What will the world of custody look like in a couple of decades? Some things are certain. The global savings profile will change. The USA and EU will dominate global markets much less. Investment instruments will evolve from their listed securities bias. Automation will be an overriding competitive advantage. And there will be a regulatory miasma in the old world and a more balanced approach in the new.
The global savings profile is changing. The greying of much of the old developed world and a harsher economic climate has affected savings. Wealth, for many in the developed world, will come not from savings but inheritance when their parents’ properties are left to them. In the emerging markets, or should we say dynamic economies, with their more advantageous demographics and lack of universal established wealth, saving becomes an imperative. After all, in many of those markets, there is also a lower level of state retirement benefit, compounding the need for the individual to accumulate wealth on their own. So whilst savings ratios in the old developed world will plateau, and may even fall, those in the dynamic world will grow. World Bank data places the gross savings ratios to GDP at 51% in China, 47% in Singapore and 32% in India, but 13% in the UK and 17% in the USA.
Market capitalisations vary by country and reflect the historical roots of companies rather than the location of their business operations. As populations grow and dynamic markets become wealthier, the trend for production and services to decentralise further, or for new regional entrants to emerge, will change the global landscape. And capital is also mobile, not just in terms of capital movements, but also in terms of capital sourcing. As savings grow in the dynamic economies, we can expect more cross listings, more locally listed subsidiaries and more liquidity being sourced from outside the old developed world. Many markets that were nascent just two decades ago are now global leaders. After all the top twenty world equity markets now include China, HK, India, Korea, Taiwan, South Africa and Brazil.
Investment instruments are also changing. It is not so long ago that portfolios were filled with bonds and equities. They will continue to have an important role, but it appears inevitable that the changes we have seen over the recent decades will continue. B2B financial activity will increase with banks being supplanted as financial intermediaries by pools of money, sourced from investors. Private placements will become more normal with perhaps more hybrid forms of financial instrument. The TLAC bond, or similar total loss absorbing capacity instruments, is likely to spread beyond the banking market. Equities risk being superseded by an amalgam of derivatives and debt instruments, giving together a lower cost route to yield and market exposure. Governments may be less able to find low cost funding as their credit ratings fall below the major industrial entities, perhaps giving rise to corporate securities regularly trading at a premium to their home country state bonds. Hedging is likely to be a norm, not only for institutions and corporates, but also down to the retail sector.
Automation will be a game changer. The over developed and over institutionalised markets of the West will be overshadowed by the willingness of peers elsewhere to accommodate genuine change. The human barriers to automation are less established in the dynamic economies. There is a willingness to jettison legacy processes in favour of more efficient ones in the dynamic markets, where often labour laws, but, more importantly, local work ethic and culture, facilitate change. It is no secret that process inefficiency hits our global industry with billions of dollars of unnecessary cost. The cause is simple. There are too many intermediaries; the trend is for consolidation across the entire private sector with country specific consolidation long having been superseded by cross border consolidation. Firms work off common operating models. Technology is based in multinational hubs. Processes are outsourced for reasons of cost and skill arbitrage. There is a similar quieter consolidation occurring across infrastructure. The trading space now has global players, recognising that a few hundred counters in the equity space, as an example, account for the bulk of the profitability of their sector. And that phenomena is repeated across instruments, be they bonds, equities or derivatives. Companies like OMGEO or SWIFT dominate the trade matching space. SWIFT and FIX dominate the messaging arena. But will it be Euroclear, Clearstream and DTCC who really dominate world custody, clearing and settlement markets, or will it be the possible single Chinese market? Or will it be a new Asia, Africa or Latin American “Clear”?
And regulation will be a material differentiator. Old Europe, especially, will place its trust in over regulation, with those at the extreme among the legislators ignoring any concept of caveat emptor, endangering any entrepreneurial management by creating culpability for any error as an automatic default and fearing wealth creation as an undesirable by-product of a flawed market structure. The rest of the world will be somewhat more measured, albeit uncertain and fearful of a crisis that will threaten public purses. Would we again see a bail out of markets by a Central Bank buying up to ten per cent of a market, as we saw in Hong Kong during their crash? Will we ever again see private sector banks swallowing up the walking dead, as they did in the US and much of Europe following the Lehman crisis? And will lenders of last resort ever emerge for those new risk masters of the universe in the central counterparty space? Regulation will not be simple in any jurisdiction. The cost of compliance will continue to compound at alarming rates. But flexibility is more likely to prevail outside of Europe, although the US is more aligned to the forbidders than the facilitators.
If capital flow arises outside the current major financial centres, if instrument innovation is more acceptable in the dynamic world, if automation will be applied there to destroy that permafrost of unnecessary cost in our business and if regulators in those regions are seen as flexible but firm, the world will change. The financial pendulum is already heading east rather than west. And the great danger is that the change will hit the overpriced and under developed traditional markets before they appreciate the fact that they have become financial backwaters.