A roadmap to escaping the danger zone in securities services

For an industry facing multiple headwinds, now is the time to revisit the profligacy of its business models and eradicate the billions of unnecessary costs that custody businesses casually absorb, writes John Gubert.

Are we in the danger zone? And, if so, how do we get out? Profit wise I see red warning lights flashing; with markets at near peaks, commodities in demand, escape products such as Bitcoin being lionised and social unrest growing. As in prior years, assets under custody have risen sharply over the last year but revenues have risen more slowly. Market appreciation, capital formation and higher savings rates benefiting institutional and personal portfolios appear to be the main engines for growth. Margins continue to be squeezed as pricing trails the efficiency curve and costs continue to escalate in an ever more complex environment both in terms of product and regulation.

The trouble with the current environment is that bear markets, which in custodian terms relates to the value of aggregated institutional holdings rather than the performance of markets alone, are painful examples of the effect of reverse leverage on revenues and profits. Although sub custodian, depository and a few other costs decline in bear markets, the bulk of costs, heavily dependent on the cost of our people, continue to grow. In a bear market, profit can then turn to loss and the senior management love affair with the business can erode as quickly as the bottom line.

Now is the time to revisit the profligacy of the current business model and seek to eradicate the few billions of unnecessary costs that our businesses casually absorb. I see some low hanging fruit. We need an urgent new line of sight on standards. We need a fresh dialogue with infrastructure – both market and technology – about new utilities to eliminate non-value-added common industry processes and to create sound shared technical platforms.

None of this is going to be easy. There are vested interests who cherish their market position and see non-standard environments as barriers to third party entrants and a means of leveraging their scale into a superior unit cost position. And many others, without those advantages, still believe they have the magic wand of self-invention and internalise all development and activity. Long term those will be the losers if the rest of the market get their acts together.

There have been material advances in industry utilities. Reference data, standing settlement instruction databases, LEI databases or ISIN databases are incredible tools but they need to be brought within the regulatory framework to ensure consistency, accuracy and timeliness of data. Market issues need to be resolved including the digitalisation of company new issue information, the usage of pre issuance ISINs, the consistency of data within organisations and across products, or the acceptance of a single identifier across trading and post trade markets for a specific data element.

However, utilities need not be limited to data provision. A corporate action database has been much discussed but always fails when liability issues arise. We need to consider how real such issues are in an age of automation and the likely maximum potential loss they could generate as well as the insurability of any potential failures. Tax reclamation is an area where there is little competitive advantage in processes but where utilities could both streamline activity, pressurise document intensive locations to digitalise and standardise; thereby sharply reducing unit costs as well as becoming vehicles for progress. Pricing is also a logical utility function, especially as well over 90% plus of all pricing of listed securities is straightforward data capture from the appropriate price formation location. Would we not operate in an enhanced and lower cost environment if we could centralise corporate action databases, automate global withholding tax data and flows or have a golden source for pricing even to the extent of agreed algorithms to accommodate scale of holdings (which may well be on the regulatory horizon at some time in the future)?

And we must look more assiduously at technology standards. Industry developments are exacerbating the situation with the proliferation of new apps and the emergence of Blockchain. As one who went through the agonies of messaging standards from the days of ISO 7775, through to the more recent tribulations around ISO 20022, I am well aware of the stress such initiatives place on legacy platforms as well as new developments. But the benefits of blockchain, beyond the peripheral advantages that have so far been gleaned, will never come to fruition unless we adopt a standard taxonomy. The same can be said of the plethora of APIs that almost every supplier is offering clients; clients who often operate with multiple suppliers and thus need to operate multiple diverse interfaces or require each of their suppliers to map their product to the appropriate environment. Once again, many still assume that bespoke interfaces offer them a competitive advantage, a mentality that in the last century made the inevitable move to ISO/SWIFT connectivity so painful to achieve. It is not a competitive advantage; it is a cost burden, a technology risk and a competitive disadvantage as ease and safety of connectivity is a prime requirement of our industry buy-side.

Product side we also have a standards delinquency. The major example is in the ESG world as different providers of ESG products struggle to define their own parochial parameters and shy well away from the need to consider global standards. Experience has made me somewhat cynical about the drivers for ESG definition. I can recall a major Middle East fund in the 1970s defining the Distillers Company as a pharmaceutical (it had a division that distributed the lamented Thalidomide drug) rather than a whisky company as their rules forbade investment in alcohol. The same self-delusion unfortunately appears to drive some thought processes in parts of the ESG world.

I doubt the market and the multiplicity of well-meaning industry bodies will successfully tackle these issues in a reasonable timeframe. So, we have a choice between perpetuating the status quo, which would be disastrous, or seeking resolution through different channels. G20 intervened after the 2008 crash and their then demands included the promotion of CCPs on the infrastructure front and the promotion of standards such as LEIs. It would be beneficial if they could return to the battlefield and make a pre-emptive strike for standards both on the technology and product front, as well as facilitating the launch of trusted utilities in areas such as pricing, global tax, corporate actions and data sources; this time ahead of any upcoming but inevitable crisis. Regulators, just as they did on spot foreign exchange, pre the launch of CLS, could then codify the riskiness of the current environment and demand capital support if resolution on some, if not all, of these issues does not occur within a specified timeframe. Given the scarcity of unencumbered capital across the industry that could well be the catalyst for the required action across the marketplace.