New division builds on Citi's competitive streak

Citi scored a major coup earlier this year when it became the custodian to Norway’s $850bn sovereign wealth fund, winning the prized mandate from arch rival JPMorgan. The seven-year contract with Norges Bank Investment Management, which oversees Norway’s Government Pension Fund Global, demonstrated the clout of Citi’s custodial and securities lending business. It also underscored how banks in the custody and prime brokerage industries are adapting to new regulations and the changed market environment following the 2008 global financial crisis.

It was in response to the new landscape that Citi created a unit at the end of 2013, combining prime finance, futures and clearing, collateral management, custody, and fund services. Called 'global investor services', it is headed by Okan Pekin, who is based in London and used to be responsible for sales of foreign exchange and interest rate products to Citi’s institutional clients.

Mr Pekin says that winning the Norges mandate was not all down to Citi’s establishment of global investor services. The bank’s geographical spread – it is on the ground in most of the world’s main financial markets – was crucial to the success of the pitch, which took place over about 18 months. However, he does believe that the new structure helped win over Norges and that other potential clients will also be enticed by the amalgamation of the business lines.

“We saw a clear need to bring them together and integrate them into a single platform,” says Mr Pekin. “By doing so, we have become more relevant to our clients.”

As well as cutting costs, tying Citi’s securities holding business more closely to its investment bank was seen as way to cross-sell products more easily and allow clients to finance their trades, and manage their collateral and assets in a seamless fashion. “All this has to happen flawlessly,” says Mr Pekin. “Ease of facilitation and ease of access are crucial for our clients.”

Regulatory shifts

Regulation is near the top of Mr Pekin’s agenda. Similar to other parts of investment banking, prime finance will be deeply affected by bans on proprietary trading by banks and more stringent capital and liquidity requirements, not least those emanating from Basel III. While many new rules do not become fully applicable until towards the end of this decade, Mr Pekin says that banks have little choice but to begin the transition early. “When a new regulation is announced, it tends to have an immediate impact as shareholders expect banks to comply early on [even if] requirements for full implementation may still be a few years away,” he says.

He adds that while several major details still have to be agreed on, the inevitable result of the changes will be that prime finance clients find it harder and more expensive to access liquidity. “The new requirements regarding capital and liquidity will have a significant impact on the industry and will constrain the amount of leverage that banks are able to provide,” he says. “You have to be very careful with how and where you allocate capital. Demand for prime brokerage financing is outstripping banks’ ability to provide it, given the changes in regulation.

“Three years ago, there were so many liquidity providers that clients didn’t worry. Now, liquidity is on the top of the agenda as many of our competitors have been scaling back.”

This could result in a so-called 'agency model' developing, with non-banks – perhaps hedge funds and private equity houses – replacing banks as market makers and lenders. “The agency model, whereby banks facilitate access to finance but don’t provide liquidity, is on the rise,” says Mr Pekin.

He denies that this might turn banks into mere brokers, arguing that the relationship between Citi and its clients will be too deep for that to be the case. He says that the development could actually force institutional investors to rely more heavily on their banks. A good example is collateral management. The reason Citi opted to move this part of its business into investor services and position it alongside prime services was that its bankers felt hedge funds and other investors would have increased and more complex collateral needs in the future. They are likely turn to banks for advice on how best to administer their pools of collateral and counterparty risks.

Hedge funds evolve

Citi and its nearest rivals could also benefit from trends that are making it increasingly tough for small hedge funds to survive. Citi published a prime finance survey late last year that said the traditional '2 and 20' model – under which funds charge a 2% management fee and 20% fee on profits made – was fading, with fee levels falling to as low as 1.58% of assets under management for all but the largest funds. Moreover, regulation is causing compliance costs to soar. The result, according to the survey, is that hedge funds need to have at least $300m of assets just to break even.

This could lead to consolidation in the hedge fund industry over the next few years and an increase in the number of big funds, which would likely be of greatest benefit to the large prime service providers such as Citi.

Citi sees its global platform as one of its key advantages. Despite restructuring following its bail-out by the US government in 2008, it has retained a wide geographical presence. Its custody network covers 62 markets and is the world’s largest, while it has trading desks in about 80 countries. This appealed to Norges, which invests in 82 countries and 44 currencies and, rather than have to work with third-party banks, prefers its custodian to be present where its money goes.

Mr Pekin says Citi’s worldwide reach will hold it in good stead over the long term, especially with many of its rivals having been forced to scale back their ambitions to be global universal banks. “Today, there are only a few true global players in the markets business,” he says. “A global footprint and platform is a big attraction for clients.”

Technology or bust

The investor services team is largely in place. At the senior level, Jerome Kemp, who joined Citi in 2010 and is a well-known figure in the futures industry, is global head of futures, over-the-counter clearing and collateral management. The respective global heads of custody and fund services are Sanjiv Sawhney and Patrick Curtin.

One of their priorities is to combine the technology systems needed to run the different businesses. “Our team integration is pretty much complete and we are working hard to streamline our technology and operations platforms,” says Mr Pekin. “Technology platforms are a core competitive advantage. If you do not invest in the right technology, you will get left behind.”

Winning more mandates will be crucial. While those the size of the Norges deal come along only very rarely, Mr Pekin says the publicity from that has boosted Citi’s appeal to other potential clients. “We have a busy deal pipeline,” he says. “The size and scale of the Norges Bank Investment Management mandate has helped us increase awareness about our global capabilities with a number of large, global investors.”

Mr Pekin emphasises the importance of the US and Europe, Citi’s main markets, to investor services. But he is looking to bulk up elsewhere, particularly Asia. “Asia is key for our business,” he says. “The Asian sovereign wealth funds are important to us. The Australian pension funds, which have been growing their assets quickly, are another example.”

Citi has big ambitions for its investor services arm. Mr Pekin concedes that winning more market share will be tough, not least because differing preferences among clients mean banks have to focus on improving in several areas. “What does it take to be number one?” he says. “It could be financing capabilities, trading ideas, the quality of clearing or the breadth of the network. Criteria will vary according to each client’s needs.”

Nonetheless, he is confident that Citi can meet its targets. “We have a selective approach and would like to maintain or get to the number one position across targeted products,” he says. “We know where the gaps and largest revenue opportunities are. We are looking to do more business with hedge fund clients in the prime space. We want to be a market leader in that area.”