As the very last drop of Pimms gets drunk and Londoners go back to their default state of grumpiness, the City is coming down from three weeks of sportsmanship, beguile and fun. But there was a lot happening in securities services for more than three weeks that should give the industry something to smile about.
Over the last three weeks, while Usain Bolt was winning, the securities services industry has had a lot on its plate and should perhaps be awarded with its own medal, particularly when considering upcoming regulation such as EMIR, UCITS V, AIFMD and the ESMA guidelines on UCITS ETFs. The industry is carrying on despite the host of regulation weighing down on it.
It is perhaps in spite of these regulations that the industry appears to thrive. Take, for example, EMIR, which will force the industry to post extra margin as collateral for OTC derivatives trades and require efficient collateral management for the upcoming changes facing these trades.
The fact that many counterparties will now need to optimize their collateral in the wake of EMIR could give rise to further outsourcing opportunities. The industry is often criticized for its inability to change its fee structure and work out ways to charge more. But in fact it should perhaps be applauded for making do with what it has and its growing ability to cross sell across various business lines.
Combining a business that provides financing and margin lending on one hand with custodianship on the other can provide the buy side with the comfort of knowing that their assets will be safe from a risk management perspective and are being taken care of from an operational perspective. By entrusting their assets to securities services providers that leverage their investment banking capabilities, these institutions can get on with the business of managing assets.
For the securities services provider, while it is not necessarily reinventing the fee model, it is reinventing the business model in such a way that it can offer additional services and charge extra for those services. J.P. Morgan, Citi, BNY Mellon and BNP Paribas are among the examples of investment banks that have combined the agency clearing business with securities services business, thereby offering buy-side and sell-side institutions a one-stop shop for financing, collateral management and custody.
The collateral requirements in EMIR are bringing about new and interesting challenges for the securities services industry.
Pension funds and other institutional investors are sitting on a goldmine of collateral, and the increasing regulatory change means they will need someone with the skills and technology to manage that collateral pool in the best way possible. Many have already discovered this. CalPERS and the three pension funds of an Italian bank chose State Street as their securities services provider, while Rhode Islands pension fund selected BNY Mellon, and AP4 in Sweden and a U.K. fund manager recently said they would go with Northern Trust for securities services.
Hedge fund managers are also facing a raft of regulatory change through AIFMD and are seeing the benefit of outsourcing not just their back office but vitally important functions in the middle office, as investment manager Victory Capital Management did when it outsourced its middle office, covering $27.7 billion of assets, to Citi.
Regulatory changes may not immediately bode well for the smaller clearing firms that do not have the technology to invest to meet their clients collateral requirements, but they have the niche services and pricing model to undercut the larger investment banks.
Research firm Celent said in a report last week that while custodians are at crossroads with their business models, silver linings are appearing in the form of increased assets under custody and revenue growth in 2011. It also noted that custodians are under pressure 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.
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 onward, 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, for 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.
If necessity is the mother of all invention, custodians have taken this a step forward, and their ability to reinvent themselves amidst unprecedented regulatory change should not go unnoticed.
– Janet Du Chenne