State Street Corporation (NYSE:STT) has quit as a primary dealer for the U.K. and German governments’ debt issues,  citing regulatory concerns, mainly the Volcker rule, as the major reason to resign. State Street joined other banks, such as Bank of America (NYSE:BAC), Barclays (NYSE:BCS), Goldman Sachs (NYSE:GS), only three months back as the market maker of the U.K. government’s bond auctions. The decision shows uncertainty among the financial institutions regarding the implication of new laws, such as the Volcker rule, which was introduced after the financial crisis in 2008 as an effort to make the financial sector safer and more manageable. Also, the instability in Europe and the recent lackluster bond auctions is causing banks to reassess their relationships with the governments.
In any country, primary dealers pledge to buy share of government-issued debt in exchange for a right to partake in the auctions. State Street’s decision to quit brings to the fore efforts taken by financial companies to cut down on their debt and risks, and have ample capital as per the rules set down on both sides of Atlantic. It is likely that few other banks may follow suit as new regulations tighten the banks’ scope of activities to reduce the inherent risks involved, for instance, proprietary trading with a conflict of interest between keeping clients’ money safe and earning profits. As a pragmatic solution to the increasing debt problem still eludes European leaders, bond markets are weakening across the continent, threatening banks with the risk of unsold bonds staying on their balance sheets.
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A renewed focus on its core operations to provide custody and fund administration to its clients is good for State Street as it continues to grow in assets and acquire new contracts in this competitive environment.  The company is expanding its range of product offerings, such as the new fixed income funds or active ETFs to be launched next year. It’s also diversifying its business to various geographies to cap its risks and capture a greater share of the assets in the emerging market due to its market positioning and expertise in the field.  We think that increased attention to cost savings, aided by efficient business operations and IT transformation plan, will benefit the company in the current low interest, low asset valuation conditions.
Our price estimate for State Street is $46, which is around 15% above market price. We are revising the price in light of these recent changes and macroeconomic scenario.Notes: