Bank of New York Co.'s clearing unit, Pershing LLC, and Fidelity Investments' clearing arm, National Financial, are finding a wealth of new business from banks, both large and small, that want to remain in the investment management business but are not interested in maintaining their own back offices.
"The regulatory environment has gotten tougher and less forgiving over the last five years," said Randall Reynolds, the managing director at Pershing. "And as a part of that we have seen banks of all sizes looking for ways to reduce and mitigate any compliance risks and any reputational risk that they may have."
Mr. Reynolds said that, since Bank of New York bought Pershing in May 2003 from Credit Suisse First Boston, the Jersey City clearing firm has expanded its assets under custody to $807 billion, from $474 billion.
Mitch Bell, a director in Pershing's product management and development group, said banks traditionally have borne the burden of clearing for their mutual funds and annuities but now are choosing to outsource rather than deal with the regulatory scrutiny.
Pershing is generating a lot of new business from banks that no longer want to self-clear or manage proprietary investment products and instead have chosen to work with third-party marketers, Mr. Reynolds said.
Originally, he said, the sweet spot for third-party marketers was to work with regional and community banks with $1 billion to $5 billion of assets, but now larger banks are interested in outsourcing their clearing services. Six of the top 50 banks are self-clearing, he said, and Pershing has relationships with about 56% of the other 44.
"Ten years ago, you'd have been very hard-pressed to name even a couple $15 billion banks that outsource their investment arms," he said. "Today, there are a lot of firms partnering with third-party marketers."
Mr. Reynolds said the rationale is simple: Banks want to avoid regulatory scrutiny and the black eye of scandal.
"I have been around bank-run investment management programs for a long time, and you can make some money with this business, but for the most part, these programs don't make or break the bank," Mr. Reynolds said. "Banks want their broker-dealer to be a quiet, solid revenue growth engine for their shareholders that won't land them on the front of the Wall Street Journal."
Fidelity's National Financial has also grown steadily since it was spun off as a stand-alone company in 2002. Since the end of that year, National Financial's assets under custody have grown to $700 billion, from $200 billion.
Mark Healy, an executive vice president and the chief operating officer at National Financial, said banks and other financial services companies have become increasingly interested in outsourcing to a clearing firm.
"Firms have changed their mind-set," he said; "it is really a fundamental shift. They want to partner with someone that can help them face some of the challenges and help them to find growth and manage the risks associated with this business."
Matthew Schott, an analyst at the TowerGroup unit of MasterCard International in Needham, Mass., said that the share held by the largest clearing companies continues to grow rapidly as higher regulatory and technology demands make clearing more complex and expensive. "It is harder to make a go of it with self-clearing," he said.
Mr. Healy said larger and larger banks that once did their own clearing are outsourcing.
"We saw two years ago that self-clearing and the fully disclosed market were on a collision course," he said. "Because of the level of integration and consolidation that has occurred in the past few years, firms are interested in outsourcing their clearing because it is just simpler."
Analysts said some banks remain wary about working with a clearing firm that is owned by another bank, as Pershing is, but Mr. Reynolds disagreed. Since being bought by Bank of New York, he said, Pershing has grown substantially and has improved its capabilities and technology.
"Our scale has increased," he said. "Generally, Bank of New York is viewed as a custodian, not as a competitor."
Mr. Reynolds said he is confident that Pershing's business will continue to expand as larger and larger banks choose to outsource.
"What we have seen is, banks have a very, very, very low threshold for reputational risk," he said. "They'd rather outsource than take a chance with their reputation."
