State Street moving up the food chain

State Street is at a crossroads. KK Tse, the bank''s chief in Asia, maps out the new world custodians face in the region.

To most investors, the name State Street means settlement and safekeeping. But KK Tse, managing director of State Street Bank and Trust in Asia, thinks that idea is dated. Now, it's not even a custodian bank.

Q: So what has changed?

A: We became the custodian to the first mutual fund in the States in 1924. In the '70s, we decided to develop custodian and money management businesses. For the new century, State Street is focusing on the institutional investor segment. Some people think that custodians are only responsible for settlement and safekeeping. Some think we also cover fund accounting and administration. I think when time moves on things become blurred.

Q: What core services have you added at State Street?

A: At the moment we don't even know what's core service and what's value-added service. We're buying companies that provide software solutions to institutional investors. We've bought a company called Princeton Financial Holdings that provides accounting software to insurers and fund managers, and developed a risk management system called Askari for institutional investors. We bought a company in New York called Elkins/McSherry that provides trade execution monitoring services.

Q: What do your clients in Asia need from you the most?

A: Information. It includes the characteristics of their portfolios, duration, exposure, return and credit ratings. Asian investors seem to focus more on this type of information than our clients in the States.

Q: Why?

A: I think Asian institutional investors have become very much risk-averse. Nowadays, the board of trustees and senior management want to make sure that things are done on a very systematic basis as a result of the financial debacles we've witnessed in the past few years.

Q: Is it difficult to set up a good network of subcustodians in Asia?

A: The subcustodian business is constantly being augmented to serve the needs of our increasingly global client base - despite [the fact] it's been in existence for almost 30 years. We cover 15 markets in Asia using about 40 subcustodians. The top two or three players are always there. Local banks at times want to become a major subcustodian. But commitment is often lost as they realize they need to continue to invest into information technology. State Street normally would not appoint start-ups.

Q: How does State Street view lending to fringe investment?

A: Being a very conservative double A-rated institution we have been a bit shy of the hedge fund business because we don't want to risk our reputation given their highly geared structure. Also because our clients are institutional investors, they tend to be more conservative, too.

Q: What new markets are you looking at?

A: China. China has a centralized pension system and we think of ourselves as being able to provide expertise in that area. The development of its mutual fund market will be interesting when the government starts to dish out licences for joint venture of mutual funds and when the first open-ended fund is launched. The market is not open to foreigners at the moment but we are working actively with some local players to share with them our market experience.

Q: What is State Street's business strategy in the new economy?

A: Move up the value chain. We look at the investment market as three segments: pre-trade, trade and post-trade. Custodian services and fund accounting, clearing and settlement are post-trade businesses and State Street is a leader in this area. Trade means transaction, encompassing all execution services like foreign exchange and brokerage. Pre-trade is all the information and analysis investors need for investment decisions. We would like to move up that value chain by not only concentrating on post trade but also trade and pre-trade.

Q: Why is it important for State Street to move up the value chain?

A: The custodian market is experiencing increasing margin squeeze. State Street has been providing its shareholders with double digit growth in earnings per share for 22 years. To continue to do that we need to go up-market because that's where the value is.

Q: How will you overcome the disadvantage of being a newcomer on the trade and pre-trade levels?

A: We have a franchise around the world with $6.2 trillion under custody and $720 billion under management. So we already have a large captive client base. We're not trying to get 30% of the market. Just 5% would be extremely profitable for State Street. With our client base, even if only 20% of them use our trade and pre-trade services, it will make State Street very rich. We're trying to utilize our existing franchise to provide our clients with additional services.

Q: What are some of those additional services?

A: Research, analytics, information, portfolio optimization, trade execution across multiple assets and markets via services like Global Link, and risk management systems designed especially for the institutional investor.

Q: On the risk management side, is it different from what you've been doing in the past?

A: Very different. Some people consider monitoring service as a part of risk management. But that's on the post-trade level, after the transaction. With a risk management system like Askari, it can provide scenario analysis. For example, if interest rates change, what will happen to the characteristics of the portfolio from the duration perspective.

Q: You're moving from a back office role to a front office capacity. Does that not make your investment manager clients uncomfortable?

A: No. Because of the role we play they often see us as partners and also as innovators. You might have noticed when we launched our FX Connect Multibank, Deutsche Bank was very public about saying they had adopted the system.

Q: Is there room for custodians in Hong Kong's MPF market to differentiate?

A: It's difficult. I think first of all the custodian requirements in the legislation are challenging to the custodians. We play an active role though at an industry level and we're working hard with the government to resolve these outstanding issues.

Q: Anything you would like to add?

A: I would like to emphasize that State Street is no longer a custodian bank. Things have changed a lot over the last few years and that's why we say "we're here to service institutional investors" and not "we're the best custodian in the world". I would describe our two core businesses now as asset servicing and asset management.

Q: Thank you

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