In anticipation of the Global Custodian Awards Dinner at the Savoy in London on Thursday, I want to celebrate, in this particular blog, its first quarter of a century by considering four of the most radical of the changes we have seen in that period.
In my brokerage office, some four decades ago, three or four ladies sent telexes worldwide and worked out commissions and considerations on mechanical calculating machines, as they opened the post to remove dividend checks or the occasional allotment letter. In Midland Bank, in the late 1980s, the advent of the Financial Services Act 1986 had caused serious challenges for the trustee division; a challenge that occupied some four years of my time to resolve. Paradoxically, it was uncertainty about the scope of the Act that caused them the problems; that scenario has similarities to our current situation as we battle with those never-ending waves of unfettered regulation.
The biggest change has to be the closure of the vaults. The 1980s were, at least in my home markets of the U.K. and much of Asia, an era of paper. Vault management was a serious challenge. I recall establishing that we were borrowing stock we had lent out, but could not recall in time for settlement, in the U.K. I remember, with pain, the physical deliveries of a hundred thousand dollars of Reliance scrip in Mumbai, hundreds of dog-eared certificates carried to the counter in the pouring rain in an old blanket by two clerks from the selling broker. I shudder as I think of the number of times we restacked the vault in Indonesia as investors piled in and paper piled ever higher. In Pakistan, they had a defective registration procedure and, as a result, transformed a certificated market into a de facto bearer one in a quite lawless environment. And then there was our messenger who was mugged in the City of London while carrying several hundred million pounds of bearer money market instruments. Thank heavens for dematerialization and, to a lesser extent, immobilization as long as the definitive instruments are not held, as was the case with DTCC, in a vault below potential flood water level!
The second biggest change has to be in messaging with SWIFT, the undoubted hero of this space; although OMGEO also merits a worthy mention. I do not miss opening the post, deciphering the appended contract notes, rolling up the never-ending telexes or unblocking the fax machine. The only shame is that SWIFT has not extended its franchise further, for, as markets have grown, so has the volume of non-automated or quasi-automated processes. And it is also wrong, in these days of ever tighter trade-to-settlement cycles, that same day trade matching has not become a regulatory imperative wherever it is feasible. But we could not have survived in today’s volumes without SWIFT and the automation that it enables. And we need to rethink again this space if we are to flourish in the next quarter century. We need more dynamic and broad-ranging data utilities, less lip service to the principle and more genuine standardization of process, much more regulatory attention to the quality of automation throughout the value chain and real interoperability between the market utilities we either own or enable.
The third biggest change is the development of market infrastructures. The CCP and the advent of its netting structures in an almost zero fail environment has to be the major dynamic in enabling exponential trading volume growth over the last 25 years. The CSD, and its often maligned but much more influential sibling, the ICSD, have had impact well beyond their annihilation of the past power of registrars and the introduction of book entry settlement. They do, or have the ability, to improve asset servicing, or reduce settlement risk, especially in central bank money real-time gross settlement (RTGS) systems, and improve asset safety if they operate in the right legislative environment. There are fault lines in this space. I have already mentioned the lack of true commitment to interoperability, at least in areas where there is potential competitive disadvantage. The proliferation of infrastructures is nonsense with many of the micro and mid-size markets being costly dinosaurs in a modern world. The regulatory obsession with CCPs as risk free through their collateralization structures is as flawed as the theories on default likelihoods with 99.99% certainty, which were behind the last, and still running, financial crisis. The belief in the infallibility of the public sector as a provider of infrastructure has some credence, if based on history, but there are new and material fault lines in organizations, which do not hold always capital, insurance or member liability commensurate with the risks inherent in their structures. The market may be seriously underestimating the potential risks from cybercrime, internal fraud and operational failure, which if arising at some of the new, or even, established, infrastructures could seriously destabilize markets.
The final change I would mention is product. 25 years ago, the market was basic despite the oft-cited declaration of the great Marsh Carter of State Street that the custody business line was so wonderful because it had fourteen different possible revenue streams. Custody was global then but mini-global, whereas now it is truly global in scale and market coverage. Holdings tended to be equity and debt, rather than equity, debt, derivatives and a stream of alternative investments. The alternative funds market was in existence, but marginal, and nowhere near as large a player in the space it currently dominates, namely in its share of trading in securities, financial and commodities markets. Leverage was almost non-existent for funds and surprisingly modest for many brokers, but then trading volumes were minimal relative to the modern day, high-frequency and active trading scenario. Asset finance was limited to stock lending, mainly on a single lane between institutions and brokerage houses rather than being a standard tool for funds and other investors. The concept of prime brokerage had still to be invented and, although collateral management was in place, volumes were minuscule and most CCPs required cash rather than instruments. And regulators had started to have an impact but their presence was felt in the background rather than as the major concern of all in the business from the most senior manager downwards.
Things have changed. The change has been for the better. If only we could rid ourselves of some of those pesky lawyers and compliance officers, then perhaps the change in the coming 25 years could be even more beneficial for investors and intermediaries alike!