The sub-custody industry faces many challenges as TARGET2-Securities (T2S) threatens potential disintermediation among service providers, but the outlook is not all gloom.
At NeMa 2014 in Vienna, a panel of network managers from global custodians and investment banks, along with sub-custody providers, debated the survival of the sub-custodian in the current decade.
As a result of T2S, and the quest for the right model for value services, the large-scale providers will prosper, said a investment bank network manager, while the smaller providers will have to carve a niche to add value.”It will be a challenge for the niche provides to deliver as they won’t have the scale to deliver collateral benefits across our network,” said the manager.
An audience poll then revealed the level of confidence in T2S and other regional infrastructure initiatives as game changers that would enable service providers to expand their current business—by offering new services and entering new markets—and increase their revenues. ICSDs (37%) and cross-market sub-custodians (38%) would benefit the most in this regard, while less of the audience was confident in the benefits for CSDs (19%) and bespoke single market custodians (6%).
“Regional sub-custody providers will lobby as the voice of change and will apply some logic to the changes. To be effective they must make sure the voices of institutional investors are heard,” said a global custodian network manager.
The key challenges that need to be examined at the sub-custodian level include intraday credit. “We hold a huge amount of liquidity, and the risk is that credit will get pulled with these [infrastructure] changes. What will be important going forward are credit neutral sources of liquidity and the capacity of intraday liquidity by sub-custodians,” said the global custodian representative.
The panel also put forth the notion that regional sub-custodians will have natural scale advantages versus single-market ones, and there will be a reduction of single market providers as a result.
In debating whether this would lead to fewer choices for network managers, NeMa delegates heard that emerging markets, which is the path for institutional investors, would present fewer sub-custodian choices. Developed markets make it easier for regional providers to put another market in play. On the other hand, this would be more difficult for a single-market provider. “We would like to see more choice of single-market providers in emerging markets,” said one network manager.
In a poll of sub-custodians and service providers about the evolution of global revenue streams for providing sub-custody services in the next five years, the respondents were closely split, as 33% said revenue streams would increase, 31% said it would decrease, 27% said it would remain stable.
In a separate poll of network managers, 52% said the evolution of the overall fees/total expenditures being paid to sub-custodians over the next five years would decrease, 25% said it would increase, and 22% said it would remain stable.
The audience also answered the question “Assuming there is an increased cost of delivering sub-custodian services with the increased liability incurred as a result of regulatory changes who should pay for it?” The majority, 56%, said the investors should pay for it, 7% answered global custodians/investment banks, and 5% said sub-custodians.
Speaking to Global Custodian at the end of the first day, BNP Paribas’ Alan Cameron said the industry was also grappling with the practical changes that T2S would bring. For example, the new settlement fees and the liquidity levels resulting from autocollateralization in the new system are yet to be determined. Autocollateralization will lead to a reduction in the amount of liquidity required but the calculations in the new system, which will replace’s banks’ internal settlement algorithms, are required first, he said.