Once labeled by this publication as a “firefighter” within State Street, Executive Vice President Nick Bonn has spent the past three years attempting to restore the firm’s image in the transition management space.
Art by Joe Ciardiello
CIO: Let’s just start at the start. State Street had issues in 2011 with your transition management business and how some clients were being charged.
Bonn: We discovered them in 2011.
CIO: Yes. We reported on those issues, and to be fair, you seemed to have dealt with them quickly.
Bonn: Yes, we also self-reported the issue to our regulators in the UK, and then set about an extensive review of our controls environment. We revamped the controls environment and recommitted to transparency, because that’s at the heart of what happened.
CIO: As a journalist, I certainly like to inflate the importance of what we reported—but I get the sense this revamp was larger than just issues in the UK. Market forces were also pushing a rethinking of the business, weren’t they? Because many players have dropped out of the transition business since 2011.
Bonn: I think a lot of banks took a step back in the face of margin compression in the business—as well as a heightened standard of care—if you will, that was brought on by this and other competitive issues. When some banks took a look at the margins in transition management, as well as the heightened standard of care you have to apply, they said ‘it’s not worth it.’
CIO: In March of last year, you said you were ‘smack dab in the middle of’ evaluating the business too. What’s been the result?
Bonn: I think we’re always looking at what we do, and this caused us to take a look at the strategic nature of our transition business. The outcome of that was that we decided it is core and strategic to what we do. If you think about it, as a custodian, and as an index manager, you have to be a good transition manager.
CIO: Transitions are still essential to these asset owners, so it is somewhat counterintuitive that the universe has shrunk so much.
Bonn: In my opinion, it’s the heightened standard of care that everyone has to apply to his or her clients in this business. It requires transparency to the source of all revenues associated with the transition. We’ve re-embraced transparency. We tell clients how we execute their transactions, the decision processes around where to send them, why we make different and best execution decisions, and the sources of the revenues we make.
CIO: Okay, so not just your firm, but the whole industry was painted with a negative brush a few years ago. How has that changed the conversation with asset owners?
Bonn: I think there’s no more benefit of the doubt.
CIO: And are they fine with that as long as it’s transparent?
Bonn: Yes, disclosure is just essential.
CIO: Partially as a result of this, there’s been a rise of firms doing external transaction cost analysis. I think of Harbor Analytics and Inalytics. I’d assert that they are the biggest beneficiaries of upheaval in this market. Are they providing a valuable service?
Bonn: We provide transaction cost analysis in our post-trade, but that’s being provided to you from the folks that executed the trade—so, some clients feel more comfortable getting that from a third party, and we think that there’s nothing wrong with that. Clients want to know what the performance of the trade is, first and foremost: What did the legacy portfolio do, what did the target portfolio do, and what performance did you actually deliver to me? And outside firms can help confirm that.
CIO: What are the biggest threats to the transition management business going forward? I assume increased regulation is always a threat, but specifically, within regulations, what is the threat if there is one?
Bonn: I actually don’t think regulations have been impacting this business as much as others. Margin compression has been a big threat, as have other fundamental changes in the industry: the decline in active management, the move towards alternatives, and the move towards de-risking, all of which reduce the number of transitions needed.
CIO: Looking forward, is there the potential for new entrants into the transition management market—or do you think this trend of firms dropping out will continue?
Bonn: To be honest, I was surprised by some of the participants that dropped out. As a large custodian, your clients are moving investments all the time, so transition management is an important service to offer.
CIO: Especially because of the trend among asset owners to have fewer and stronger relationships, it seems to me you should want to give people a place where they can go for multiple things.
Bonn: You’ve got to add value to your customer, especially around services that might be considered commoditized. If you’re not adding value to your client, helping them do their job, managing alpha, managing risk, it’s easy for them to go somewhere else.
CIO: Do you see any potential for a newcomer?
Bonn: There have been a lot of smaller firms that have tried to enter this business. I think that they’re operating at the margin, but not really getting involved in a meaningful way on more complex transitions.
The low-hanging fruit for new transition management entrants are the active-to-active defined benefit exercises. Maybe the average size is $250 million, $300 million. That’s a fairly straightforward transition exercise, and it’s easier to have a larger bidding pool for a simple transaction like that.
A smaller portion of trades—but a much more meaningful part of the business—is very complex, defined contribution changes, and very complex insurance sub-advisory changes. For these exercises, there are very few competitors to bid for those kinds of transactions—two or three at the most. Those are very complex, very long-duration exercises that, I think, separate the committed providers from those people who are operating on the margins.
CIO: I probably know one-tenth of what happened three years ago. My read is that you’ve dealt with it the way issues should be dealt with: acted quickly and said ‘Here’s what we did. Go tell to your clients.’ Is there anything you would change about that?
Bonn: We tried to do everything we possibly could in the best interest of our customers, in a very, very difficult situation. Looking back, are there things that we would do differently? Overall, I think we approached it the right way.
It was a tremendously difficult period for State Street, for this business, and for this industry. You learn that trust and goodwill is built over years and it’s destroyed in a minute. Three years ago we started rolling that rock back up the hill with our customers to rebuild that trust, and I think it’s largely been successful.