same core services. What’s more important is how they deliver these in terms of quality, timeliness, accuracy and completeness,” he says.

Brown adds that risk framework and compliance are likely to be the next areas of focus for master custodians, given the regulatory attention that the superannuation industry is currently attracting from the Government and regulators.