A juggling act
New regulations, new competition and new cost pressures mean custodians and sub-custodians have more balls in the air than ever before
What kind of challenges are custodians facing today? How have these challenges changed over the last five years, or so?
Attila Szalay-Berzeviczy: Custodians have gone through a number of significant alterations to their offerings over recent years. Apart from establishing a strategy for Target-2Securities, in the case of those active in euro clearing, the major changes affecting the business were driven by the new regulations, such as the European Market Infrastructure Regulation, the Alternative Investment Fund Managers’ Directive (AIFMD), the Central Securities Depositories Regulation, the Foreign Account Tax Compliance Act (FATCA) and the fast-approaching second Markets in Financial Instruments Directive (MiFID II).
While the so-called regulatory tsunami is far from over, a new challenge has already emerged. This is in the ability to keep up with the fast-advancing new technological initiatives which are slowly entering the custody business, too.
We are seeing a growing number of financial technology companies entering the securities and payment services business with highly competitive offerings. Accordingly, to keep up with the changes, custodian banks should work on their IT strategies and the attractiveness of their service models.
Banks should, in other words, become technological companies as well, to be ready to embrace the challenge.
Richard Anton: There are several key themes we are seeing in the market, particularly around regulation and governance, data and operating model choices. The march of regulation—its growth in complexity, scope and expectation—has been immense over the last decade. Even markets like Canada, which fared well through the financial downturn thanks to a strong regulatory regime, have seen enormous regulatory evolution.
More recently, there has been greater focus among clients regarding the critical importance of data to power their investment decisions, and to affirm that the necessary governance, transparency and oversight is in place. Market participants need flexible and timely access to information, and they are looking to their asset servicing providers for solutions. We are also seeing significant attention focused on the assessment of insourced and outsourced capabilities, and across both home markets and global operations across custodians and sub-custodians. While clients want to achieve global mandates, they must also navigate through and execute locally across diverse market requirements. For custodians and sub-custodians alike, the challenge is to build flexible and scalable solutions to support diverse needs while maintaining and growing a strong and efficient core offering.
To what extent have custodians settled in to the new regulatory environment? What are the main challenges that remain?
Anton: Ironically, given that a huge part of our business is ‘settlement’, I don’t think custodians will ever be able to settle into the regulatory environment, other than into an expectation of ongoing change. The regulatory environment is not limited to any one local jurisdiction, but rather is the interplay between many different regulatory regimes and how rules and requirements can intersect or even conflict across borders. US tax requirements such as FATCA, 871(m) and 305(c), for example, or EU rules for fund managers, can also have sweeping implications for other jurisdictions.
More recently, at least in Canada, regulators have turned their attention to operational models and in particular to vendor management. The translation and framing of global and local regulatory impacts for clients is one of the areas in which sub-custodians can set themselves apart in helping global clients navigate domestic waters.
The goal is not only to support clients’ compliance efforts, but to efficiently position clients with the necessary reporting, transparency and demonstrable governance to achieve compliance without over-consuming financial and human resources—a point that can come into tension, given the scale of some regulatory asks. It’s not just about helping clients get it right, it’s about helping to make it easier for them.
Szalay-Berzeviczy: By now, all custodians have implemented most of the requirements due to the numerous regulations that have come into effect during the recent years. Things such as strategies and models of over-the-counter derivatives clearing, reporting of transactions and collateral, segregation of assets, new depositary contracts, and so on, have all been analysed and duly incorporated. However, further new or updated regulations are already slowly entering the legislative framework.
The next significant piece of legislation that has consumed a lot of effort among capital market participants is MiFID II, coming into effect in January 2018. Some of our network banks have only just finished implementing AIFMD, and we hear that policymakers are already working on AIFMD 2. The implementation of regulatory changes has become a part of our daily tasks and thus, we should all be accustomed to it by now.
How have client demands changed? And how are custodians coping with meeting those demands?
Szalay-Berzeviczy: One of the changes that has appeared in a number of the directives over recent years is segregation. For instance, by introducing more thorough segregation rules for safekeeping of alternative investment and UCITS fund assets, the regulations led to a burdensome process of opening multiple segregated accounts in every market within a custodians’ network. It is worth mentioning that the European Securities and Markets Authority (ESMA) released an official opinion on segregation of assets in July 2017. In its paper, the regulator stated that omnibus accounts designated for clients’ assets would be the minimum sufficient level of segregation.
ESMA noted that the need for further segregation, in order to ensure asset protection, depends on the applicable insolvency and property laws and indicated that, while it is ok to provide the minimum segregation in most markets, in others further segregation should be applied.
While most custodians have already opened multiple segregated accounts by the time this paper was released, only time will tell whether clients will continue to demand higher levels of segregation, regardless of this opinion.
Anton: We’re hearing that clients continue to seek to leverage technology to optimise, digitise and grow their businesses. In particular, we believe that timely and flexible access to relevant data is central to a great client experience. This is where we’re putting significant focus, positioning our people to help clients navigate the data.
At the most basic level, market participants want to know, and show, that they are doing a good job, relative to regulatory requirements, investment benchmarks, stakeholder expectations, their own goals, and so much more. At CIBC Mellon, we’re focused on platforms, processes and people—making sure we have the right systems in place, affirming that our operations are structured to deliver results for clients efficiently and, perhaps most importantly, that we have great people in place to help clients navigate the challenge.
We believe people are what make the difference for the client experience, which is why the firm is so heavily focused on recruiting, retaining and motivating employees.
Equally, what are custodians demanding of their sub-custodians? What should they prioritise in terms of service?
Anton: I think custodians are facing many of the same pressures as their underlying global clients, with questions of how to execute a global mandate across more than 100 local markets, how to drive efficiency yet grow our business, and how to help clients stay abreast of local market developments.
Custodians are looking for timely information about local market regulatory change, and also for support in contextualising that change. To deliver a great client experience, I think sub-custodians need to understand how to meet clients’ needs for data, governance and relevant local insights. In many ways, it really comes back to having great people in place to help clients navigate the market requirements, challenges and opportunities.
Szalay-Berzeviczy: Besides the everlasting pressures on fee reductions, the maintenance of high-quality services, lobbying efforts and continuous enhancements of IT systems, additional demands have come along with the new regulations over the recent years.
AIFMD and UCITS V, for instance, started an industry-wide trend of opening multiple segregated accounts in each market for the funds’ businesses. Other types of clients have also begun demanding further segregation, as it is seen as the key component of general asset safety. As mentioned earlier, time will show whether such account holding structures will remain in place, following ESMA’s opinion released earlier this year.
The other significant change is the number and extension of due diligence questionnaires. As every custodian needs to run the due diligence processes on a regular basis we receive a large volume of requests to respond to.
How much pressure are custodians and sub-custodians under to reduce their fees? Is this sustainable?
Anton: The custody business has always been about scale and efficiency and, in turn, the industry has continued to invest tremendously into technology to keep pace with the demand from clients to drive value. Certainly there’s pressure on cost, but in many ways the pressure is about sub-custodians being looked at to do more—to deliver more governance reporting, more data delivery, and more insights and actions, all while the fee pressure stays on.
The question of sustainability is actually one that market players need to answer themselves, by driving value and providing higher-quality services for clients, and by focusing on continuously improving their own operations. I think it’s safe to say that client expectations will continue to rise, and it’s up to companies like ours to respond to the challenge through continuous improvement of our products and services. We have a great team with a lot of exciting ideas for what’s ahead as we move into a new era of data, flexibility, governance and client-focused service. The pressure will be huge, but I know we’re up to the challenge.
Szalay-Berzeviczy: The new competition from the new category of entrants in the market, such as financial technology firms, together with the need to implement the regulatory requirements consuming budgets, is leading to additional demands from clients and making sub-custodians reconsider their business models. There is a clear need for automation and consolidation in our industry, possibly with the use of new technological solutions.
It is really crucial that sub-custodians come up with some unique service offerings that are also reasonably priced, in order to justify their business cases in front of their management boards.