IN PUBLIC STATEMENTS, if not always in private, bankers are normally quite a polite bunch. So what does Tom McCrossan of State Street put on his breakfast cereal?
Whatever it is, he is highly critical about his rivals’ outsourcing ventures. “I think we can be pretty confident in suggesting that many of the outsourcing deals have been lacklustre in their success,” says the State Street executive vice-president. “I’m not saying anything out of turn here. I think the market perception is one of problems and troubling situations that have occurred.”
In the rarified world of investor services – where just three banks dominate – this is a stinging attack. Nor does McCrossan stop here. He says that it is precisely the problems for competitors such as Bank of New York and JPMorgan that are blocking the market as a whole. “Their lack of success has held the market back from diving into this new outsourcing arena,” he says.
Faced with such direct criticism, its targets have react quite differently. JPMorgan Investor Services declines to comment, not wishing to get involved in tit-for-tat mud-slinging. Bank of New York, though, feels compelled to answer back.
Daron Pearce, managing director, European outsourcing services, for BNY SmartSource (the new brand name for Bank of New York’s outsourcing group) is stunned by the suggestion that his bank’s deal with JPMorgan Fleming Asset Management might be “lacklustre”.
“I can’t imagine what [McCrossan] is alluding to,” says Pearce. “JPMorgan [Investment] have gone on record to say how pleased they are with the success of the partnership. We have a very happy client. It is far from lacklustre – it is phenomenally successful.”
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Pearce: BNY’s partnership with |
But McCrossan is not pulling his punches about the competition. “Lack of success in other deals has been a hindrance for the whole market,” he says. “Although I hate to say it, it would be nice to have some successful competitors out there because that would help validate the model. But having only one – and we view ourselves as the one – makes it more troubling for asset managers because they feel they don’t have a lot of choice.”
And despite Pearce’s indignation at McCrossan’s attack, other industry sources say that State Street does have a point. “It’s fair to say McCrossan is right, to an extent,” says a senior custody banker. “Both the JPMorgan/Schroders and Bank of New York/JPMorgan outsourcing projects have had their ups and downs.”
He adds that timing has worked against the custody banks. When outsourcing became the new holy grail for fund managers looking to cut back-office and middle-office costs, perhaps the banks were not quite ready to deliver.
“The investment services business has been unlucky with its timing because it has had its teenage years in the full glare of the press,” the banker says. “It should have been able to make its debut, to burst on the scene, as a handsome young man instead of what happened. It ended up coming out as a gawky teenager with braces and acne.”
Another difficulty when comparing the relative performance of outsourcing’s three key players – State Street, Bank of New York and JPMorgan – is the different structures of their key early deals.
State Street’s tie-ups with Pimco and Scottish Widows were lift-outs, where it took the existing back-office operations, including the staff, and brought them in with State Street.
Bank of New York and JPMorgan took different routes, developing their outsourcing models with their first fund management clients, JPMFAM and Schroders, respectively. Once these models were up and running with their first clients, the strategy was to sell the product to other investment houses and build scale. This second stage is crucial to the businesses. Without new clients, the large investment needed at the start will never pay off.
Key to significant returns
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McCrossan: Competitors’ lack |
Even the bullish McCrossan admits that State Street has yet to see the significant returns on its investment that it hopes will come through as outsourcing takes off. “We’re still making investments in the technology,” he says. “We are very comfortable with the margins that these relationships are bringing to State Street. You could look at it in the context of our ability to sell additional services across our different business groups as part of these outsourcing initiatives.” For him this means providing such add-ons as foreign exchange, securities lending, custody or fund accounting to the fund manager.
McCrossan adds that though investment is still being made, he is pleased with the performance to date, although State Street clearly has much bigger ambitions for the future. “We’re seeing returns on the investments,” he says. “But, absolutely, we have built our model to be able now to drive more business into it so that we can create more leverage and scale.”
So with this great sense of urgency now to build the business, McCrossan’s criticisms of his peers take on greater significance. Are problems in the early outsourcing deals holding the market back? Or could this be a smoke-screen? Could it be that leading custody banks underestimated the complexity of managing outsourcing projects, or perhaps that there simply won’t be enough interest from fund managers ever to make outsourcing pay?
One outsourcing player takes issue with McCrossan. “It’s not what has happened with the existing deals that is holding up market development,” he says. “If you’re a fund manager, you fundamentally need to have the desire and philosophy to want to do this. There is cost, upheaval and inefficiency to think about and it’s not a decision to take lightly.”
It may be slow but, the investor servicing banks say, interest is coming from all sides. BNY’s Pearce says he expects three new European clients to sign up soon, as well as a further two in the US.
State Street’s McCrossan says prospects are promising. “In the immediate future, we would certainly like to see customers from the European and North American markets coming on board,” he says. “We’re talking to several right now and some of them look quite promising. We’re anticipating that hopefully, within the next several months, we will have some indication as to some additional customers making the decision to come on.”
A source at JPMorgan also confirms a good level of business interest. “Our pipeline is chock-full,” the source says.
However, the outsourcers might not gain much encouragement from the views of the head of a global asset management business, who declines to be named. “There hasn’t been a 12-month period since I took over here when I haven’t thought about outsourcing,” he says. “All my instincts told me it would make great sense for the business. But then when we looked into it seriously, all the stats said ‘no’. We’re too big.”
Perhaps more ominously he says now, after settling into the business: “It looks even less attractive today, three years down the track.” Collapsing equity markets have placed a big strain on traditional fund management companies. And in this market, costs become all important. But isn’t outsourcing supposed to save a fund manager costs, at least in the long term?
The asset management CEO has an answer. As other costs have come down, he says, so has the cost of traditional custody services. So he feels he has a position of advantage when cutting a deal and doesn’t want to lose that.
“If you outsource your back office or your middle office, inevitably you will be running down your skills set and then the bank you’ve outsourced to will have you by the throat on fees,” he says. “And their fees have come down to such a low level. Now I don’t want to lose that margin.”
Inevitably, as traditional custody players have looked to grow their business beyond the staple areas of safe-keeping, securities lending or fund accounting, they have been looking to make more and more inroads into asset management operations. The CEO says he does not like the idea of handing over too much of his business to an outside organization.
“We all make mistakes but I feel much more comfortable with us having control of our own operation,” he says. “There are people who have outsourced and a mistake happens and then they have a hell of a job finding out how, where and why it happened and what to do about it.”
He argues that outsourcing will probably prove more popular among smaller investment operations but will not be taken up by too many of the larger players, the ones which obviously would prove more attractive from a fee-earning point of view for the outsourcing banks. “I’m not saying it doesn’t make sense for a small fund manager but if you are a big, ugly gorilla like us then it won’t work to your advantages and I think we work better without it.”
He argues that the very nature of back and middle offices makes them resistant to change, hence an outsourcing project would, for him, become a huge headache. He talks with reference to recent reorganization. “When we were putting everything together, I had more trouble in the back office that anywhere else,” he says. “The people have a love of their accounting systems. They grow up with those systems and they don’t want to change.”
He concludes that should his business ever choose to outsource, it would only do it for certain business sections or regional offices and he would look to farm out contracts to more than one bank rather than signing an exclusive deal. “If we were to do it, I would insist on a double-digit timescale on the contract to fix the fees and I would go with more than one provider.”
While this will hardly be music to the ears of the business development planners at the banks, they may be more encouraged by the views of the CEO of another global asset management house. “I am a big believer in outsourcing,” he says. “I think more and more asset managers will go down that path.” He cites successful examples of investment servicing banks taking fund administration and accounting problems off the backs of fund managers, leaving them freer to concentrate on finding good investment ideas.
“There have been some very successful outsourcing deals in the market in smaller isolated situations,” he says. “The next logical step involves much bigger operations.”
He says fund managers are nevertheless still unsure when they should make the leap of faith. “For myself, I have sat back and watched State Street and Bank of New York having a fist fight over the business,” he says, arguing that these two banks are better positioned strategically to offer outsourcing to him. “I’m not sure I would be happy to work with JPMorgan because they’re such a competitor for us in asset management.”
So there is a wide variety of views about the value of an outsourcing deal. However, the outsourcing banks’ estimations of new interest suggest that the market, after a stuttering start, is about to take off.
As one custody banker says: “The thing is, outsourcing has been happening for years, and tremendously successfully. Custody is outsourcing, fund administration is outsourcing. What we’re trying to do now is move to the next level.”
But it is this muscling in on their business that concerns some fund managers. As one says: “To grow their business they need to take more fees off us by providing more services. But where does it end? Will we just be left to read research reports? Or are they going to do that for us too?”
That comment may be somewhat flippant, but asset managers are more than ever conscious of the need to focus on costs and outsourcing non-core operations remains an obvious strategy.
The misnomer of costs
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Five years of outsourcing: Key deals |
However, he adds that despite the clear opportunity to make savings through outsourcing, fund managers are deterred by the size of the initial investment. Controversially, he says the fund management world is being misinformed by competitors.
“I don’t understand this misnomer that it costs lots of money to outsource,” he says. “We’re totally perplexed by that position in the market, particularly in the UK. We believe that our competitors have put that idea out there in the market to hold people back, or fend people off from making those decisions.”
McCrossan says State Street will bear a lot of the expense in helping asset managers make the transition on to its technology and platform and locations, so the cost for a fund manager can come down to project management through the transition.
This comment brings howls of protest from other corners of the industry. “The fact is there are costs in setting up an operation,” says BNY’s Pearce. “The cost of transferring people around, for starters.”
This staffing issue is a big factor in any outsourcing deal. Some have involved lift-outs of operations, like Scottish Widows and State Street. Some have involved building new partnerships, as between Schroders and JPMorgan. In every instance, there will be staff moves and redundancies, though the banks will always stress how they work to keep these to a minimum.
A to-do list from hell Another outsourcing banker points out that it is not just the money involved but all the handholding as well. “If you go into an outsourcing deal then you are writing yourself the to-do list from hell,” he says. “You have to contact all your clients, and if you’re a retail fund manager, you don’t really want to be having to do that. They have a rule of thumb: unless you’ve got good news, don’t write to them.”
He argues that it’s wrong to deny there are costs in an outsourcing deal. “In today’s market you have to ask yourself what is a lot of money. And fund managers at the moment will probably say ‘anything more than a penny’. If you are going to lose staff, there are redundancy costs, if you are going to transfer staff, there are all those costs. Then there are the systems costs.”
This is not a prospect that will help the outsourcers to get new clients in, however much they say this is imminent. To date, most players only have one or two significant global partners on their books.
State Street says that after the lift-out deals with Scottish Widows and Pimco it has brought two further clients, J&W Seligman in the US and Swiss Life’s Belgian operation, on to its proprietary model. “The technology is complete, that’s the good news,” says McCrossan. “Now we’re rolling it out.”
BNY’s Pearce says its partnership with JPMorgan went live in 2001, so it has two years’ track record. Schroders’ deal with JPMorgan is close to going live and revenue benefits are being seen. So the three big players each say they are well set to scramble for new business.
But nothing is that simple.
Critics of State Street, for example, say that it still needs to sort out its own sales strategy in order to make better progress.
As one former State Street man says: “They haven’t got their structure worked out because they’ve got more than one business group looking after outsourcing sales. They’ve got people in Boston, people in London, people in Luxembourg and they trip over each other. Winning business there is a pissing contest.”
McCrossan concedes that State Street is changing its make-up. “We are creating what we term horizontal integration across State Street,” he says. And while at many levels of the organization it is clear that everyone is trying to work to the same ultimate objectives, on the ground it may be a bit more challenging.
“We may have aggressive sales people who are obviously looking for sales opportunities and that’s something that, over time, may look to work at a better integrated level across the businesses,” says McCrossan. “But quite frankly, right now, we’re obviously soliciting new business opportunities so we’re encouraging the sales individuals to be out there in the market.”
If the sales force are treading on each other’s toes that may show the urgency of the need to bring in new clients to turn a business that to date has simply soaked up investment, into one that makes money.
McCrossan says: “We have a clear, strategic objective across State Street in the context of providing one integrated solution across different businesses.”
Obviously this is something that is still causing concern as sales teams are having to be closely briefed to put across a clear and unambiguous message.
“We’ve made several business proposals to large asset management companies where we may already have relationships at different levels,” says McCrossan. “And we’ve spent a lot of time with our own teams working together to ensure when we present to these prospects that we are creating one State Street.”
So McCrossan, may admit that the problems of developing the market are not exclusively to do with the performance of competitors’ early deals. No bank is perfect and State Street still has work to do on its own set-up, regardless of whether its outsourcing model is in good shape.
At Bank of New York, Pearce is very bullish about his own operation’s prospects. “I think BNY is acknowledged as the market leader,” he says. “We are an automatic choice when people are looking to draw up a shortlist – we are seen as a must-have.”
Without mentioning it by name, he, like McCrossan, points a finger at JPMorgan’s deal with Schroders when he says: “Where there have been failures in the market, that is not an encouraging sign for an organization going down the outsourcing path.”
However, he sees no such problems on his own doorstep. “BNY is really at the forefront of the outsourcing movement,” he says. “We were very lucky that we had a committed partner in JPMorgan who had an excellent grasp of what was required – we had a meeting of minds.”
With that deal safely bedded in (although for how long remains a point of speculation in the industry, given that JPMorgan must surely consider moving its outsourcing business to its own custody arm at some point) BNY is looking to add scale to its model.
And with the stakes being raised, after the huge investments that have been made in developing outsourcing operations, tempers are already somewhat frazzled. The fact that banks are prepared to launch brickbats at each other in public suggests that a lot hangs on the success, or otherwise, of these still fledgling organizations, these “gawky teenagers”.
Some fund managers, are clearly happy to watch this space, observing the progress of the pathfinding deals, such as Schroders at JPMorgan, before taking the plunge themselves. Although clamping down on costs is more important than ever for asset managers, they will not throw in large amounts of investment without being confident of success – and success via the easiest, cheapest route.
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