Finadium has released its annual survey of asset managers opinions on concerns and future trends across securities lending, custody and collateral management.
Now in its fifth year, the report features responses from 38 asset management professionals in North America and Europe, covering US$14.7 trillion in assets or 22% of the P&I/Towers Watson list of top 500 asset managers by AUM.
Global regulations have lead to widespread changes within the three industries analyzed since 2008. Asset managers, too, have been impacted by regulations such as Basel III, Dodd-Frank and Solvency II, leading them to scrutinize their service providers more closely.
On custody, the report finds that the continued growth of global custodians has shown benefits of scale in technology and processing, but struggles remain in the ability of custodians to manage large numbers of human based challenges. Centers of Excellence are criticized for their inability to see interconnections between products and tasks and their frequency of referring problems back to individual business units.
Over half of those asset managers were using more than one custodian, with State Street, BNY Mellon and J.P. Morgan being used the most, due to legacy relationships, mergers and geographical or product differences.
An emerging consideration is data management for OTC derivatives, where asset managers are evaluating outsourcing their entire data management platforms to their custodians. While the legalities of how this can occur are not yet certain and the challenges of data security in a cloud-based custody environment could forestall further progress, executives noted that this is a topic worth exploring.
While custodians invest heavily in data management, storage and scrubbing, what matters is what is done with the data, said the report. Some asset mangers want their custodians to come up with new reports that detail risks, where fails are occurring and where processes are manual. Other executives see data reporting as a decision that the asset manager can still control on a proprietary basis whether the original dataset is managed in-house or is outsourced.
In terms of outsourcing the middle and back office, 88% of the managers surveyed are not currently outsourcing their middle or back office; 6% have concluded an outsourcing arrangement and another 6% are evaluating their options. Most managers with no outsourcing arrangements who commented said that they had not yet considered the matter carefully; this was on the agenda for two to four years from now. However, some executives considered middle and back office activities as core competencies and would not seek to outsource them.
While Finadiums researchers heard less criticisms of custodians this year than last there were some contentions with Centers of Excellence that custodians have set up to manage operations or processing across divisions. Asset managers felt that custodians keeping staff with their business units provided better service to the client and more educated people about the specific business issues that managers face.One North American asset managers head of operations said: The Centers of Excellence dont understand interrelations between products; curveballs like a corporate action in a foreign tend to confuse them quickly.
On securities lending, the report found that the custodian remains the dominant providers to lend securities. Asset managers see separating the RFP for custody and securities lending as an important best practice. In 2012, 72% of respondents used their custodians for at least some part of their securities lending activity, how there are differences in terms of size of the firm. Asset managers with under $250 billion in AUM engaged in lending through their custodian 77% of the time.
Asset managers with over $1 trillion in AUM engaged in lending used their custodian 100% of the time for at least some portion of their lending activity, but frequently used a third party lender or an internal lending desk as well. The $250 billion to $1 trillion group was the most likely to not use their custodian at all; only 50% of these managers engaged in lending used their custodian for some portion of lending activity.
31% of asset managers used a third party for some or all of their lending, while 72% used their custodian. While reasons of convenience were cited for staying with the custodian others said they did not want to be overly dependent on just one securities lending agent.
For the second year in a row, communication and reporting trumped revenues as the driver of good service from a securities lending agent. 25% of respondents cited individualized services as an important driver of good service. Risk management, stability of the relationship and expectations of quality service were more important than revenue
31% of Finadiums sample of lending firms ran an internal desk for some or all of their lending activity, both for the control it provides an asset manager as well as the information it feeds back to portfolio managers on a real-time basis
As asset managers have become more familiar with the concept of securities lending CCPs, their interest appears to have declined, said the report. Last years report found that 9% of respondents preferred a CCP over a bilateral arrangement; this year there were none. Also last year 57% of managers preferred bilateral arrangements; this year the figure rose to 70%. These are important numbers, says the report: if CCPs were to become mandated, that could affect the willingness of a large number of asset managers to engage in a largely optional securities lending program. Several asset managers noted that their agents, who exert the most influence on them, had spoken negatively about CCPs. Executives believe if CCPs were more efficient than bilateral lending then agents would use them. Second, managers need to be convinced that outsourcing their counterparty credit risk management activities to a CCP in exchange for transacting with a AAA rated counterparty is a good move.
Lastly, credit ratings may force the hand of asset managers towards the CCP model, said the report. One executive surveyed noted that with the financial services industry averaging lower than a single A rating, there was an active risk of who would still be on an approved lending list.
Ultimately, many managers assume that CCPs in securities lending will gain traction at least somewhere, although maybe not in their home countries, said the report. In order to gain industry acceptance, CCPs must win over agent lenders and show asset managers that outsourcing counterparty credit risk management to CCPs is to their benefit.
More managers this year than last years survey reported using a form of benchmarking to monitor the performance of their securities lending program; the figure rose from 68% to 77%. The most satisfied managers were comparing two securities lending agents against one another directly for overlapping portfolios; comparing the rates both agents received for the same security at the same time. Another satisfied group was subscribing to data services without the involvement of their securities lending agent; SunGard ASTEC and Data Explorers were both mentioned.
Many of the asset managers surveyed understood the requirements of and were were getting prepared for traded clearable OTC derivatives as mandated by Dodd-Frank or the European Market Infrastructure Regulation (EMIR). As such they were discussing conducting searches of derivatives clearing merchants to facilitate their trading activity. A hole continues to loom however in the case of FX Forwards, a popularly used OTC derivative that is not expected to be centrally cleared under Dodd-Frank. The report noted that total average daily trading volumes on FX Forwards were $353 billion in October 2011, up from $300 billion in October 2009. While three asset managers surveyed talked about the need to collateralize FX Forwards, others did not discuss this as a priority and some were unaware of the potential demands altogether. For managers not currently thinking about how to collateralize non-cleared derivatives in the future, there may be a scramble in the future to ensure that all collateral obligations can be met, said the report.
(JDC)