GC Friday Interview: Mark Johnson, Head of iShares UK

BlackRock’s ETF arm iShares has unveiled a custody initiative to enable U.K. pension funds and other institutional investors to access ETFs directly through their custodians for the first time.

BNY Mellon, State Street, HSBC and JP Morgan are working with iShares to simplify the ETF purchase process so that schemes can now buy and sell ETFs directly through their custodian. Northern Trust is also thought to be in the group although the custodian would not confirm or deny its involvement.

Mark Johnson, head of iShares UK, talks about the importance of custodians for the company’s ETF push and further opportunities as a result of the partnership.

How long have you been working on this initiative for?

MJ: For about six months. I have been with Blackrock for nearly 16 years but I joined iShares from the institutional business in October of last year and I became aware fairly early on in that move that one of the challenges for pension schemes in the U.K. was that because of the way that pensions regulations are set out there hasn’t been the need for them to have brokerage accounts because typically they don’t, unless they’re authorized to do so by the FCA. We buy stocks and shares for them, which are typically held in custody accounts, or they buy a pooled fund and the assets of a pooled fund are also held in a custody account of the pooled fund. But they don’t have access to products that trade on an exchange as ETFs do. So the learning was that having had these conversations with pension funds and their advisors in the consultant community, they said “it’s all very well talking about ETFs but we can’t buy them” and I realize pension funds are not likely to set up brokerage accounts for that reason so we had to think of a different way of approaching them. I was aware that the medium and large sized pension schemes have relationships with global custodians and those custodians have a very strong link into the pension team, the in-house team and the consultant and since those custodians are typically part of a boarder investment bank, maybe there was opportunity to create a connection between the custody arm of the bank and the broker services part of the bank. So we started having these conversations with them about six months ago and said “do you think your clients would be interested in ancillary services provided by you?” and they all said “yes of course” because they have an interest in growing and identifying these relationships with their clients and in fact some of them had already taken some tentative steps in this field by providing FX services for example so we ask “what about the opportunity to buy and sell ETFs also trading on exchange through your broker dealer desk?” Some of them were closer to a model that would allow that than others and what’s interesting is that each of them had a slightly different solution in terms of the way that the client would be routed.

What we did is come up with a two-page fact sheet, which said if you think you’d like to invest in an ETF, contact your relationship manager at your custodian (one of these firms that we’ve been working with) and they can help you and at that point you really hand over that relationship to the custodian and the client would contact the relationship manager and they will have determined an appropriate process for helping the client internally. It may be that the relationship manager speaks on behalf of the client to the trading desk. It may be that the client speaks directly to the trading desk. It may be that the client has already done a fairly lengthy due diligence process to get their custody account set up so no more work is required, it may be that they need to set up a brokerage account and fill in some more forms. We liked it and why the custodians liked it is because initially at least to become a custody client you have to do all the fundamentally KYC and AML checks so the clients were already set up as clients so therefore its not that much more of a requirement for them to take on new or ancillary services from their custodian. We thought it was a great opportunity for the custodians to develop relationships with their clients, we thought it was a great opportunity to bring to pension funds in the U.K. an instrument that historically they had difficulty in accessing unless they were the dozen or so FCA schemes that were authorized and had direct broker or market access. So that’s the story. Over those six months, we’ve been working with them, speaking to them, teaching their relationship managers about ETFs – we’ve been into their offices and so fourth.

What has take up been like?

MJ: I am told that they (custodians) are already getting clients calling them asking them about this. We’ve told our clients, they’ve told their clients, and the media has picked up on the story. The important thing to note here is that its not an iShares exclusive: the clients can access any ETF that trades on exchange but as the market leader we felt is was our responsibility to take this forward. But of course clients can access across nearly 5,000 funds globally but we happen to be the market leader and we happen to have taken the initiative but it’s not only iShares exercise. This is really about growing the opportunity that is ETFs.

In addition to the five custodians in the pool, is there an opportunity to add more?

MJ: We picked those custodians because they are the biggest ones. We know them very well and across BlackRock we have some terrific relationship with those firms that look after our clients so that was the obvious starting point. Clearly if other custodians we didn’t speak to were to offer this type of service we’d be delighted and we’d welcome it but by at least approaching them in the initial phase that would reflect the bulk of the market.

How will the initiative work in practice?

MJ: Each of them has a slightly different approach and a different model but very simplistically and for good reason the custody arm of these organizations is ring fenced and separate from any commercial activity that would exist within the broking arm and that’s as it should be. We’re not changing any of that. I think what we’ve tried to do is create a dotted line between the two that allows them to offer a range of services that previously weren’t available to their custodian clients so its not that they are physically relocating broker services teams into the custody banks or anything like that but an example would be that you as the client, a U.K. pension scheme, are advised by a consultant and you determine that you want to invest in a particular asset class and the most optional way of doing that is through an ETF. So having made that decision the key question is how do we achieve that, how do we buy the product? So you contact your relationship manager at your custodian if its one of the names we’ve mentioned and if it is that person will be able to then help you process that trade. Generally speaking they’re going to essentially hold your hand through their organization, work with you so that the order is routed through to the broker desk. They will all have different ways that the order will be communicated. You may speak to the relationship manager and the trading desk. Each of them had a slightly different approach and importantly when the trading desk is executing the order it will go to the market, it will source the ETF that you want to buy and it will confirm the trade. It will then settle the trade in your custody account. So the custodian is already holding the proceeds to settle the trade. So you’re simplifying it dramatically. The ETF will be acquired and will be then held or sitting in your custodial account with all of your other assets and the proceeds for that trade will also sourced from your custody account.

Whereas in the past if we didn’t have this, what you would have had to do and probably been unlikely to do is open up an account with a third party, the third party would conduct the transaction and the custodian would have sent the proceeds to the third party, the third party would then have to receive the proceeds, settle the trade and send the share or ETF back to the custodian. So you’ve just taken out one leg of that story and made it much easier.

How will you build on this initiative? Are there plans to add further asset classes?

MJ: That question is really one for custodians in terms of the services they feel they could offer. What I can tell you is that relationship managers at the custodians got really excited about this because it presented them with an opportunity to develop their relationships with their customers. Whether they use this as a springboard to offer other services. That’s to be determined by them. For us its an opportunity to develop the market in the U.K. in a way that had not previously been available but the institutional market is clearly one that’s very important to iShares and that’s why we put so much attention behind this initiative. We’re delighted these great firms wanted to work with us on this and we hope its’ the start of a much deeper partnership between custodians, ETFs and customers in 2014. I don’t know how its’ going to develop but I think it’s a great place to start. Its really about helping people to understand what an ETF is, how they trade and how you can buy the.

How will this service be charged?

MJ: The custodians will charge a fee. It’s a way for them to broaden their relationships with their clients. I would hope that because of their ability to deal in scale across the market that they can provide a very cost effective solution for those clients.