Looking back to forge ahead
Securities services, beyond basic safekeeping, is a relatively recent invention. The first modern mutual funds were launched in the United States in the 1920’s, and UK Corporate pension schemes only date back to the early 20th century. The Stock Market Crash of 1929 led to the first real regulatory structure: the 1934 SEC regulations. It was the gridlock in Wall Street following the 1960’s boom that led to the launch of the DTCC in 1973.
Regulation and infrastructure have been the primary drivers for outsourcing over the last century. As the financial world continues evolving at a rapid pace, these drivers are becoming more challenging, creating client demand for new thinking around global investment administration.
Modern day outsourcing – essentially custody, cash and asset services – started modestly with quite vanilla services in the 1970’s and 80’s, as a result of the demands of emerging investor protection regulation such as the 1974 ERISA act in the USA or the 1986 Financial Services Act in the UK. Alongside such regulatory change we saw the birth of modern financial infrastructure, as well as the internationalisation and diversification of institutional investment. Scale became important. Geographical and product reach became paramount. Risk increased as portfolios adopted new products, went into new markets and faced up to a growing regulatory burden.
Outsourcing was a means to reduce cost, but, just as critically, to enhance risk management, thereby allowing the relatively small corporate entities handling the bulk of the US$74 trillion of institutional portfolio assets to focus on their core purpose: portfolio structuring, performance and client acquisition.
As we look forward to future developments, some commentators question if the CSDs or other new future utilities will not supplant the custodians. Others believe that internalisation will be the answer for all but the small and mid-size market players. Regardless of your position, it is widely understood that there is a need to revisit traditional operating models and further eliminate cost and risk, whilst ensuring compliance with the new demands of the broader end-to-end supply chain. The supply chain creates complexity.
In order to review the implications of a broader CSD model, we can consider the following points:
The advocates of the broader CSD model should consider revisiting their position. The CSD, culturally, is a low risk assumption product delivery vehicle. The securities services provider matches that description as well, but is also a client service-oriented risk absorber with a balance sheet allowing broad financial service support.
Internalisation is also not the way forward. The demands for capital to support traditionally historically capital-free operations is increasing, and the complexity of operations, as noted already, is also rising exponentially. The potential for operations to crowd out the other critical success drivers in a fund management or brokerage operation impairs the internalisation argument. But that does not mean that there will be no need for change.
Investment will remain global and multi-product, but use of the OTC and tailored derivatives markets is bound to increase as some of the strategies around alternatives move further into mainstream.
Regulation will become more demanding on capital, especially as solutions are found for the current liquidity and collateral fears of some in the markets. Regulatory reporting will move from the data flow to data plus analysis.
Infrastructure will be disruptive as it surely must consolidate down from the current 125 or so CSDs, several hundred exchanges and trading venues, or 100-plus central clearing houses around the world.
Messaging will become more complex as demand for automation requires usage, as well as design, of new standard messages.
Much of the data will be sourced, perhaps not from public, but commonly owned industry utilities.
And the investment business will also continue to change, with new entrants, especially in the index and quasi index tracking markets, requiring low cost and high performance services.
Indeed, a changing competitive landscape will be a critical driver in the search for cost efficient and performance effective partners. The US$102 billion, or 10-15 basis point average return on assets of the global fund management sector, will come under pressure as fee differentiation between types of funds reduces, with automation increasing capacity faster than demand.
A Harvard Business School report by Professor Clayton Cristensen, an expert on disruptive innovation, said “Innovation almost always is not successful the first time out.” In an industry such as ours, where the pace of change is likely to increase, that is a concern. It militates for prudent change management, incremental wherever possible, but, as a result, continuous. The successful players on the supply side will be those that have scale, growth, delivery excellence and an ability to manage innovation. And, in a relationship and ethical business such as ours, they will also have a culture of sound corporate, client and social responsibility.
BNP Paribas and the Economist intelligence Unit did a recent series of article on supply chain innovation that should hopefully inspire you to have more conversations on how you can benefit from a new way of thinking the future.