Moving target

The advent of fierce competition between superannuation funds, a product of the implementation of choice legislation and the updated Australian Prudential Regulation Authority (APRA) licensing regime, is forcing custody providers to add more value to their service offerings.

Speaking about the institutional area of the industry, master custodies, key players identify the major growth factors in the Australian market as being the increasing sophistication of stakeholder requirements and the trend by investment managers towards outsourced back-office functions.

These broad factors can be broken down into a number of more specific impacts. At the member level, growing awareness of superannuation and investments mean more regular and more sustained contact with superannuation funds, and a greater demand for detailed, timely information. This requirement flows from members through to the fund and external providers such as custodians and administrators.

“These are the two things that are powering our business. On the super side, we’re seeing the institutional investors becoming more sophisticated themselves, whereas previously, more expertise resided with investment managers,” says NAB Custodian Services general manager Peter Kempster.

He refers to the increasing trend for superannuation funds to create chief investment officer functions and other similar roles to increase their penetration into this side of the business. “Many of the large funds … increasingly still rely on external managers, but have more expertise to balance the expertise of the external manager,” Kempster says. “The more funds under management [you have], the more professional you want to be about it.

“More and more funds are becoming concerned about achieving best performance for members. Because funds under management is rising, we’re seeing super funds becoming more and more sophisticated in the activities they’re undertaking,” he says.

According to Kempster, largely as a flow-on from increasing awareness of superannuation, each fund is looking for new ways to differentiate itself from competitors.

One way funds are going about this is by further diversifying their available investment options. This includes adding offshore asset allocations and alternative investments, those outside the standard realm of equities and bonds, to the portfolio.

“Super funds will be seeking higher absolute returns, investing in alternate assets such as unlisted securities, overseas securities, private equity and infrastructure. They’re moving asset allocations further away from just traditional equities and bonds.”

Meeting this demand has impacted the service levels custody providers need to deliver to the Australian market.

“If you’re a master custodian it doesn’t matter what your client invests in or where they invest, you have to do all the accounting and tax and custody of those assets,” Kempster says.

Referring to the experience of NAB Custodian Services, he says its client base is spread across some 80 international markets. “We have to facilitate the settlement of those assets, and using Australian tax laws … we settle whatever security they trade in whatever market they trade.”

The experience of BNP Paribas Security Services is much the same, according to Chris Briant, head of sales and relationship management at the global corporation. With superannuation funds continually looking for competitive advantage, the demands they place on investment managers and custody providers is adding greater complexity to their role.

He says superannuation has traditionally been seen as a relatively simple investment vehicle, but this has changed in recent years. “It’s now recognised that superannuation funds are becoming just as complex [in requirements] as our investment managers outsource [clients].”

While they used to be less difficult to service, demanding less rigorous turnaround and release timeframes, he says this has tightened.

According to Briant, the key focuses for institutional clients and their service providers are performance and compliance. “This is dramatically increasing at the moment. Traditionally [a consideration for] asset consultants, there is now more of a drive to get custodians doing this,” he says.

He says BNP Paribas’mandate compliance monitoring and automated board reporting services are some of the main value-adding services for clients of its custodian service.

In recognition of the diverse member base of most superannuation funds, and the growing requirement for timely data, it makes board reports available for hosting on member websites in 12 different languages. Briant also points out that its mandate compliance-testing platform automates 95 per cent of the process.

“The key change is competition between funds … to do that, [they are] looking to differentiate,” he says, pointing to the adoption of these services as part of the ongoing search for new efficiencies.

“Custody is more or less a commodity; we differentiate on value-added services,” Briant says.

State Street vice president, investor services, Greg O’Sullivan has a slightly different view. “Custody is not a commodity. When you’re talking about the value of the data that we’re able to provide … we have a focus on investment services globally,” he says.

But he does agree that the increasing sophistication of superannuation funds and the blurring of the boundary between them and investment managers is probably the biggest issue being addressed by custody providers.

State Street head of sales and marketing Chris Field explains it this way: “Funds themselves, I think, have become more of a full investment vehicle for their members … they’re becoming more of an all-encompassing financial institution in their own right.”

Field and O’Sullivan also identify the move toward more regular unit pricing and alternative asset classes as challenges State Street has had to address.

“What we’ve seen, driven by that growth, is a greater requirement on us in the provision of data … [Superannuation funds are] morphing into the services that investment managers would require,” Field says.

The interminable push for higher rates of alpha has seen many of State Street’s master trust clients add alternative asset classes to their portfolios, increasing custodians’ workload in providing reporting and pricing data.

Field explains that while funds have historically looked at rates of return on a monthly basis, many are now moving towards weekly and daily pricing.

“If you’re talking about an asset class that’s valued quarterly, how do you take the performance of that and integrate it into a portfolio that’s priced weekly? It’s quite an interesting concept,” Field says.

Superannuation funds that are adopting more exotic investments like infrastructure, hedge funds and commodities may generate higher margins, “but the difficulty in gaining access to data and the like … focusing on getting non standard data, that will come at a price”, he says.

State Street is negotiating this hurdle by re-examining its fee structure. “On private equity … what we’ll try and do is unbundle our fee schedule. At the end of the day, you don’t want to be paying for something you’re not getting,” Field says.

The move from crediting rates to weekly and daily unit pricing by superannuation funds is another opportunity BNP Paribas and other custody providers have leveraged in recent years.

While many of its superannuation fund clients have done this, Briant stresses the importance of doing so for the right reasons: to add value for members, not simply to be seen as progressive and a more attractive proposition in a competitive marketplace.

“They need to ensure the benefits do outweigh the perception,” he says.

Briant says custodians shifting from crediting rates to more regular unit pricing do add to costs, but stresses that these costs are not out of control because of the depth of market competition.

From the perspective of custodians, he says they also need to be diligent in ensuring pricing is conducted in accordance with the guide to good practice jointly developed by APRA and the Australian Securitiesand Investments Commission at the end of 2005.

While the rationalisation of superannuation funds predicted in response to choice legislation and registrable superannuation entities licensing has not hit as hard as expected, it is widely acknowledged that some consolidation has occurred and is likely to continue, particularly at the smaller end of the industry.

Briant believes the consolidation of superannuation funds has had a similar effect on custodians. “A lot of providers have exited the super servicing market because of the increasing complexity,” he says.

Prior to the introduction of choice, there was also the fear that those acting as a custodian to boutique funds would lose business as the smaller funds were acquired by their bigger counterparts.

While this has occurred to some extent, it often turns out that the same custodian is already acting for the fund or master trust making the acquisition.

According to Briant, BNP Paribas mitigates this risk by increasing its due diligence when submitting tenders for new business. “We pick funds that are growing and going to be the acquirers, not those that will be acquired,” he says.

Field also believes consolidation is occurring, which is making it harder for smaller scale custody providers to compete.

“I certainly believe it’s becoming more of a global players game, just through volumes and the direction of those investments …,” he says.

In recent years, the Commonwealth Bankof Australia sold its domestic custody operation to NAB Custodian Services, and Westpac Banking Corporation (WBC) was acquired by State Street.

Field points to comments made by WBC chief executive David Morgan at the time of the sale as proof of his reasoning: “The reason David Morgan gave for getting out was that global players are best equipped to do it.”

This leaves ANZ, a much smaller operation, and NAB Custodian Services as the core domestic-based players, along with others such as Whitefund Industries and HSBC, which cater specifically for boutique institutional clients.

State Street’s re-investment of over $1 billion a year into technology provides it with a competitive advantage, and this technological development is set to continue.

“Straight-through-processing — we’re not there yet, no one is, but we’re moving down that path,” O’Sullivan says. “The less hands of people that are touching things, the lower the error rate and the lower the cost.”

Briant thinks the European heritage of BNP Paribas means it is more flexible in tailoring its offering to meet the demands of clients from a diverse mix of international markets.

By way of comparison, he uses the example of US-based custodians, which he says tend to be more rigid in their global approach because they have such a large, homogenous domestic market.

Superannuation funds agree they are becoming more demanding of external service providers in general, including those that provide custody. “We’re probably looking to the custodian to do more than what they used to,” says Australian Super deputy chief executive Mark Delaney.

Australian Super, one of the country’s biggest funds, which resulted from the merger of the Australian Retirement Fund and the Superannuation Trust of Australia, outsources custody of its assets to JP Morgan. “We are looking for them to do more, to be more sophisticated and to handle different assets,” he says.

“It’s becoming more challenging for custodians; funds are becoming bigger, becoming more sophisticated and making more demands of service providers, and service providers are adjusting to that world.”