A somewhat coy press release put out by Brown Brothers Harriman (BBH) last week announcing plans to provide “global custody system support” to Bank of Tokyo-Mitsubishi UFJ (Luxembourg) S.A. (BTMUL) through their BBH Luxembourg subsidiary did less than justice to the size and importance of the deal.
In effect, a major Japanese trust bank is buying in a global custody capability from BBH. The deal is worth $400 billion in assets. Winning the business of a major trust bank in Japan is a significant coup, since they manage and custody the assets of the giant Japanese pension funds. And the story of how BBH secured such a prestigious deal is, needless to say, a complicated one.
Unlike other global custodians, BBH chose not to seek business from Japanese pension funds by setting up a trust bank of its own in Japan. This was sensible. The structure of business in Japan meant pension funds were not free to appoint outsiders, even if they were willing to do so. Besides, Japanese banks like Bank of Tokyo Mitsubishi (BTM) initially harboured ambitions of their own to become global custodian banks – a number, including Bank of Tokyo, had in-house networks covering all major markets well into the 1990s.
BBH – which has a sizeable operation in Japan, servicing mainly mutual funds – instead built global custody distribution relationships with all three of the Japanese trust banks: Mitsubishi, Sumitomo Mitsui and Fuji. But it has always had a particularly strong relationship with the Mitsubishi Trust Bank, to which it has provided a global custody network since the mid-1990s.
The Boston-based bank has also used BTM and its predecessor Bank of Tokyo as its Japanese sub-custodian since the 1980s, and the Japanese bank has done likewise with BBH in the US market, where the relationship extended beyond sub-custody to encompass US brokerage services too. “We have had a long standing relationship with the bank and trust bank since the 1980s,” says Susan Livingston, a partner at BBH. “They used us for US sub-custody and brokerage originally in the eighties and then we expanded to a global custody relationship with the trust bank around 1992.”
In a country where longstanding relationships still count, this put BBH in a strong position should circumstances change. And they did change, dramatically, in October 2005 when the Mitsubishi Tokyo Financial Group merged with UFJ Group to create the Mitsubishi UFJ Financial Group. Suddenly, two trust banks had become one, prompting the question of how the merged trust banking arms of the groups would now handle their global custody needs. The new Mitsubishi UFJ Trust and Banking Corporation (MUTB) also faced a more immediate challenge: how to replace an ageing technology platform.
BBH was obviously in a strong position to retain the business, because Mitsubishi Trust Bank was easily the larger of the two merger partners, but it was the technology developed by the American bank that clinched it. On the technology side, MUTB faced a classic choice: build in-house, purchase a system from a vendor, or find another technology partner. In the end, MUTB effectively opted to employ the BBH platform, as the lowest cost and least risk option.
So, from the first quarter of 2008, BTMUL will use BBH technology for both its current book of business and future business growth, including the increasingly complex requirements of the fund managers used by Japanese pension funds. The Japanese bank will use the technology on a white-label basis. “They view our technology as industry leading, and reasoned it was better to contract with us rather than a vendor or doing it in-house, and finding themselves fighting the vendor all the time or spending a lot of money on upgrades,” says Livingston. “For us, obviously it is leveraging our investment.”
But the BBH-BTMUL deal is about much more than technology. BBH will also supply a global custody network, asset-servicing, and foreign exchange as well. “Initially, they were comparing us with other technology vendors as a potential supplier of a global custody system,” explains Livingston. “But we only use our technology in a sale to bring things into our core business. Our end game is to have custody, foreign exchange and all the execution services that we do, come along with the technology. So it was because it was a very large custody mandate that we thought we would entertain it.”
The term “custody mandate” is significant. Unlike some alliances between banks, such as ABN Amro-Mellon, the BBH-BTMUL relationship is not being sealed by a joint venture, or even a joint marketing agreement. “This deal is really an in-sourcing rather than an outsourcing,” says Livingston. “They will maintain all of the contact with their clients. This is not a deal where we are trying to do any joint marketing. They are completely maintaining that. It is an entirely straight forward technology plus global sub-custody relationship. Where they used to have their own network, they are now going to be using the BBH network instead.”
BBH will provide the network services and the technology through its operation in Luxembourg, to Bank of Tokyo-Mitsubishi UFJ (Luxembourg) S.A., a vehicle owned 70 per cent by Mitsubishi Trust and Banking and 30 percent by BTM. “Our Luxembourg bank and their Luxembourg bank will be working hand in hand,” says Livingston. Why in Luxembourg? Because the Grand Duchy has long proved a geographically convenient, tax-efficient and regulatorily less demanding location for Japanese banks to base their global custody operations, and both BTM and BBH have well-established operations there.
“It is fairly straightforward to set up,” says Livingston. “We are calling it BBH Direct, in order to have a name for this kind of bank-to-bank solution. The details, in terms of how all of it will work and the timing, we will be working on throughout 2007, especially customising the system. Our teams are working together already, and we received approval from the Luxembourg authorities about two weeks ago.”
$400 billion is a large slice of assets for a bank which had just $1.5 trillion in assets in custody at the end of last year. Where the $400 billion is invested and in what assets, is not yet being disclosed, but a typical outbound Japanese book of business today would be divided 50:50 between equity and fixed income, with a sizeable piece invested in emerging markets, especially in Asia. So describing this as a transformational deal for BBH is, for once, not an exaggeration.