Kozak’s immediate concern was from a securities lending point of view, given that Lehman was a counterparty both as a borrower and because some of J.P. Morgan’s clients’ money was invested in Lehman paper. “Just as six months earlier when no one was 100% certain of what would happen to Bear Stearns, we were again making sure that we understood the implications of opening up on a Monday morning without one of the main broker-dealers.”

 

Kozak, who spoke to The Asset exclusively on a recent visit to Hong Kong, says the events of Bear and then Lehman Brothers have shone a “really bright light on the way banking institutions operate, whether as a custodian, a service provider or as a principal, such as an investment bank”. In his view, it was not just a bright light shining on what institutions have done right but also on what else needs to be done. “We were able to learn and start thinking even more creatively about the risks we were facing and how we could perhaps take the strict controls we already had in place to the next level.”

 

 

Risk is certainly front and centre of discussions today. Kozak believes that the crisis has drawn attention on the need for a much more robust definition of risk management. In good times, such as the bull market experienced before the crisis, the system forgives mistakes. “When there is a huge amount of volatility and the overall price of securities is going down, the opposite applies,” he notes. “When you make a mistake, you can lose a huge amount of money. The crisis has focussed everyone’s mind on the basics.”

 

At the same time, however, he points out, it has also encouraged everybody to consider completely different types of risks – “stuff coming out of left field that perhaps you would not have thought about or anticipated”.

 

In the last 10 to 20 years for example, if you’d asked executives in asset servicing and custody what the biggest risk in custody was, the stock answer would have been corporate actions. “It is the easiest way to lose money of a reasonable amount on a day-to-day basis,” he explains. “Today, if you asked the same question, you would probably get a more thoughtful answer because it isn’t just about corporate actions; it is really about securities lending, collateral management and tri-party arrangements. These have become bigger issues to worry about during this crisis than corporate actions.”

 

Take the case of hedge fund administration in which J.P. Morgan is active in servicing the fund-of-funds business. “We have re-doubled our efforts to make sure we understand who our clients are and what funds the funds are investing in,” he says. “We are [already] pretty stringent and have a short list of clients we want to do business with.”

 

On securities lending, Kozak says that while the firm has been criticized in the past for being too conservative – with 98% of the collateral it invests going through segregated, customer-specific accounts – he feels the crisis has vindicated the bank’s stance. “Certainly, we don’t intend to change going forward.”

 

 

Nevertheless, he is of the view that with this crisis the securities lending business has changed irretrievably. “I won’t be as bold to say that it is never going to be the same but it will take a long time to go back to how things were,” he believes. “With the borrowing community – the broker-dealers – deleveraging more and staying deleveraged, we are going to see lower volumes generally of collaterals being borrowed. Activity in the securities lending business will be much more driven by the intrinsic value of the trade itself.”

 

On cash collateral, firms will become much more conservative in their approach to reinvestment both in terms of the instrument invested and the tenor. Kozak notes that in the industry there was a mismatch in the way securities lending was being used, which was to gear up on risk. “It is probably not what it should be used for.”

 

He believes that the securities lending business remains an essential part of the industry. “If it disappears, it would do a major disservice to the overall investment trading process. Run well and conservatively, we think it is a good business. I hope some of the excesses we have seen over the last few years will not return for a long time, if ever.”

 

 

Kozak expects that one of the most important developments underway is the changing landscape in the asset management industry. Traditional asset managers are increasingly moving into the alternative space and are launching hedge funds including 130/30 funds. On the other hand, hedge funds are starting to move in the other direction, starting to run regulated funds, in some cases, pure long-only funds. “We see a big opportunity presented by the firm’s ability to integrate traditional prime brokerage and custodian fund accounting services into our platform,” he adds.

 

He sees this change benefiting J.P. Morgan with last year’s acquisition of Bear Stearns, which was among the top prime brokers globally before it run into trouble. For example, he notes that for some funds doing business with its prime brokerage unit, they may not be allowed to keep their unencumbered loans with the prime brokers “We have linkages so we can allow the collateral to flow back and forth and provide consolidated reporting; we continue to see increased demand for that type of servicing,” he notes. “On the other hand, hedge funds that have gone the other way will be looking to services such as fund accounting, in addition to their prime brokerage requirements.”

 

Another important development is the move to outsourcing. Kozak says that in the past 12 months even large US asset managers, which used to keep everything in-house except for custody, are actively talking about outsourcing fund accounting and in some cases, investment operations. “There is an acceleration from asset managers to outsource because it is not their core competency, they save money and are able to shift the risk,” he believes. “There is also an increasing demand for sophisticated reporting.”

 

Given these developments, Kozak says that while the rest of 2009 will remain a challenging year to grow revenue because market values have come down, the underlying business remains strong. He is also bullish about developments in Asia. “We have seen massive growth in this region although from a smaller starting point relative to the US and Europe,” he says. “In the next 4 to 5 years, we will continue to see this pace of growth that will propel the business.”

 

Kozak cites the intention to increase investments in Asia. “Three years ago, we were doing accounting for our Asian clients in Dallas. Now, in addition to the facility we have in Australia, we do fund accounting here in Hong Kong.” This year, the firm will also “move performance analytics to Hong Kong, which is being run out of New York at the moment”, adds Laurence Bailey, Asia-Pacific CEO of J.P. Morgan WSS. “What clients want is to see that dashboard on their desk – what is their exposure across multiple aggregate portfolios. What we are bringing out to the region is the clearance and the tri-party collateral, which were US and UK products. But we are building the foundations so that we are ready to integrate it with the convergence of the hedge funds and traditional managers who may need those services.”