RBC-Dexia sees the silver lining

To say it is business as usual for custodians is putting it a bit strongly. But today’s market turmoil affects them much less than it does their hard-pressed clients. These providers of the infrastructure of securities distribution take minimal risks, so they make comparatively limited returns during the good times – and this is when they are regarded as dull.

However, during the bad times, when markets are volatile and investment firms are floundering, custodians can stand back and notch up their fees for transacting trades and restructuring the battered portfolios of hedge funds or pension funds and investment vehicles. During these times, global custodians look positively exciting.

Rob Wright, chief operating officer at RBC-Dexia Investment Services, a leading custodian, says: “We are not heavy users of our balance sheet and our risk profile is more conservative. We have been less affected than most.

“The earnings of most custodians are up year on year compared to many in investment banking, retail broking or asset managers, where revenues are down.”

The firm, which is a joint venture between Royal Bank of Canada and Dexia, the Belgian financial services company, has $2900bn in client assets under administration. It is rated AA3 by Moody’s and AA- by Standard & Poor’s.

Opportunities

RBC-Dexia chief executive Jose Placido sees some light amid the gloom. “Where there is volatility, there is also opportunity. The transactional activity and the different currency strategies are really important and that is decreasing because we are paid on basis points. But it is not a perfect storm by any means,” he says.

“There are other sides to our business, like securities lending where there has been a shift from equities to fixed-income assets. We have clients that want more aggressive strategies on their cash portfolios. That has diversified our revenue flow and helped at least maintain a respectable level of revenue growth and profitability,” he adds. Fund managers are looking to custodians to scrutinise their products to save costs and facilitate their distribution. This is no time for excess or opaqueness.

“There is a move back to much more transparent, simple, easy-to-transport product. Many clients are rejigging and streamlining their product offerings,” says Mr Placido. “Many mutual funds that have a multitude of funds are consolidating them and collapsing them. The transparency of what they are introducing will be much greater. There will be transparency of commission, transparency of fees, transparency of the investments, transparency of the underlying investments.”

He continues: “This whole situation has caused the industry to take a pause, and to reflect. Funds are regrouping before they launch something. We see a lot of clients wanting to know how they should merge funds. They are looking at the streamlining. The shelf space has been really overcrowded. The liquidity crisis will be the trigger for a simplification of the funds industry.”

Clients can expect greater scrutiny during turbulent times, says Mr Wright. “RBC-Dexia is more diligent about the activities of some clients, especially those in the fund-of-funds space, when we take collateral, or when we are in the structured product space when we take some financing pieces. We work with our clients to make sure they don’t have ­liquidity problems if there are redemptions against certain funds.”

Spotting problems

Custodians seek to spot problem clients before they feel the pain, says Mr Placido. “As a situation looms, we go to our database and pick out everyone that’s impacted. We do that proactively. We know who has the asset-backed commercial paper. Our relationship management team has strategic review meetings with our clients and asks questions about what’s going on. A lot of our clients come to us and say, ‘you’ve got to help us manoeuvre these thing’s. So we help them as long as it stays within the industry standards.”

Risk assessment rises up the scale of priorities during periods of volatility. “The lesson we take from this crisis is that you have to choose your clients really well. RBC is a very risk-averse bank. Our risk structure is not there to stop business happening, it is there to make sure to remind yourself that you are taking good business. If you take an element of risk, you must make sure that you know what it is, and that it is manageable. It is very important to ensure that the risk managers have an equal voice to those that are selling.”

Pricing has also moved to the fore as a risk factor in turbulent markets. Mispricing has the capacity to cause a client reputational risk and that will rebound on the custodian who is charged with delivering a reliable net asset value for a fund. Markets with shorter histories and less transparent infrastructure, such as property funds, hedge funds and over-the-counter derivatives, cause greatest concern.

Mr Placido says: “Where pricing sources are not robust, you have to double-check that the pricing source is correct. If you misprice a security, you misprice a net asset value (NAV), then it goes out to the market and the unit value is wrong, that causes a whole series of things that are wrong. Failed trades have consequences from an operational perspective. This can cause reputational issues for the client if we send out an incorrect NAV to the paper.”

Accounting standards also give cause for concern and the custody industry convened a meeting of all key players to thrash out a set of standards for asset backed commercial paper. Mr Placido says: “We have to make sure that everybody follows the process, so that if you are client A with custodian B, you are not getting a different set of accounting principles. We need to give pension funds financial reports, so we have to make sure that the accounting principles are standardised. It serves no purpose if accounting is different. We have to make sure we are solving the issue, not making it worse.”

The asset-backed commercial paper in Canada has particularly hurt a number of the firm’s Canadian clients. This market remains frozen for those that went through non-bank arrangers, says Mr Wright. “We have a lot of clients who have commercial paper that they can’t redeem. This is before the courts and in restructuring programmes. The short-term paper will be turned to long-term paper, over a number of years. That is a unique situation and we have had to work with our clients.”

Market instability is a catalyst for consolidation as well as caution. Smaller players in investment services, in particular those which operate in a single country and where the service is not core to the bank, may decide to leave the market to the specialist global providers. RBC-Dexia is headquartered in London and has offices in 15 countries, but Mr Placido wants the firm to expand its reach into Germany.

German expansion

He says: “A lot of smaller players are doing strategic views of business lines and deciding what is core. We want to expand into Germany. There is no real dominant player there, and a lot of smaller domestic players. This business is global and international. You can’t survive or make the investment in the infrastructure if you don’t have a cross border strategy.” He adds that the firm will pursue opportunities in a range of countries, including France, Hong Kong, Ireland, ­Luxembourg and Canada.

While global reach is a prerequisite for the ambitious custodian, clients increasingly demand the capacity to handle sophisticated products such as alternative investment strategies and real-time, mark-to-market approaches.

“Clients decisions are no longer about whether you can manage their long mandates, but whether you can manage more complex mandates. That will be the new benchmark for choosing investment services providers.”