State Street prioritises mutual funds

Being top of the league in terms of volume of serviced assets must feel pretty good. Knowing that you have a strategy to maintain that position in the future would be even better.

For State Street the first is a fact; and they are working on the latter. Assets under custody for the Boston-based firm increased from $6200bn (E5100bn) at the end of 2002 to $9400bn at the end of last year.

A huge percentage of this growth came from the acquisition of Deutsche Bank’s Global Security Services business (GSS) at the beginning of 2003.

With more than a year gone since the deal was announced it is now time to look back and evaluate if getting bigger has also meant getting better. The GSS acquisition was significant in that it fuelled State Street’s plans to enter major fund markets across Europe. It also allowed them to bring product diversification and new solutions into the US market.

Significant boost

Crucially, State Street has significantly boosted its share of the European distribution market. In one fell swoop, it has become custodian of all Luxembourg-registered funds issued by DWS, the retail funds subsidiary of Deutsche Asset Management and one of Europe’s leading fund players. The GSS deal has also established a presence in expanding markets such as Italy and Austria.

“In general, we added products, customers and expanded our geographical presence,” says Jeff Conway, head of State Street Investors Services for the UK, Middle East and Northern Europe.

‘Moving into open architecture brings the need to provide better fund accounting, tax and transfer services’

Jeff Conway, State Street Investors Services

He believes the acquisition was a major move towards the way the company will operate in the future. “In Europe, it meant extending existing relationships and creating new ones in different markets.”

“A large proportion of new customers came from markets where we were already present, with a significant part coming from the UK and the offshore markets,” says Mr Conway. In the UK, for instance, the acquisition of Edinburgh-based performance analyst The WM Company helped expand product capability, whereas in Germany State Street can now use Depotbank’s capabilities and should reap the benefits of an extended securities lending service.

So far, so good, but there are many challenges lying ahead, including a fundamental change in the nature of assets and markets which State Street and its competitors are servicing.

Mr Conway mentions the move from defined benefit (DB) to defined contribution (DC) pension schemes as having a significant impact in the future shape of the fund management market, as assets migrate from retirement schemes into mutual funds.

“This shift opens up the need for more robust securities services, because we are talking about funds, open architecture and multinational pooling,” he reveals. “Moving into open architecture means entering the collective fund space and the need to provide better fund accounting, tax and transfer services.

“The key is to have the ability to provide efficient and accurate reporting, but this is complex because you are dealing with multiple counterparties. So the need for the custodian to offer a more timely and accurate information delivery is critical.”

According to Mr Conway, what his company wants to be able to provide is “a service that really starts from middle office outsourcing services to product level accounting, whether we are talking about DC, wrap wealth management products or transfer agency”.

Transfer agency is one of the areas that is becoming increasingly important. State Street provides transfer agency services in the UK and in the offshore markets such as Luxembourg and Dublin, and is exploring the possibility of offering these services in other markets, but “we are not there yet”.

For Mr Conway, the fragmentation of the fund management industry in Europe is one of the main challenges. “Different tax and regulatory regimes result in different products. In Germany you are talking about KAGs, in the UK you talk about Oeics and unit trusts, in Luxembourg you have Sicavs. There may be 70 or 80 per cent commonality among these products, but it’s that 30 or 20 per cent difference that makes it difficult to operate across markets.”

Supermarket arena

In order to exploit fast-changing distribution channels, State Street has also decided to enter the funds supermarket arena. IFDS, the record-keeping specialist firm owned by State Street and DST, has recently acquired 30 per cent of UK funds supermarket Cofunds. “It is a wonderful opportunity for us to be able to complement the transfer agency services we offer with a fund supermarket solution. It is very important because is a link to the IFA community in the UK,” says Mr Conway.

Looking to the future, Mr Conway’s priority is now to concentrate and consolidate operations in those core markets where State Street already has a presence, and to build on the expanding products, lines of transfer agency and wealth management in a disciplined fashion, while demonstrating long-term commitment.

“We are also looking at markets that are dynamic in their financial and pensions infrastructure so the Netherlands and France are attractive countries for us,” says Mr Conway.

State Street has a longstanding presence in Europe, but there is no claim of infallibility. “I wouldn’t suggest we always got it right in the past,” admits Mr Conway. “But we are certainly getting it right now and the acquisition of GSS has complemented our efforts.”

Wealth managers can avoid burden of administration

For State Street, expansion of its wealth management division has been an important part of the strategy for attracting new and diversified revenue streams.

Part of the idea of developing this department came from listening to clients on the institutional side that were asking for help to manage their private accounts and wealth management business.

“We created the wealth management division over the last two to three years,” says Wilson Leech, managing director at the European division of State Street Wealth Management Services. “This area is probably one of the top five or six initiatives in terms of new revenue streams that we are undertaking.”

‘We cannot forget Germany, because it has such large numbers of high net worth individuals’

Wilson Leech, State Street Wealth Management Services

At the moment, Mr Leech has eight clients that are already live on State Street’s platforms and he has been pitching for several new accounts, which are expected to be confirmed in the near future.

Increasing demand

The division employs around 650 people, most of them based in the US. Around 40 people are based in London where the demand for these services is significantly increasing.

“The UK is the market where we see more demand for services from private banks and asset managers and we are also looking at Switzerland for being the largest offshore market in the world for private assets,” confirms Mr Leech. “On the other hand we cannot forget Germany because it has the higher number of high net worth individuals.”

Regulation and different tax systems across Europe have made it difficult to serve a sector characterised as complex and difficult to administer.

“It is good to be able to standardise some of the products but you always need an element of bespoke service,” Mr Leech says. “We are finding partners in different countries and learning from them about the different rules and requirements.”

One of the main reasons for managers of private accounts to outsource their custody and accounting responsibilities is to minimise investment in technology and avoid the administration burden.

“We have technology that is integrated globally to our custody and cash management system and we are trying to bring all those benefits to the wealth management industry,” Mr Leech explains.

A single solution

“Also, we can provide private asset managers with a single solution. Custodian banks have normally been offering back-office services and moving to the middle office, and we are certainly trying to do all that. But we are also able to offer a front office trading platform if that is what is required.”

Mr Leech is positive about the months ahead. “I think this will be a very good year for us too. We have new mandates that we will convert during 2004.”