A new report by research and consulting firm Celent has highlighted the pressure on custodians to rethink their business models in the wake of increased regulation and declining spreads on value added services such as securities lending cash and FX.
In a new report, Global Custody Market: At the Crossroads, Celent looks at the recent development of the global custody market and discusses its future evolution in the aftermath of the financial crisis. Despite the challenges facing the industry, the report also points to various silver linings in terms of increased assets under custody and strong revenue growth in 2011.
Celent notes that until recently, custodians existed in a comfortable, symbiotic relationship with CSDs and prime brokers but the following events have disturbed the status quo:
– The custody industry has seen further consolidation and it is becoming more difficult for the smaller firms to survive. The top five firms control almost 75% of the market, says Celent, while the top 10 control 91%. In such a scenario, there is little room for new competitors to enter, and this also slows down the pace of innovation in the industry, says Celent.
– The AUC growth was mixed between 2010 and 2011, with some such as JPMorgan, BNY Mellon, RBC Dexia, Northern Trust and State Street seeing a rise in their assets. However, most of the other firms saw a decline in the assets, reflecting a tough market environment.
– Interestingly, in terms of revenue growth, most of the firms studied performed well in 2011. This shows that the picture is not completely cloudy. There is a silver lining as well. The rise in equity markets in 2011, along with efficiency gains, helped custodians to put in a good financial performance. However, to some extent, this did hide the general decline in securities lending revenues, which is becoming a cause of worry for these firms.
– The leading performers were Bank of New York Mellon, State Street, and JPMorgan. Some other firms that performed well include BNP Paribas Securities Services, and HSBC.
– The custodians business model is under threat as the spreads on cash, FX, and securities lending decline due to market conditions. In the long term, it is becoming imperative that custodians rebalance their fee structure and ensure that they charge the appropriate fees for each service provided instead of cross-subsidizing some activities such as custody and safekeeping.
– Much higher levels of accountability and transparency are being demanded. The recent market developments have broadly led to a rise in regulatory and compliance requirements for custodians, as for other participants in the securities services value chain. While these developments are understandable, it does mean that there is less room for them to maneuver in, and this constrains their business performance as well.
– A further plus point, Celent noted, is that outsourcing has re-emerged as an attractive option for asset managers. Outsourcing of middle and back office functions was at its peak between 2004 and 2006. Thereafter it declined in the 2007 to 2009 period. However, from 2010 onwards, Celent has seen a rise in outsourcing again as asset managers try to benefit from the economies of scale and efficiency gains on offer. Custodians on their part have also been improving their outsourcing platforms to enable rapid transition of the asset managers middle and back office processes to their systems.
Global custodians have to rework their value proposition in this tough economic environment, says Dr. Anshuman Jaswal, senior analyst with Celents Securities & Investments Group and author of the report. The requirement for ring-fencing clients assets, as well as the demand that custodians take more responsibility for their sub-custodians operations, means that there will be higher costs incurred by custodians.
(JDC)