David Linds, senior vice-president, business development and relationship management, with CIBC Mellon, says that in dealing with some of these alternatives, the difficult part is the independent valuation. “For many years, for these kinds of alternatives, the pricing was done by the agent—but that’s not independent valuation. One of our jobs is to determine the value of the asset. We’re scanning the globe and identifying legitimate, accurate, reliable sources of pricing valuation.”
Another difficult part is the settlement of these kinds of trades. Some of the very sophisticated derivatives, Linds says, can sometimes be created overnight. CIBC Mellon’s product can handle the valuation, settlement, pricing and management of these assets. Specifically, the valuation service including quantitative in-house models, management of the derivatives lifecycle and the integration of collateral management services to provide end-to-end capabilities for derivative servicing.
Canadian Western Trust (CWT) recognizes that expanding its current product line will require additional investments in technology, says Matt Colpitts, vice-president and general manager with CWT. Though it is not yet in the derivatives business, primarily because of technology limitations, the custodian is looking to change that soon.
Yet while all of the custodians interviewed say their clients are asking for enhanced technology in some way, not all are using the custodian’s current complete offering. Sharma says many of the newer technologies for alternatives, derivatives and risk analytics are built for larger clients. “What [custodians] haven’t done—and every single one is guilty of this—is, they’re not doing a good job of penetrating their existing client base with these new tools,” she says. A custodian’s own client base can provide a source of new revenue if the custodian is proactive in pushing out the new tools, she adds.
However, it’s not that simple. Linds says that out of roughly 1,000 clients, about 100 are using the newer tools for derivatives or hedge funds. For the remaining 900 clients, CIBC Mellon informs them of the available services and provides demos—but there may not be any uptake. “We’re in the investment services business,” Linds says. “It’s not our job to tell the plan to invest in alternatives.” But if smaller plans do want to use them, CIBC Mellon will be ready. “If I’m ready for the $60-billion pension plan, the product will be there for the small or mid-size [plan],” says Linds.
Baillie agrees that an education process will peak interest but adds that smaller plans are more cost-sensitive. “There’s a cost associated with it. But, in many cases, it’s quite reasonable when compared with the total cost of executing the investment strategy.”
Big spenders
To keep up with their competitors, custodians are making significant technology investments. Northern Trust spent $520 million on technology last year. For 2011 to 2013, the organization has budgeted about $2 billion.
CIBC Mellon’s technology is built on that of its U.S. parent company, BNY Mellon, which invests more than US$1.5 billion annually into the technology powering both companies’ products and services. Citibank spent about $450 million last year, half of which was on new development.
State Street, historically, has devoted 20% to 25% of its operating expense budget to technology per year. “We also introduced an IT initiative in 2011, geared toward allocating more resources to development,” says Chris Perretta, executive vice-president and chief information officer with State Street Corp.
RBC Dexia estimates about the same: 25% of its revenue this past year. “That 25% would represent hundreds of millions of dollars to support the ongoing maintenance of all of the technology and the key programs and development work that we have,” says Lockbaum. And despite the headline news of a financially troubled Dexia, a 50% shareholder in RBC Dexia, being helped by France and Belgium, it’s “business as usual,” according to Lockbaum. “The situation with our shareholders has absolutely no impact on our business or on our operations.”
But it’s not necessarily what you spend; it’s how you spend it. “$520 million—it’s probably not the biggest [number] out there,” says Baillie, “but because we’re maintaining only one system, we actually invest a lot more into new products and services as opposed to just maintenance. Seventy percent of every dollar we invest goes into new products or enhancing products.”
It will take ongoing investment and innovation to remain a key player in the custody business. While the scale of a custodian may be gauged by its assets under custody, some, like Baillie, would argue that’s the wrong measure. “It’s how much scale you get out of your technology investment.”
Brooke Smith is managing editor of Benefits Canada. brooke.smith@rci.rogers.com
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