The increasing willingness by asset managers to cede control over trade confirmation, record keeping, and other "middle-office" tasks has the handful of U.S. processing specialty banks scrambling to ply their outsourcing services.
Analysts estimate the worldwide asset management outsourcing market at $55 trillion, with $9.4 trillion coming from Europe, where asset management privatization is booming. Asset custodians are expected to generate $13.9 billion of asset servicing and outsourcing fees this year, according to TowerGroup, a Needham, Mass., unit of MasterCard International.
These functions, which also include trade reconciliation, risk management, compliance, and cash management, were once considered core tasks at many investment managers. But revenue pressure, the desire to cut costs, and increasing regulatory burdens are encouraging companies to hire outsiders to handle these tasks, so the companies can focus on managing money.
This trend encouraged Northern Trust Corp.'s corporate and institutional services group to make a deal to acquire the mutual fund servicing and outsourcing business of ING Group NV's Baring Asset Management of London.
"Revenue has been under pressure," Rick Waddell, Northern Trust's president of corporate and institutional services, said Nov. 22 the day the $480 million deal was announced. "Fund managers have come to the conclusion [that] those client-facing attributes are what they want to focus on, and the back office and those other areas are better left to others, assuming they can provide the level of quality and at a cost that is advantageous to them."
State Street Corp., Bank of New York Co. Inc., Mellon Financial Corp., and even J.P. Morgan Chase & Co. are vying for a bigger piece of the outsourcing pie, especially abroad, where capital markets are still evolving.
Many of these U.S. banking companies also have struggled with earnings growth over the last few quarters, because of poor market-driven revenue. They are looking for ways to expand into areas that focus less directly on what the equity markets are doing.
Last month Mellon announced its intent to service the assets of F&C Asset Management PLC, a European fund manager created in October from the merger of F&C Management Ltd. and ISIS Equity Partners PLC. The deal with F&C Asset Management, which has $220 billion of assets, nearly doubled the assets for which Mellon provides outsourcing services, to $480 billion.
Mellon, which has $3.7 trillion of assets under administration, provided outsourcing services to F&C Management before the merger with ISIS.
Also this year the Pittsburgh banking company signed up TIAA-CREF and Old Mutual PLC as customers.
In September, Bank of New York announced that it would take over the middle- and back-office services for RCM (UK) Ltd.'s $8.8 billion of assets. (RCM is a unit of Allianz Group AG.)
JPMorgan Chase closed a deal in mid-October with Morley Fund Management, a London unit of Aviva PLC. The deal, in which Morley and JPMorgan Chase's fund administration platforms were combined, brought $208 billion of assets to JPMorgan Chase's asset servicing business. JPMorgan Chase handles fund accounting, securities administration, business analysis, and client reporting, among other things, for Morley's customers.
"There is a big market out there of investment managers that traditionally say, 'Processing is not my core competency, but if I don't do it, I can't run my investment' " business, said Steven Papulak, Mellon's business manager for investment manager solutions.
Jay Hooley, State Street's head of investor services, said Nov. 16 at a Merrill Lynch & Co. investor conference that there is a less obvious reason for companies to outsource the back- and middle-office functions. "Many of the growth opportunities for investment managers will involve introducing new cross-country/cross-border products which require sophisticated platforms and operation systems," he said.
State Street provides outsourcing services for $1 trillion of its $9 trillion of custody assets. In a Nov. 2 investor presentation, its chairman and chief executive, Ronald Logue, said he expects 50% of its revenue to come from outside the United States in four years. Next year 1% to 2% of its revenue growth should come from outsourcing deals, Mr. Logue said.
Bank of New York has $310 billion of outsourcing assets, out of $8.7 trillion of assets under custody. Gerald Hassell, its president, wrote in an e-mail that he expects European demand to continue to grow. However, he also wrote that companies must be mindful of cultural differences between the United States and other countries.
"The European market has to deal with individual country regulations, as well as a host of unique human resources issues," he wrote.
Bank of New York's pipeline remains "robust," Mr. Hassell wrote.
For the banks offering the outsourcing services, the business is a way to pick up fee revenues by getting to manage more components of transactions in which they are already involved.
Paula Sausville-Arthus, the head of JPMorgan Chase's asset manager solutions group, said that by becoming a manager's complete investment operations provider, "you are servicing their entire book of business," instead of acting as a custodian for only a subset of a customer's assets.
JPMorgan Chase does outsourcing for about $355 billion of the $8.5 trillion of assets it has under administration.
JPMorgan Chase's asset servicing business is operating in full scale in Australia and the United Kingdom. Its U.S. operations are still on a piecemeal basis, but it plans to establish a platform that runs across multiple customers in multiple regions. It has a pipeline of $400 billion of outsourcing assets, most of which is U.K. business, Ms. Sausville-Arthus said.
Getting to this point has not been easy for the processing banks. Traditionally they used a "lift-out" strategy to obtain middle- and back-office technology - and their first investment managers.
Many processing banks "lacked the understanding of how the middle and back office of a firm worked, and they lacked the tools to emulate the back office," said Tim Lind, a consultant with TowerGroup.
Perhaps one of the most successful lift-out stories occurred in August 2000, when State Street acquired the investment servicing operations of Pacific Investment Management Co. of Newport Beach, Calif. The purchase created State Street's investment manager solutions unit. At the time Pimco had $190 billion of assets, which transferred over to State Street.
The Boston company expanded its outsourcing business globally in January 2003 when it acquired a majority portion of Deutsche Bank AG's global securities servicing unit.
State Street says it's in negotiations to bring on outsourcing contracts covering $390 billion of assets and has closer to $600 billion in the pipeline.
Companies acknowledge that the investment of time and resources in the outsourcing business is a gamble.
"Clearly the name of the game is to integrate and deliver on the synergies as soon as possible," Ms. Sausville-Arthus said. However, the average contract is only seven years. In the outsourcing business, "we're locking into an arrangement for a longer time period, and that's part of the process of getting the financials to work."
Pricing for outsourcing deals could also be an issue, and analysts said many banks are trying to buy their way into the business.
"Pricing continues to be under pressure, and there is really no pricing power in the market, so the companies must continue to focus on specific business opportunities and gain additional technological efficiencies," Jacqueline Reeves, an analyst with Ryan Beck & Co. Inc., wrote in a Nov. 22 research note.
Richard X. Bove, an analyst with Punk Ziegel & Co. in St. Petersburg, Fla., agreed with that assessment. It has been customary "to give away service … in order to get exclusive arrangements," he said. Banks are "continuing to offer their core product at low prices but are now starting to price compete with the product where they were supposed to make the big profits."
Mr. Bove also cautioned that the industry will have to deal with overcapacity issues. "Some people will have to go out of business," he said.
JPMorgan Chase and Citigroup Inc. will be among the few survivors, and State Street could be the first to sell itself to a larger company, he said.
Another challenge is integrating back-office services and systems with the front- and middle-office tasks.
"Our back-office technology and operating model is fairly simplistic; it's the interactivity of that information back with the investment manager where many of the challenges come in," Mr. Papulak of Mellon said. Potential integration problems are why Mellon purchased Eagle Investment Systems Corp. of Newton, Mass., in 2001, he said; as a result of the purchase, managers can find information on one platform instantaneously.
Mr. Hooley of State Street countered that there are some middle-office outsourcers that do not understand "how to make it different to the customer - and how to make money off of this."
