By Rob Nicholls, UNSW

SYDNEY: 3 September 2013. Custodian banks, commonly known as custodians, play a vital role in the superannuation industry. Custodians hold assets such as shares on behalf of the superannuation funds and, according to the industry association for custodians ACSA, “improve efficiency through scale, expertise and technology investment”. However, there are very few custodians creating a very concentrated sector and this invites analysis as to whether that concentration is problematic.

The Australian “six pillars” policy was introduced by Treasurer Paul Keating in 1990. The policy was to prohibit mergers between the four major banks and the two largest insurance companies.  It became the “four pillars” policy in 1997 as part of the government response to the Wallis Inquiry (Wallis actually recommended that bank mergers should be reviewed by the Australian Competition and Consumer Commission like any other).

However, the four pillars policy has been restricted to retail operations of the major Australian banks. A critical function that used to be performed by all four of the pillar banks is to act as a custodian bank. A custodian bank provides safekeeping of securities on behalf of investment bodies. This is typically achieved by the custodian bank establishing a nominee entity which acquires securities on behalf of the investing institution. In the case of shares, the investor remains the beneficial owner of the shares with the custodian holding the equity as a bare trust.

One of the major classes of user of the services of custodian banks is the superannuation sector. This user class, in the Australian environment where employer defined contributions to pensions are mandatory, leads to custodian banks holding significant assets under custody. ACSA puts the value of assets under custody at more that $2 trillion. Although there is some overlap, this compares with APRA statistics showing that bank held assets are around $3 trillion.

The history of consolidation in the custodian bank sector in Australia is somewhat surprising. In 2003, the National Australia Bank (NAB) acquired the custodian function of the Commonwealth Bank of Australia (CBA) with no objection from the Australian Competition and Consumer Commission (ACCC) in its application of the “significant lessening of competition” (SLC) test under s.50 of the (now) Competition and Consumer Act 2010. The ACCC found that there would be no SLC when HSBC acquired the Westpac custodian bank in 2006 and made a similar finding when JP Morgan acquired the custodian function of the Australia New Zealand Bank (ANZ) in 2009.

Source: Bank websites, ACSA

In addition to the public reviews of merger activity, in recent months there has been further concentration as a result of commercial deals. In June 2013, NAB (with a group share of nearly 27% of the custodian sector, measured as assets under custody) announced a deepening of its relationship with BNY Mellon (with a share of 4%, measured consistently). In August 2013, Suncorp announced a custodian bank deal with NAB. Suncorp group companies have about 0.8% share of the custodian sector. The top eight providers of global custodian services are six of the top eight in Australia. This is shown in the table above.

Is this a problem?

Custodians are “hard wired” into the Australian superannuation system and provide vital functions such as fund valuations and transactions. They are interconnected with superannuation funds, fund managers, administrators, actuaries and consultants. These interconnection links may operational, financial, collaborative or social. A single custodian nominee company may represent the beneficial ownership of a large number of superannuation funds. In response to the inquiry into the Trio failure by the Parliamentary Joint Committee on Corporations and Financial Services, the Australian Securities and Investments Commission (ASIC) identified a number of risks associated with custodians. These included holding of assets outside the custodial relationship, cash held on deposit and offshore outsourcing.

The four pillars policy was not designed to reduce concentration in the custodian sector. However, the top three custodians in Australia now have 60% of the assets under custody. Measured using the Herfindahl–Hirschman Index (HHI), Australia’s custodian sector is more concentrated than the global one. Perhaps this is not the best measure. The current ACCC merger guidelines (in Chapter 7) use HHI as a measure of concentration. The proposed ACCC merger guidelines do not. A high degree of concentration is not problematic in itself. However, it introduces the potential for systemic risk.

In November 2012, the US Financial Stability Board (FSB) issued its update to the group of global systemically important banks or G-SIBs. The “too big to fail” banks were grouped into “buckets” corresponding to the required level of additional loss absorbency to no longer be considered a G-SIB. The higher the bucket number, the greater the absorbency required. In the same month, the International Monetary Fund (IMF) found that each of the Australian four pillar banks is a domestic systemically important bank or D-SIB. This leads to the table below. 

Source: Bank websites, ACSA, FSB, IMF

Each of the leading custodians in Australia is strongly interconnected with other stakeholders in the superannuation sector and this is a potential source of risk.

CLMR acknowledges the financial support of the Centre for International Finance and Regulation (CIFR) under project E033 “Identifying, Monitoring and Managing Systemic Risks in Australia’s Superannuation System”.  A video overview of the project is available as well as a working paper.