What the HSBC/Bermuda deal means

Last week's announcement that HSBC would acquire the Bank of Bermuda for $1.3 billion will create a behemoth in the Asian funds administration world that is going to have consequences for the entire industry. A series of interviews with market participants as well as deal insiders indicates that, although the merged entity will have price-setting power, the vacuum will provide room for other players that have long sought entry to Asian funds administration but would have found little room with two major players involved.

In effect, the market's desire to have an alternative is creating space for rivals, and that means the North Americans will get a crack at it, now that the two British houses are aggregating. Potential entrants include Citibank, JPMorgan Chase, Mellon Financial (which has a strategic partnership with ABN Amro Bank), Royal Bank of Canada and State Street.

(For an in-depth look at the challenges of Asian fund administration and State Street's intentions to enter the retail segment, see the October/November edition of AsianInvestor magazine.)

On the traditional side, Bermuda's stronghold in Asia is Hong Kong, where it dominates administration for blue chip ORSO schemes, as well as administrates MPF schemes for the likes of Allianz Dresdner, Fidelity and Invesco. It also has a dominant presence in Singapore via a strategic partnership with UOB.

HSBC's core funds administration business is proprietary, where it has a 45% market share of MPF funds as well as a large cash funds business in Hong Kong. It has also acquired the dominant Korean administrator, AMTeK.

Integrating these two businesses will not be easy. Bermuda's systems platform is generally considered superior, and integrating that will take several years, depending on the degree of resources HSBC dedicates to it. Moreover, the customer bases differ, with HSBC catering to the multitude of employer retirement schemes via HSBC Life, and Bermuda focused on big companies. Functions such as recordkeeping will take the longest to merge, although more immediate synergies may be found in funds accounting, which is fairly standard. Detailed integration planning can only begin after HSBC and Bermuda shareholders approve the deal.

Fund managers that now use Bermuda's services say their primary concern is that the same degree of service is maintained. Deal insiders say Bermuda agreed to the acquisition on condition that service levels not be affected. Although insiders say the Bermuda brand name will be subsumed into HSBC's, the actual service for the short term will largely remain independent, at least until HSBC figures out a way to merge systems.

The acquisition not only creates a giant in the industry, but also paves the way for a pan-Asian funds administration platform, a feat no firm has ever achieved. But the enlarged HSBC will find itself the top player in Hong Kong, Singapore and Korea. Its greatest challenge will not be fending off American upstarts, but in changing a traditionally country-specific business culture. If HSBC is able to forge a truly regional service platform, it has the chance to dominate the business for a very long time.

Hedge funds: the crown jewels

As compelling as Bermuda's traditional line of fund administration may be, the more important reason for the acquisition was its global dominance in administration for hedge funds. Bermuda has about 600 hedge fund clients around the world, around 10% in Asia; HSBC has six, and they're all in Asia, including important players such as Asian Debt Management, HT Capital and Long Investment Management.

If the clients give permission, HSBC is expected to migrate them to Bermuda and establish that as its alternative investment division, under the HSBC brand. Paul Smith, who currently runs Bermuda's fund services business in Asia, is likely to take over HSBC's hedge fund services globally.

HSBC has realized that funds admin is a good way to get access to the growing hedge fund universe. Once the senior people at hedge funds come to trust their administrator, they are open to pitches from other parts of the business. This represents a tremendous opportunity for HSBC Republic, its private banking arm, as well as its structured products and capital markets teams to flog all sorts of ideas to hedge funds.

By the same token, insiders say HSBC has taken a strategic decision not to enter prime brokering. Prime brokers are a major source of Bermuda's business, and the acquisition depended in part on not alienating this sector.

Putting HSBC's capital behind Bermuda's hedge fund admin experience is going to be a powerful creation. Asia's number-two funds administrator Citco, which has grown its asset base rapidly over the past two years, is going to be under new pressure. But independent analysts believe the hedge fund space in Asia is growing so rapidly that rivals will have room to grow, despite facing a new 800-pound gorilla. And like in the traditional admin space, the acquisition is likely to create a vacuum to allow big hedge fund administrators from the USA forge a role in Asia for the first time.