On the brokerage dealer front, Julien Kesparian, head of UK sales at BNP Paribas Securities Services, notes: “Historically, mid-tier firms would significantly outsource their back and middle office operations and the larger banks never did. That is changing because of the combination of the regulatory impact, shrinking margins and the expense of running a back and middle office. It was reported that Societe Generale has outsourced its back office functions to Accenture and I think we will see similar deals in the future.”
Pension funds are also under much greater pressures not only to generate returns but also to improve their transparency and governance, according to Penelope Biggs, head of Northern Trust’s Institutional Investor Group for Europe Middle East and Africa.
“The result is that there is an increase in outsourcing certain activities and as a result services we provide in the middle office such as compliance and risk analytics, investment oversight solutions and collateral management have moved further up the decision making chain. We are now much more involved in conversations about the whole process from executing the trade to reporting and risk management than five years ago.”
John van Verve, global head of custody for HSBC Securities echoes these sentiments. “It has become much more complex and difficult for clients to deal with regulations such as EMIR and the Alternative Investment Fund Management Directive (AIFMD) in terms of knowledge and IT. Clients are turning to us to provide middle office solutions. I think one of the biggest areas will be in the provision of data in real time and in a format that can help their investment strategies.”
This is substantiated by recent research conducted by State Street in Europe. Canvassing 150 pension funds, it found that only 60% of defined benefit schemes felt they had access to portfolio data that allowed them to understand their total risk exposure, while only 42% were confident their data provided full insight into their investment costs.
“With a critical mass of data already at its fingertips, the custodian can provide the foundation for a consolidated picture and drive advanced analytics through new tools and dashboards,” says Campbell.
Expanding the footprint
Although custodians across the board are raising their game very few have the girth to take advantage of Target2-Securities, the European Central Bank’s platform for harmonised securities settlement across Europe. So far only BNY Mellon has thrown its hat in the central securities depository (CSD) ring alongside Euroclear and Clearstream.
“I expect there will be another one after BNY Mellon but it will be interesting to see if the remaining custodians will feel the competitive pressure or not,” says Catt. “There must be a compelling business case to do so.”
According to Hani Kablawi, head of asset servicing for Europe, Middle East and Africa for BNY Mellon, the decision to establish BNY Mellon CSD was “in order to expand our footprint in the trade lifecycle from the front to back end. In many ways it was repackaging the existing capabilities that we had to offer a greater breadth of scope.”
CSD status will enable BNY Mellon to help institutional investors access high-quality collateral needed to meet margin obligations plus it should improve interoperability for post-trade activity by linking to cross-border CSDs and offering local market services from a pan-European perspective.
Not surprisingly, many of these new services may come with a higher price tag. In the past, clients enjoyed a bundled service but today the economics do not make sense especially when firms will have to shoulder increased legal responsibilities. For example, under the AIFMD, effective in July, custodian banks acting as depositaries will have to assume greater liabilities in terms of indemnfications and these costs are likely to be shared by the fund community.
As Kablawi puts it: “Clients understand that this regulatory change will have a material impact on the custodian and the conversations today are more about the right price for the right level of risk. Regulation aside, the business model in custody has come under pressure because securities lending and foreign exchange are not the value-adds they once were.”
The industry is also re-evaluating cost structures of struggling businesses such as securities lending. There is talk, for example, of custodians taking a larger slice of the average fee splits, which is income generated by the activity that they typically share with the institutional clients who provide the assets out on loan. The rates have not changed since the early 1990s, with industry sources estimating a typical split being between 70% and 85% of the revenue returned to the lender, with the remaining 15% to 30% retained by the custodian or agent lender.
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