Appendix: Independent Professional Services (IPS)
As discussed above, the Law Debenture Corporation, through a group of subsidiaries operating independently from the investment portfolio, is a leading provider of independent professional services comprising corporate trusts (including trustee and escrow banking), pension trusts, corporate services (including agent for service of process), treasury services, whistleblowing services, and governance services to client boards and pension funds. The subsidiaries that provide these services are collectively referred to as IPS, representing c 3% of LWDB’s IFRS NAV or c 13% on a fair value basis. IPS is highly profitable, contributing c 40% of LWDB’s overall revenue per share with relatively little volatility. We also note above how the scale and regularity of this income flow provides LWDB with scope to even out fluctuations in dividend income from the investment trust portfolio, and provides the investment trust manager with greater strategic flexibility in asset selection. IPS also contributes towards tax efficiency within LWDB by providing an opportunity to utilise otherwise unrelieved tax losses in the investment trust.
The purpose of this section of the report is to provide a deeper analysis and description of the IPS businesses.
The services provided by the IPS businesses are subdivided into four broad areas of expertise:
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Corporate trusts, including trustee and escrow banking.
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Pension trusts and governance services.
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The whistleblowing service, Safecall.
Safecall operates in the UK and increasingly in Europe. The professional services are provided through offices in London, Dublin, New York, Delaware, Hong Kong, the Channel Islands and the Cayman Islands.
We show a summary financial history for IPS in Exhibit 11. The table begins with gross profit, which avoids the distortions to revenues from legal costs charged to clients (and reflected in cost of sales). In the 10 years from end-2006 to end-2016 the operating margin (operating profit/gross profit) has averaged 35.9% with a high degree of consistency. The 2016 net results exclude non-recurring group charges (£3.1m) relating to the decision to withdraw from the insufficiently profitable corporate trust business in the US. Activity had been focused on acting as an independent trustee to take a successor role in bankruptcy, requiring a capital commitment of $50m despite diminishing opportunities. LWDB expects to redeploy the $50m (within IPS or within the investment trust) by the end of 2018. In H117, a 1.8% y-o-y decline in gross profit was more than offset by lower administrative costs such that PBT increased 4.7%. Net income declined by 5.4% y-o-y as a result of the anticipated increase in the effective tax rate (to 11.9%), reflecting the introduction of HMRC’s new BEPS rules from 1 April 2017. Management expects full-year results to be broadly in line with previous years.
Exhibit 11: IPS summary 10-year financial history
£m |
2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
2013 |
2014 |
2015 |
2016 |
10 year CAGR |
Gross profit |
18.4 |
24.1 |
22.7 |
23.1 |
24.2 |
26.7 |
26.1 |
27.2 |
27.2 |
27.1 |
27.3 |
4.0% |
Administrative costs |
(11.7) |
(15.2) |
(15.2) |
(14.5) |
(15.7) |
(16.7) |
(16.7) |
(17.1) |
(17.6) |
(17.5) |
(17.6) |
|
Operating profit |
6.7 |
9.0 |
7.5 |
8.6 |
8.5 |
9.9 |
9.4 |
10.1 |
9.6 |
9.6 |
9.7 |
|
Operating margin |
36.3% |
37.1% |
33.0% |
37.3% |
35.2% |
37.2% |
35.9% |
37.0% |
35.3% |
35.5% |
35.7% |
|
Net interest |
1.3 |
1.2 |
0.9 |
0.2 |
0.4 |
0.6 |
0.2 |
(0.2) |
(0.3) |
(0.4) |
(0.3) |
|
PBT |
7.9 |
10.1 |
8.4 |
8.8 |
8.9 |
10.5 |
9.6 |
9.9 |
9.3 |
9.2 |
9.5 |
1.8% |
Tax |
(2.0) |
(3.5) |
(2.2) |
(2.1) |
(1.7) |
(2.0) |
(1.8) |
(1.7) |
(1.2) |
(0.8) |
(0.4) |
|
Effective tax rate |
24.7% |
34.9% |
25.7% |
23.8% |
18.8% |
18.9% |
18.3% |
17.0% |
12.9% |
9.2% |
4.3% |
|
Net income |
6.0 |
6.6 |
6.3 |
6.7 |
7.3 |
8.5 |
7.8 |
8.2 |
8.1 |
8.4 |
9.1 |
4.2% |
IPS revenue return per ordinary share (p) |
5.12 |
5.63 |
5.35 |
5.69 |
6.19 |
7.25 |
6.67 |
6.96 |
6.87 |
7.09 |
7.68 |
|
IPS revenue return as % LWDB total revenue return |
42% |
40% |
34% |
44% |
47% |
47% |
44% |
43% |
41% |
39% |
41% |
|
Source: Companies House, Edison Investment Research
Although not disclosed in detail, our analysis indicates that the overall growth rate of IPS over the period reflects good progress from most business units (the growth of Safecall stands out), while the corporate trust business has faced some headwinds. As indicated in the 2016 annual report, management has implemented an organic growth strategy in each business and this is now firmly in place. The interim report says that early indicators are positive, although it will take some time for material results to become apparent, and that some investment will be required.
Exhibits 12 and 13 show the results of our analysis of the breakdown of gross profits of the main UK-registered LWDB subsidiaries that constitute IPS, by IPS business unit in 2007 and again in 2015. We have taken the data from publicly available filings at Companies House, choosing 2007 as an indicator of the position before the global financial crisis and 2015 as the most recent year for which all annual results have been filed (although we would not anticipate a material difference in the 2016 results). A deeper analysis of profitability after administrative costs is hampered by all UK professional services staff being employed through one subsidiary. These main UK subsidiaries account for a substantial part of IPS (85% in 2015 and 89% in 2007) and are therefore likely to be fairly representative of the overall IPS business unit split, although likely to slightly understate the contribution of corporate services and, to a lesser extent, corporate trusts.
Exhibit 12: Main UK entities, 2007 split of gross profit
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Exhibit 13: Main UK entities, 2015 split of gross profit
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|
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Source: Companies House filings, Edison Investment Research
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Source: Companies House filings, Edison Investment Research
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Exhibit 12: Main UK entities, 2007 split of gross profit
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Source: Companies House filings, Edison Investment Research
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Exhibit 13: Main UK entities, 2015 split of gross profit
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Source: Companies House filings, Edison Investment Research
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Based on our analysis of the UK subsidiary data, the corporate services and pension trusts business units have both grown gross profits and share of IPS gross profits between 2007 and 2015, and Safecall has grown rapidly, but from a smaller base. As we discuss below, for the main UK corporate trust business unit subsidiary, gross profits dipped during the global financial crisis but had recovered by 2011 before drifting off.
Corporate trusts, including trustee and escrow banking
When The Law Debenture Corporation was founded in 1889 it was for the purpose of acting as trustee to facilitate the issuance of corporate debenture stock. Today, through the corporate trust business unit of IPS, it is the UK’s leading independent (non-bank) corporate trustee, with many decades of experience and deep market connections, providing a wide range of services that include:
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UK and international bond issues and medium-term note (MTN) programmes.
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Securitisation, repackaging programmes, and international project finance transactions (eg holding security in relation to offshore and onshore wind farms).
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Tailor-made trust arrangements to facilitate regulatory compliance or mergers and acquisitions activity (M&A); to hold (in trust) and exercise special voting rights in complex mergers.
As a non-bank provider, with no financial involvement in transactions, IPS is more clearly free of potential conflicts of interest, which in many circumstances is likely to appeal to investors and borrowers. The business unit also operates a relatively flat structure compared with many competitors, especially large banks, which can be an advantage in terms of fast decision making and sign-off. Banks can often be fairly rigid in terms of the jurisdictions in which they choose to operate, their chosen counterparties, or the products they offer. IPS management believes that it is sufficiently nimble to look at transactions individually and react quickly.
The corporate trust business unit operates internationally to provide trustee services to a broad range of debt issuance markets, is trustee for more than 4,000 trusts, and includes a large number of high-quality issuers among its clients. We would direct readers to the company’s corporate brochure that can be found on its website.
The demand for tailor-made trust arrangements is often M&A-related and generally involves the use of a trust to separate ownership from control. This may be a way of satisfying foreign ownership limits or perhaps restrictions on market concentration.
The business unit operates as an independent third party with a dedicated treasury team supporting its activities in trust and escrow appointments for project financings, whereby it receives, manages, and disburses the cash receipts. It is also trustee for the operator of the UK lottery, Camelot, and trustee for the Europe-wide lottery, EuroMillions. Additionally, M&A-type transactions, requiring an independent third party to hold cash (or shares, or other assets such as real estate) in escrow, often pending the fulfilment of warranties, is an area of increasing activity.
We have found no way of quantifying the overall market for corporate trustee services in which the corporate trust business unit operates. We believe that a substantial share is accounted for by the banks, especially large operators such as BNY Mellon, Deutsche Bank, and HSBC. Significantly, the banks are more likely to see trustee services as part of an overall package, and this may be one factor behind a highly competitive environment for setting fees in recent years. IPS prefers to seek more complex transactions where it has more possibilities to add value and generate appropriate fees.
Given the range of activities undertaken it is difficult to identify specific drivers for the business. Global debt issuance in a very broad sense (sovereign, corporate, securitised, structured etc) is obviously key to the debt-related trustee income that we suspect remains the larger share but, given the size of the overall markets, IPS’s ability to secure a role in appropriate transactions on attractive terms is likely to be equally important. Participation in new issuance generates acceptance fees as well as replenishing the stock of outstanding trusts on which recurring annual fees are generated, in addition to post-issuance fees that may arise from restructurings, rating downgrades and other actions required by the trust deed. M&A activity is also likely to be a driver of some of the bespoke trust arrangements and trust and escrow appointments.
It seems likely that post-issuance work would have been boosted in the immediate aftermath of the global financial crisis and we suspect that the subsequent improvement in borrower credit quality and performance may explain the apparent decline in business unit gross profit (based on our analysis of the main UK subsidiaries) since 2011. Management describes a solid year overall for corporate trusts in 2016 and sets out in the annual report a number of the new appointments secured during the year.
Pension trust and governance services
The IPS pension trust business unit is the longest established and the largest provider of independent pension trustees in the UK. Among its more than 200 pension scheme clients, with over two million members and in excess of £150bn in invested assets, it works with some of the largest and most complex pension arrangements in the UK, as well as more than 100 smaller schemes that each has fewer than 500 members. As well as the traditional defined benefit (DB) schemes, defined contribution (DC) schemes and sole trusteeship services account for a growing share of the business. The latter provides an efficient and cost-effective simplified governance structure, which most commonly appeals to legacy (closed) DB schemes.
As a result of the rising cost of provision, active membership of UK DB schemes has declined from 2.4m in 2010 to 1.7m in 2016 (source: The Pensions Regulator) as increasing numbers of employers have closed DB schemes to new contributions and replaced them with DC schemes. Just 15% of DB schemes were open to new contributions at the end of 2016. However, as closing schemes are likely to have members who are receiving pensions or non-contributing members with preserved pension rights, and the time between a scheme closing to contributions and meeting its final pension obligations is likely to take a great many years, the decline in active members is not fully reflected in scheme numbers, which have declined at a slower pace. There were 5,900 private sector DB pension schemes in the UK in 2016, according to The Pensions Regulator, compared with 6,900 in 2010. Including DC schemes, the number of active occupational pension scheme members has increased quite noticeably from less than three million in 2013 to 5.5 million in 2015 (source: ONS). Although these numbers exclude automatic enrolment workplace pensions, it seems likely that their introduction has stimulated occupational scheme membership.
Although the steady decline in DB schemes presents a headwind, management notes that the increasing complexity, particularly of larger schemes, provides an offsetting increasing demand for pension trustee services, generally charged by the hour. The growth of DC work and sole trustee work are similarly positive. IPS indicates that new client interest remains strong and several additions to its team have been announced in recent months so as to increase capacity.
Competition in the market tends to be of a fragmented nature and it is not uncommon for experienced individuals (eg a retired CFO or company secretary) to offer trustee services. For such operators, keeping abreast of increasing complexity and regulatory developments may well prove challenging. We believe the collegiate culture that is a feature of the IPS professional services business units to be a differentiating factor compared with larger competitors and that this is a factor in maintaining high levels of service. Larger competitors include Capita, Capital Cranfield, Pitmans Law, and BESTrustees.
This business pillar also includes the smaller activities in governance services, which include the external and independent evaluation of board effectiveness against governance codes and providing advice on improvements.
The corporate services business unit includes the provision of a range of corporate services provided mainly to special purpose vehicles (SPVs) as well as the service of process business. The services are provided across each of the locations listed above but are tailored to each country’s legal and taxation requirements.
The corporate services provided by IPS include the provision of independent corporate directors, corporate secretarial services, corporate governance services, and accounting and administration services. The SPVs include structured finance transactions (securitisations), mergers and acquisitions, infrastructure projects, sale and leaseback or any other circumstance where a third party wishes to set up a company for a specific purpose. We refer the reader to the division’s corporate brochure, which can be found on its website.
The UK securitisation market is one of the largest and most developed securitisation markets in Europe and an important source of finance for UK businesses. Overall issuance of securitised product remains noticeably lower than it was before the global financial crisis (€237.6bn in 2016 versus €594.9bn in 2007) but has been growing since a 2013 low of €180.8bn, according to the Association for Financial Markets in Europe (AFME). Within the structured finance space, core competitors to IPS are Intertrust, TMF, Capita and Wilmington.
In the service of process business IPS is appointed to act as local agent for third parties who are otherwise not represented in that jurisdiction. Service of process is also known by different names in some jurisdictions, including registered agent, statutory agent or resident agent. An example of a typical arrangement involving a process agent is where an overseas entity raises a loan from a UK lending institution. The UK institution will require the overseas entity to appoint a UK process agent to whom they can, if needed, deliver court proceedings in the unfortunate event of default.
Although less significant in terms of scale, a range of similar services are provided whereby IPS can act as agent to receive notices and documentation in respect of areas such as arbitration proceedings, the UK Companies Act, or the UK Land Registry.
Most service of process business is undertaken in the UK, representing overseas customers that conduct business there but have no physical representation. Utilising the IPS network of international offices allows the business unit to provide a 24-hour-day, five-day-week efficient and flexible service to those clients (eg whatever time of day a transaction is due to close, London is able to sign off for New York and Hong Kong for London). From a market environment perspective, global transaction/global trade are key drivers. World Trade Organisation data show that despite a substantial correction during the global financial crisis and its aftermath, the volume of global trade doubled between 2005 and 2015. WTO forecasts look for 2-4% pa growth over the next couple of years.