BlackRock Inc. yanked custody services from State Street Corp. on more than $1 trillion in client assets as the asset manager seeks to cut costs by putting pressure on vendors. The move of assets to JPMorgan Chase & Co. is part of BlackRock's strategy to exact lower fees, according to a person familiar with the matter. The bank said the deal was one of the largest shifts of custody assets ever. BlackRock, the world's largest asset manager, found a partner in JPMorgan, which has been growing its custody business and now services about $20.5 trillion in assets. The bank has invested in automation technology that helps it offer services more cheaply, said another person with knowledge of the situation. The bank is expected to make tens of millions of dollars in annual fees from the deal. "Many of BlackRock's clients will experience cost savings through decreased operating expenses at the fund level," Derek Stein, senior managing director and head of business operations and technology at BlackRock, said in an e-mailed statement Wednesday. BlackRock has made no secret that it planned to put more pressure on vendors. President Rob Kapito said in a conference call last year that it would seek concessions as it tries to keep a lid on expenses. Profit Margins JPMorgan's corporate and investment bank chief Daniel Pinto has said he was focusing on the custody business because of its profit margins and steady fees. One priority is improving efficiency through automation technology, he said in a February presentation. That has helped the business generate margins of greater than 25 percent. Pinto said in a Wednesday statement that the deal is a "validation of the investments we've made and the resources we've added to the custody and fund services business." The firm said it increased business with existing custody clients by 10 percent over the last 12 months. State Street investors saw the move as a blow. The company's shares fell 4.3 percent as of 2:50 p.m. in New York, the most since June.

This "may be the first inning of a trend of JPMorgan uniquely being able to grab business from the trust banks," wrote Glenn Schorr, a senior banking analyst at Evercore ISI, in a client e-mail. The average fee rate for custody assets is 1.81 basis points, meaning that the loss to JPMorgan could sap about 3 percent of State Street's earnings, he wrote. 'A One-Off' State Street Chief Executive Officer Jay Hooley said Wednesday that BlackRock approached the Boston-based custody bank as it sought to diversify its custodians. Hooley said that as BlackRock grew into a $5.15 trillion money manager it decided it needed another partner. The shift isn't indicative of a trend in the industry because most companies are looking to use fewer providers, Hooley said on the company's earnings conference call. "We appreciated where they were coming from," Hooley said. "It's a one-off adjustment for BlackRock to get better diversified." State Street had assets under custody and administration of $28.8 trillion as of the fourth quarter. It said in a presentation Wednesday that it would remain a service provider to BlackRock even after the move. Bank of New York Mellon Corp., the largest custody bank, reported $29.9 trillion in assets under custody and administration. FeePressure Price competition is fierce among the top players in the industry. Improvements in technology are driving servicing costs lower and customers are demanding those savings be returned to them, Richard Bove, an analyst with Rafferty Capital Markets, said in an interview Wednesday. "It is a significant loss at a time when State Street's fees are already under pressure," said Bove. JPMorgan expects to take over administration of the assets during the next two years. Custody banks keep records, track performance and lend securities for institutional investors. They also manage money for individuals and institutions. "Shifts of this size are pretty rare," Jonathan Watkins, editor of Global Custodian, a London-based publication that covers the industry, said in a telephone interview. "Big managers tend to keep these custody relationships in place for decades."

Questions:

Assume that the cost-mix in JPMorgan's custody business before its investment in automation technology was 50% direct labor and 50% overhead. How would its automation technology investment likely change these percentages?

b) Assume that the variable vs. fixed cost-mix in JPMorgan's custody business before its investment in automation technology was 50% variable and 50% fixed. How would its automation technology investment likely change these percentages?

c) What is the likely impact on JPMorgan's operating leverage from its investment in automation technology?

d) What is the likely impact on JPMorgan's a) custody service quality and b) non-compliance cost due to this investment in automation technology?

e) The article quotes the editor of the publication Global Custodian as having said: "Shifts of this size are pretty rare" and "Big managers tend to keep these custody relationships in place for decades". What might be some underlying reasons for these statements?