Arguably, the global securities services industry is set to face more disruption to its traditional business model over the next five to 10 years than it has ever witnessed before.
This is largely due to the dramatic shift that new entrants and technologies are causing to an entrenched and slow-moving industry. There has been an influx of innovative applications and services brought about by a new generation of FinTech firms that are agile, fast-moving, and ready to disintermediate.
According to a recent survey of 50 FinTechs in the securities services industry by global consultancy firm McKinsey, around two-thirds offer products for custody and asset servicing, while a massive 87% offer data and information services products. Furthermore, around a third provide value-added services that custodians treasure, such as collateral management, cash management and foreign exchange.
These securities services-orientated FinTechs bring to market a variety of technologies such as robotics and distributed ledger technology (DLT) that could disrupt the structure of custodians.
The majority of securities services firms will be at least slightly concerned how new technologies these FinTechs bring could leave their out-dated, legacy systems obsolete, particularly with how DLT could potential disintermediate the custodian from certain key function.
“Blockchain allows individuals and companies to make financial transactions directly between each other. There is no need for settlement, reconciliation, securing assets or providing proof of ownership, all key aspects of the custodial function,” said Feriz Hasani, head of global custody relationship management, UBS in a white paper in August last year.
“Newer smart contract technology, which allows complex business logic to be programmed in to blockchains, makes it possible to automate many asset servicing functions traditionally performed by custodians, such as reporting, registering transfer of ownership, or communicating corporate actions.”
One prime example of how FinTechs are directly competing with securities services firms is Nivaura, a UK FinTech start-up authorised by the Financial Conduct Authority (FCA). In March this year, it tapped Microsoft’s cloud technology to launch, what it claims, the world’s first blockchain-based investment product on a public infrastructure.
Using Ethereum blockchain, Nivaura registered, cleared and settled two principal protected notes (PPN) linked to the FTSE 100, one through the traditional clearing infrastructure and the second using an open public blockchain. It stated the technology helps firms launch investment products and reduces the need for middle-men in the post-trade process.
Another FinTech making waves is Betterment, the largest independent robo-advisor managing over $13 billion for 300,000 customers. Not only does it perform investment and retirement services, but also offers RIA custodial services through its broker-dealer arm Betterment Securities.
“We are a custodial firm like Fidelity or Charles Schwab, which means we are responsible for handling your funds and keeping all the records of your assets,” wrote Eli Broverman, president and co-founder of Betterment in 2014.
The company has created a robo-custodian business and over the past year has raised $60 million in venture capital and over $1 billion in assets under management (AUM).
The significance of Nivarua and Betterman is they can be seen as the first movers in competing directly with established custodians and other post-trade providers. FinTechs in the retail and payments space have made a number of dents in the banking sector, but is not until recently that FinTechs have the potential to compete with the incumbent securities services providers. And certain providers are worried about their potential.
According to research from PricewaterhouseCoopers (PWC) in 2017, almost 90% of finance firms fear they will lose revenue to standalone FinTech companies. However, the report, based on responses from 1,300 firms globally, stated a mutual understanding was being developed between FinTech start-ups and larger financial firms, driven by start-ups requiring access to capital and clients provided by the larger institutions.
One year on, has this relationship emerged between FinTechs and custodians?
Instead of directly challenging the FinTechs, custodians have learnt to stop worrying about their position and instead partner with these companies.
“There is a huge amount of opportunity for us to work with these new entrants and look at the technology they bring, rather than them being a direct threat,” says Justin Chapman, global head of market advocacy and innovation research, Northern Trust.
The fact is FinTech firms need the incumbent providers as much as the custodians need their technology. The McKinsey study found the majority of FinTechs are developing specialised tools and technologies for use by securities services firms, as opposed to going directly to the customer.
The path towards mutualisation is also encouraging banks to invest in incremental technology and start-ups that can give them the edge.
Particularly in the area of DLT and blockchain, custodians are more open to partnering not only with FinTechs but also their competitors through consortiums and working groups to help revamp the infrastructure in which they operate.
Many central securities depositories (CSDs), custodians and FinTechs are doing this through various groups to see how blockchain can revolutionise the way proxy voting and corporate actions processes take place.
Northern Trust, JP Morgan, Santander, HSBC, SIX and DTCC, to name a few, have all ventured into blockchain partnerships with FinTechs and other custodians.
“FinTech will not compete”
Furthermore, blockchain technology has the potential to create an entirely new custody, clearing and settlement model through smart contracts. Therefore, to get ahead of this custody banks are becoming more involved with FinTech and working faster to ensure their business model continues.
“FinTech will not compete with the custodian industry, however they are closely aligning. There are some that are disrupting, but you do not want capital markets to be disrupted too much,” says Walter Verbeke, global head of strategic planning, Euroclear.
“Custodians need the solutions more rapidly and therefore are coming to this point where they have to decide. Whereas such decisions previously would have taken several years, financial market infrastructures (FMIs) and custodians are now having to make them within a few months.”
However, there is a concern that rebuilding everything with new technologies brought to the table by FinTechs could be problematic.
“We think in the cash securities world that FinTech has the possibility to help replumb the entire infrastructure. However, because so much has been built up on established systems, too much disruption could be problematic,” says Vijay Mayadas, president, global fixed income and analytics, Broadridge.
“Introducing DLT into the core plumbing does not make that much sense, but what may work is introducing new technology higher up the infrastructure stack.”
Full disruption would require coordination and a broad acceptance among not only entrenched securities services firms that are competing with one another, but also broker-dealers, investors and regulators.
Rather, banks will look to collaborate on areas that have become commoditised from the top-down, and therefore easier to replace.
The McKinsey report outlines utilities in the securities services industry will be formed whereby banks and FinTechs will collaborate as the value-chains blurs and firms increase their outsourcing of less-critical functions.
These utilities are being rolled out by technology and FinTech companies across multiple areas, including KYC, collateral management, clearing, reporting and data management.
“We generally work with multiple firms at the same time. If we can help a network of banks then the whole industry benefits. The goal is to roll out new technologies across the network of banks, so if you are a large bank and are looking to mutualise and drive innovation around your post-trade stack it makes sense to work with a vendor that has other banks on that platform,” adds Broadridge’s Mayadas.
However, the problem with collaboration is for many banks this is new to them. They are not used to negotiating with competitors and to get anywhere requires a substantial amount of time and effort, particularly with blockchain.
This was evident in 2016 when Goldman Sachs decided to withdraw from blockchain consortium R3, a company it helped to found. Its departure was then followed by Santander, Morgan Stanley and then JP Morgan.
These banks have all now devised their own technology strategy which they see can be pursued without being a part of collaborative working groups.
In areas such as artificial intelligence and robotics which have the potential to significantly enhance efficiencies and change the way securities services firms interact with their clients, multi-collaborative models could appear less likely.
“The trend within DLT is to collaborate with other custody banks to gain traction. Developing solutions in isolation is not the way forward, especially in relation to market infrastructures. With artificial intelligence (AI) it is less so as we want to provide that value add to our clients. We are working with regulators on AI but we also see it as being a trend to drive to our clients the benefits of using the technology,” says Northern Trust’s Chapman.
“With AI and data analytics the smaller Fintech companies are helping drive innovation. We are spending a lot of time working with these companies to identify which ones add value to our data strategies. We have moved away from start-up incubation and hubs and are more direct with Fintech providers that are involved in AI.”
Data management is becoming a bigger part of custodian’s offerings, and FinTechs that provide the AI technology to help process massive amounts of data and develop the algorithms that can solve inefficiencies will be leading the way.
A new perspective
No matter what way custodians look at it, FinTech has brought about a new perspective. No longer can they operate at the same speed, with the pace of change always increasing.
In addition to working at a more intense level, the idea of being more collaborative with both FinTechs and rival custodians has prompted a cultural shift in order for them to both co-exist and work together.
“FinTech is prompting a new way of thinking; the day you work with a start-up you have to change your approach,” says Jean Devambez, global head of digital and acceleration, BNP Paribas Securities Services.
“We have realised for certain areas we would not do everything by ourselves and it would be more beneficial to cooperate with start-ups and tech companies on certain services.
“The cooperation between a bank and start-up involves a lot of compromising and flexibility, and installing a disruptive solution within a bank that has been used to going about things a certain way can be challenging. But in return we bring capacity and clients to the start-up and bring them all the underlying requirements they need to help them grow.”
It is this new perspective that has helped forge a number of FinTech working groups and eco-systems, such as B-Hive in Brussels, that helps spark creativity and innovation for securities services.
“This can be quite powerful, as you ultimately want to work peer-to-peer, instil an action-oriented mind-set and turn collaboration and best practice sharing into the new normal,” adds Euroclear’s Verbeke.
In-house vs partnerships
FinTech is also encouraging custodians to take a look at their existing services and find a way to reposition themselves so that they offer that same flexibility and a tailored service that the start-ups can provide.
Having an acquisitive strategy whereby the custodian takes a minority stake in the FinTech is helping facilitate this, whereby they can impart their own knowledge and working practices for the start-up to win clients, and in return they gain the technological knowledge which they can use to amend and launch new products.
This strategy however, is largely carried out on a case-by-case basis, according to BNP Paribas’ Devambez.
Last year, BNP Paribas acquired a minority stake in FinTech firm Fortia Financial Solutions, with the aim of implementing its technology within its own depositary banking business.
“Sometimes you go for a true commercial partnership, and others you don’t want to imprint too much of the bank on them.
“FinTechs can bring a new approach and challenge us in a positive way to reposition our offering. It is quite difficult for FinTech start-ups to acquire their own clients, largely because of the short-term constraints on their business. Some are coming with very interesting propositions, and we look at them differently to what we traditionally offer. It is more of a challenge rather than a threat,” says Devambez.
However, some banks are now evolving to a point where their FinTech capabilities are located in-house, and instead are partnering with other banks and leaving the FinTech start-up out of the loop.
Most recently, BNY Mellon and Deutsche Bank launched a chatbot-to-chatbot communication solution developed during a 24-hour hackathon at BNY Mellon’s Singapore Innovation Centre.
The move shows how bank are now more open to collaborate with one another in order to enhance non-differential processes in the middle- and back-office.
“What’s different here is the collaborative approach we took to resolve a real speed and accuracy need for our clients,” said Jeslyn Tan, deputy head of global product management, securities services, Deutsche Bank at the time of the launch.
“When we first brainstormed the issue, it was immediately obvious that for a truly business-enabling experience, a fully integrated solution in the form of chatbot connectivity was required between both institutions.”
It is remarkable how custodians and securities services providers have had to make overarching changes to their approach not only on technology but also client experience and interactions. FinTech has stimulated collaboration in an industry that has generally not worked well together in the past.
Most likely, the big banks will not have to worry about FinTech taking over their space. The operational risks and costs associated with switching from an established bank to a FinTech has put off most buy-side firms from making the move. However, this does not mean the securities services industry can let their guard down.
The rapid developments in DLT from FinTech’s shows the potential for custodians to be disrupted from the value chain. Furthermore, the capabilities FinTechs offer has made custodians look inwards to meet customer expectations.
The future is bright for both FinTechs and custodians and collaboration will increasingly become a part of their technology strategy. But when another player such as a Betterment or Nivaura come to market with a compelling offer, it will be interesting to see how nice everyone will play.
More and more FinTech firms are now entering the securities services space hoping to disrupt the industry, and while we’ve been busy asking whether they pose a direct threat or an opportunity for custodians, the incumbents have been planning behind the scenes, writes Joe Parsons.