Further Consolidation

State Street buys Goldman’s administration business

Originally published in the August 2012 issue

Consolidation among hedge fund administrators has taken a significant leap forward with State Street’s $550 million acquisition of Goldman Sachs Administration Services, the investment bank’s hedge fund servicing unit. The deal adds new clients and expands State Street’s reach in Asia with an office in Singapore.

It also catapults State Street Alternative Investment Solutions past Citco Fund Services into the top slot among hedge fund administrators with over $700 billion under administration. Before the buyout, State Street had about $505 billion in hedge fund assets under administration and is gaining roughly $200 billion from Goldman.

“At State Street administration is one of our core businesses,” said Scott Carpenter, Head of Client Relationship Management and Strategy with State Street AIS. “We are always looking for opportunities to grow organically or through acquisition. We consider Goldman Sachs to be a premier fund administrator and view it as a very complementary fit with our existing hedge fund administration business.”

Diffuse market
What stands out in the hedge fund administration sector is the wide number of players in the market compared with prime services where a handful of firms have virtually all the business. Among administrators there is far more diversity with a greater number of niche operators. Several smaller operators, such as Viteos Fund Services and Meridian Fund Services, have grown rapidly.

Those firms and others that are growing, such as Custom House and HEDGESERV, may also be targets for firms in the top tier. The attraction of bulking up to get economies of scale or enter new markets is expected to continue to drive consolidation among administrators.

“There has been a lot of consolidation over the past 18 to 24 months and that will continue,” says Carpenter. “Administration firms are looking at the investment required to provide solutions in an environment where major changes are being driven by both regulators and investors. Additionally, hedge funds themselves are increasingly relying more on administrators to help them re-engineer their operating models to boost operating efficiency. Many administrators will not be able to make the investments to keep up with this dynamically changing market.”

Changing regulation
The changing backdrop of market regulation contributed to the timing of State Street making the acquisition. Investment banks with proprietary trading have undergone a strategic prioritising of activities and with Goldman Sachs this led to the disposal of its fund administration business despite it ranking fourth in the sector in terms of AuA.

“Custody and administration are fundamentally what we do at State Street,” says Carpenter. “We don’t have to compete internally for resources like many other firms do that have investment banking, retail banking and other priorities that can create distractions for an administration business.”

The new demands from things like Dodd Frank, the Volcker Rule and the Alternative Investment Fund Managers Directive means that administrators need to make substantial investment. For some firms, it could be preferable to sell up rather than splash out on new technology or staff.

Though hedge funds are making less than stellar returns in aggregate, overall assets are growing slowly. New alternative investment businesses are also being formed.

“Managers on prop desks impacted by the Volcker Rule are branching out to form their own hedge funds,” notes Carpenter. “For State Street, 2011 and 2012 have been busy with new fund launches.”

The acquisition from Goldman is expected to close early in the fourth quarter following regulatory clearances. It is expected that all the GSAS employees in its operating centres (Jersey City, Cayman, Dublin, Toronto and Singapore) will be offered jobs in the enlarged operation.

During the transition, all the assets of the GSAS client hedge funds will be moved onto the proprietary applications that State Street has built for hedge fund administration. The most noticeable change for GSAS clients is likely to be a substantial expansion in ancillary products and capabilities that are available on an integrated basis with State Street’s proprietary hedge fund applications. This includes bilateral middle office capabilities in trade confirmation, managing collateral and bank loan servicing.

Other areas where automation has been developed include regulatory and investor-driven reporting requirements such as Form PF, FATCA and OPERA (Open Protocol Enabling Risk Aggregation), a new standard for investor transparency reporting.

“The strategic rationale is that there is an excellent complementary fit between State Street and GSAS,” says Carpenter. “Combining the outstanding employee base of GSAS with our industry-leading technology and product offering of State Street is central to what we want to accomplish.”

Consolidation picks up
The recent uptick in consolidation of the hedge fund administration sector is likely to have meant that Goldman Sachs entertained proposals from more than one buyer before settling on State Street. Earlier this year, Connecticut-based SS&C Technologies outbid private equity group TPG to pay £572 million for GlobeOp, a UK-listed hedge fund administrator.

State Street itself has also been an acquirer. In April 2010, it bought Jersey-based Mourant International Finance Administration, which added $170 billion of private equity and real estate assets.

The Goldman transaction will give State Street a revenue boost and be earnings-enhancing. In its most recent quarterly report State Street said that fees generated from its $22.4 trillion in assets under custody and administration dropped 3% to $1.9 billion from the same period a year earlier.
Custody banks like State Street have also been hindered by the Federal Reserve holding short-term interest rates at low levels. This has cut the return they are able to make on lending activities, sapping revenue growth. In this tough operating environment the bank has cut 2,000 jobs and is on target to make $94 million in pre-tax savings this year.

Against this, the alternative asset administration market remains attractive. Fees have largely held up as institutional investors have demanded that hedge funds upgrade the reporting system provided by administrators. In turn, this requirement has underlined the benefits of scale.

“Being No. 1 lets us communicate to the market that we are a scale player that is committed on a long-term basis to alternatives administration,” adds Carpenter.