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Are the world’s custodians really fostering innovation or is it all talk?

By Jonathan Watkins

Find me a custodian bank that would deny being an innovator and I’ll show you one that’s devoid of a good PR team. It’s like asking a journalist if they are good at coming up with story ideas, or an athlete if he’ll be able to keep up his performances next season. No custodian will tell you they are not an innovator.
But while – at some point, and in some form – each incumbent custodian bank will have had to innovate to prosper through either products or technology, are they doing so effectively right now?
You might now be casting your mind back to a conference or a news story where you’ve heard about bank X’s technology lab, or bank Y’s head of innovation. But owning a lab doesn’t make you a certified innovator; any more than owning a kitchen makes you a chef.
This is a time in the custodian lifecycle where young whippersnapper technology start-ups are claiming to be able to do what these giant organisations have spent decades mastering, only in a cheaper, more efficient and less labour-intensive way.
So in a bid to keep up with the younger models, of course a custodian will tell you it’s innovating at the same pace.
“I do despair that so much of the activity is just to be seen as doing something, and seen to be doing something quickly,” explains Conor Ogle, vice president, business consulting at Sapient Global Markets. “Unfortunately speed and publicity can often create superficiality.”
Blockchain stands out as the biggest ‘me too’ sensation when it comes to tech innovation, with market infrastructures keen to ensure they aren’t seen as the only one ignoring it.

Danger of ‘me too’
We’ve heard about innovation labs and blockchain projects aplenty from the likes of Deutsche Bank, Goldman Sachs, BNY Mellon, State Street, RBC and BNP Paribas over the past couple of years. But while disruptive technology has been a topic of conversation for quite some time now, much of it remains just that right now – talk.
“There’s a real danger of something being seen to be done,” says John O’Hara CEO of tech start-up Taskize. “Whenever I come across innovation programmes as a FinTech provider, I don’t want to be on their innovation programme. I want to be involved in a real thing.”
Part of the reason for the slow process and hurdles when it comes to innovation is due to the size and age of many custodian banks. We’ve often heard of how transformation within a bank is like turning an oil tanker, as opposed to the nimble and more flexible FinTech start-ups, free of the tight regulatory grasp surrounding the biggest financial institutions.
State Street CEO Jay Hooley explained to Global Custodian in 2016 that digital transformation was “the most essential thing custodians need to do to ensure they are relevant in five year’s time”. He added that if he were building out a custodian today he would “absolutely” build it differently.
The scale and history of a custodian bank is a strength, but when it comes to innovation and moving forward, the legacy systems are holding them back.
“You know how old the systems are back there, and how complex they are,” adds O’Hara, previously of Bank of America Merrill Lynch, RBS and JPMorgan. “Everyone has talked about turning off the legacy systems and nobody has ever managed to do it.
“The big issue for the banks is that they are choked by their own legacy. If they could work out how to sidestep that, that would be great. They are desperately looking at how to save money, but to save the money they have to invest.
“Everyone knows there is a risk profile associated with the investment and nobody is prepared to take that risk profile.”

“There is a need to identify and execute innovation initiatives to protect the core business from progressive competitors.”

MARK KERNS, FORMER GLOBAL HEAD OF INVESTOR SERVICES, STANDARD BANK

Papering over the cracks
Given the current environment of cutting costs, the constraints on balance sheets and the increasing expenditure on regulatory compliance, banks would claim they are not plush with cash to throw at innovation projects which won’t have a return on investment in the near future.
One industry expert told Global Custodian that a bank would invest between half a million to three million dollars in each effort it took seriously.
“The key issue today is whether innovation brings real benefit to the bottom line,” says John Gubert, the former head of securities services at HSBC.
“For example the moves to clearing by many providers were costly and the financial returns were emasculated by Basel capital rules. Complex infrastructure developments such as T2S and the DTCC/Euroclear collateral utility have taken excessive time to deliver and have proved too complicated for the end-to-end target community.”
The complexity and cost are obviously on the minds of anyone looking to reform parts of the core business. Resources, time and the enormity of the process will also weigh take their toll.
Sapient’s Ogle – formerly of HSBC and ABN Amro – agrees with the complexity issue, but quickly banished the notion of the costs being too high.
“There is a ton of money – hundreds of billions – just keeping organisations running the way they have run,” he highlights. “We see lots of banks embarking on lots of initiatives to digitise, optimise or automate their existing processes.”
“So they ask how they can sprinkle a bit of efficiency on their existing process and then they get to work through a hackathon, a new technology or successful implementation.
“But at the end of that process you look back and see that the rest of the world has continued to move on.
“If they can see what they want in the future that’s more valuable than moving just an inch further forward on the existing path that we’ve been on for decades.”

Be more daring
The responsibility for fostering innovation lies in the hands of two people – the chief executive officer and chief financial officer. The sentiment from the very top will seep down into the plumbing of the company as seen in places like Amazon, Google or Facebook.
The CEO of Amazon said in a recent interview “our customers are loyal to us right up until the second somebody offers them a better service”, citing this as the reason the online retailer is constantly evolving and innovating. Unlike the consumer market, investment firms aren’t quite as keen or quick to change their allegiances with much of it down to relationships. However, if one custodian was able to offer something nobody else could then perhaps we could see more situations like the BlackRock diversification where it transferred $1 trillion worth of assets to JP Morgan.
“There is client demand to see innovation and there is a need to identify and execute innovation initiatives to protect the core business from progressive competitors and disruptive new entrants,” explains former global head of investor services for Standard Bank, Mark Kerns.
“Senior management are supportive but, in my view, we are talking evolution rather than revolution as the financial, disruption and sheer complication of too much innovation is very difficult to manage. That said, for a certain scale of provider with less legacy there is an opportunity to accelerate innovation initiatives.”
CEO-level support is crucial within a custodian, it gives power to the various silos and sets the tone throughout the company. This in turn will attract young and entrepreneurial talent to the bank who can contribute both to technological developments as well as product advances.
Business Insider reported last year that John Cryan - the CEO of Deutsche Bank - sent an internal memo to employees, asking them to “be more daring” and make decisions without waiting for their bosses to tell them what to do.
Unfortunately while CEOs at the likes of State Street, BNY Mellon and Deutsche Bank have publically expressed the importance of innovation, the majority do not prioritise it behind closed doors.
Only 57% of financial services CEOs in a recent PwC survey deemed creativity and innovation to be very important to their organisation. These characteristics were ranked below adaptability, risk management and collaboration. All I can say is good luck to those CEOs when trying to relate to the next generation. Millennials don’t want to adapt or be known for their risk management (however important it may be) they want to innovate and feel valued.

Outsourced too much
“Management focus has to be much more cost-driven by investing to cut the broken delivery chain, removing duplication, manual processes and silo structures,” says Gubert. “The paradox is that the bulk of fees in custody still come from transaction fees and ad valorem ones, despite all the talk of the industry being innovative.
“New products have traditionally been seen as the panacea to counter fee erosion but have usually only had a minor effect on total revenues.”
Given the tidal wave of regulation facing banks right now there has been a reconsidering of certain business areas, whereby less profitable lines are being reconsidered.
In an interview at the World Economic Forum earlier this year, Lara Warner, chief compliance and regulatory affairs officer at Credit Suisse, said regulation has had “a negative impact on innovation and entrepreneurial drive over the last several years”.
“Decisions that are innovative take longer to make and decide, both by regulators but also by managers in areas like compliance,” she added.
Echoing Warner’s view, Deutsche’s Cryan said “as regulation becomes more granular, traditional institutions tend to become less innovative and we’re looking elsewhere for disrupters.”
The search is therefore on for partners, which takes some of the aforementioned costs and complexities out of the process. FinTech firms don’t succumb to the same regulatory constraints as their larger counterparts, while they can also be more flexible and make innovation their core business. FinTechs have much less to lose when it comes to innovation as well.
However, when outsourcing innovation you then somewhat rob yourself of internal expertise.
“The problem is that they have outsourced so much they can’t find the top people anymore,” says O’Hara. “Outsourcing has led to them not having internal expertise anymore.”
There have been many examples of outsourcing through collaboration in the securities services indsutry, such as BNP Paribas and Calypso, Euroclear and Taskize and industry initiatives such as the R3 blockchain project.

Collaborate to innovate
A panel of experts at Global Custodian’s GCSessions event in 2016 concurred that collaboration is crucial for the securities services industry currently faced with mounting challenges and the mammoth task of upgrading legacy systems.
“When you look at the technology underpinning our environment, it is 30 years old,” said Rob Scott, head of market services at Commerzbank.
“The industry is very challenged as volume is static and costs of regulation and technology are rising. Under the theme of collaboration, there is more focus on firms leveraging each others strengths to neutralise the costs, particularly the unknown costs.”
The panel recognised the need to partner with companies to develop new technologies, leaning on the experience and knowledge of some of the emerging start-ups in the FinTech sector.
“Companies that successfully work with FinTechs are able to learn each others trends and this will help them reach new ideas and talents,” said Simon Streule, managing director for strategy and business support at SIX.
“FinTechs helps companies understand business models of the future. There’s a long way to go and the ideas seen are not yet tangible, but most areas can be reachable in time.”
So innovation is tough in a custodian bank. The legacy, regulatory environment and cost pressures are all taking some toll on innovation, even if they aren’t wiping it out entirely. What’s clear is that encouragement is needed from the top, while a motivated and incentivised team that is empowered can be essential to ideas generation.
It might not be an end-to-end operating model innovation, but perhaps just certain aspects of the value chain rather. This can still be valuable in today’s rapidly moving technological age.
“Any 5-10 year strategy must include innovation in the broadest sense of the word which is why it has to be consistently on the agenda. The issue is how much change can you execute over specific timeframes and this will be organisation and leadership driven,” adds Kerns.
“I think it’s absolutely inevitable that custodian banks will buy in talent, capability and even companies themselves to develop their innovation agendas as they see that as the most effective route to demonstrate momentum and industry leadership and to assist in addressing core initiatives such as regulation, risk management, operating efficiency and new client demands.”

I’ve got an idea!

Put on an imaginary virtual reality headset for a moment.
Okay, you’re an employee of a custodian bank (I know, these headsets would be flying off the shelves if they really existed) and you’ve just come up with the next best thing for your department. What do you do next?
Sapient’s Ogle believes the attitude towards staff putting forward ideas changes depending on culture and geography. In some places you have a very open culture and in others, people are more likely to shy away and keep it to themselves.
“What struck me about HSBC was that there are communities within communities within communities and there will be people who are at the customer engagement in Hong kong who know exactly what is wrong with a particular process but would never dare to offer up an opinion, even if openly asked to do so,” he explains.
“You swing back round the globe to New York, Chicago and Toronto where people are more than happy to put forward their opinion but it doesn’t necessarily get heard because its Asia and Europe first.”
So you have some places like Deutsche Bank, where allegedly the CEO is asking its staff to ‘be more daring’. Therefore you feel like you’ve got support and you’re ready to pitch the idea. In order to do this, senior management really has to open up the channels in order for you to do so. This may be through open dialogue with c-level staff or even an internal system.
“In London, if I’m an associate, a graduate, a VP, an MD or a director – how do I navigate the organisation to make these things real?” says Ogle. “It varies remarkably, what we’ve seen over the last decade or so since the rise of social media-style platforms in organisations where it’s become easier to crowdsource and allow people to vote for them.”
Should you be so lucky to get your idea to the very top, one of the challenges is then the golden triangle of pleasing clients, shareholders and the board that your idea is a good one. Taskize CEO John O’Hara says this can be a daunting prospect.
“Presenting to your bank executives is a bit like presenting to a venture capital firm, if not harder,” he says. “Innovating inside a bank is identical to innovating outside a bank. The bar is just as high, possibly even higher. You can only go to one source of funding.”
Ultimately it will then require sign off from the CFO, who will hold the key to the treasure chest, where perhaps if you’re lucky he will invest a six- or seven-figure into your idea.
“An effective transformation or innovation needs to be support it and sponsor it across all the silos, and the banks in your readership are definitely siloed by the definition of their maturity, there’s nothing wrong with that but they need to be aligned,” adds Ogle. “The CEO or CFO – only those two roles – are able to stand, influences, direct and sponsor at that level.”
“We’ve got to a stage where the people who feel the passion also feel passion for their brand, employers and the customer and can see the issue and sponsor a change. Even if it means working weekends, nights or taking on an extra project they’ll do it.”