Tim Keaney, vice chairman and chief executive officer of Investment Services at BNY Mellon, says financial services regulation, which was designed to address risk in the system following failings of Lehman and Madoff, is one of the best things that have happened to a Global Systemically Important Financial Institution (G-SIFI) such as BNY Mellon and the industry. It has enabled the custodian to offer more services. However, he says, for too long, the industry has been guilty of “silly pricing” and urges a “wake up call” among its participants to reprice these new services in order to meet the heavy investment they require.
“To be critical of our industry, I don’t think we charge enough for what we do. When you think of the incredible responsibility we have for custodizing assets in over 120 markets around the world—the real-time technological connections you have to develop, the valuations that we have to create on any type of instrument, which people trade on, in the market, every day—yet at the same time it is a zero tolerance for defect environment that we’re in.
“I think we also got used to the changes post-Lehman where we’ve seen huge drops in capital markets related revenues and in securities lending, while foreign exchange volatility has narrowed to unprecedentedly low levels [leading us to price accordingly]. So for too long our industry got dependent on fat but fleeting sources of revenue and profits and we got away from making sure that our core business of custody, accounting and performance and risk and transfer agency generates a reasonable return for our shareholders, given the huge investments in technology that we need to make and frankly also the huge investments in people that we need to make.
“We ought to be charging reasonable rates for our services for the investment that we need to make, and we should capitalize on regulatory change and look at it as opportunities to add value to clients beyond what we do today – and, again, charge for those services. I think people who don’t have that mind-set are going to become industry statistics.”
BNY Mellon has changed its business model in order to capitalize on regulatory change. Among those changes, Keaney highlights Dodd Frank and the European Market Infrastructure Regulation (EMIR), particularly around collateralizing trades in derivatives instruments. “So if there’s another failing of a financial institution the counterparty in these derivatives transactions, someone like BNY Mellon will be holding the collateral that would make sure that that trade is money good,” he says, “and that one is not subject to bankruptcy court proceedings and so forth before there is proper financial resolution, and who is figuring out who owns the financial risk of being a counterparty or being exposed to a counterparty.”
New regulation has promulgated that all derivatives transactions are collateralised: “It was a huge opportunity for BNY Mellon, which holds a lot of collateral in our tri-party repo program, to develop a whole set of capabilities around collateral, says Keaney. “In fact we have created a whole business around it, Global Collateral Services, and it’s been one of the fastest growing products in my arsenal.”
The Alternative Investment Fund Managers Directive (AIFMD) has also presented BNY Mellon with a significant growth opportunity in Europe. “You could argue that it raises the risk and responsibilities of the depot bank or trustee,” says Keaney. “It was an opportunity for us to step up to the mark, develop some sophisticated technology that knows where collateral is at all times around the world, in real-time, for any security a client holds as collateral against any trade and any portfolio. And it also required that one has expertise that is not necessarily in line with your traditional skill set as a custodian, but as someone that really does understand investment guidelines, investment instruments and risk.”
Nowadays, 50% of BNY Mellon’s technology spend is aimed at addressing TARGET-2 Securities (T2S), AIFMD, cost-based tracking and changes in tax around the world. The bank also has teams working on the Depository Trust & Clearing Corporation’s shortening of settlement cycles from T+3 to T+2.
T2S, the harmonized settlement platform for Eurozone securities, has been called the game changer in post trade services. It has had the most profound impact on BNY Mellon as a custodian, prompting it to obtain a central securities depositary license in Europe to plug directly into the T2S infrastructure. Keaney says: “We initially really did it for our depositary receipt and our corporate trust businesses in Europe where if a company in the eurozone wants to issue a European bond, for example, we can now do the common depositary work, which is all the prelisting requirements that need to be met before that bond can be traded in the secondary market.”
The CSD is also intended to offset potential pricing changes among the sub-custodians in the new T2S environment where the cost of settlement shrinks dramatically. “So if a sub-custodian in Europe says they’re going to double their rates or they’re going to stop providing certain services, I could very easily leverage my own presence on the ground and my CSD license to provide those services for myself, plugging into T2S directly and providing all of the asset servicing, corporate actions and settlements,” says Keaney.
“So BNY Mellon can play a more active role in driving change in the European landscape and providing more choice to clients in the future having chosen to build out that CSD.”
The CSD enables BNY Mellon to “live the investment services spectrum”, which according to Keaney sees the company servicing any security that any client would own around the world, from custody through to clearing: “We’ve been evaluating the different ways in which that CSD could allow us to do that.”
He adds: “Today in the U.S., we are an authorized participant, which means we can make markets in securities. Now, from a European perspective, if someone was listing an exchange traded fund in our CSD and they might also use BNY Mellon as the custodian and fund administrator. We can then offer the services to our clients and distribute those ETFs as an authorized participant in Europe. That ETF may be investing in derivatives, and we can hold the collateral for that ETF and to the extent that ETF is being sold to another BNY Mellon client. We could also potentially consider real time settlement of that ETF as opposed to the current ETF settlement trade date of T+3, as we are also providing the custody and administration of the ETF.
“So I think of that as the power of the BNY Mellon franchise, delivered in a way that the regulators might actually see as lowering the systemic risk, and all of that is possible and plausible in a CSD in Europe.”
While the regulatory change has enabled custodians to expand their service offering to clients impacted by that change, it has also impacted those custodians in terms of the costs. To account for regulatory change, BNY Mellon started its re-pricing journey about two years ago. “I am repricing,” says Keaney. “I started modestly with our smaller clients. And at this point I’ve re-priced somewhere between 600 and 700 clients. I’ve lost some – but I’ve lost less than 8% of what I have re-priced, and I’ve re-priced clients to where I’m satisfied that we are generating a reasonable return for what we do. And as new client contracts come up for review, including the larger ones, we are repricing them as well.
“There are a number of clients where I do have pricing power and those are the ones that I am re-pricing. But if you looked at my largest clients, it’s still very price competitive and the game is slightly different for those clients. It’s about trying to do more with them. They are predisposed, by the way, in this environment to do more with fewer companies because operationally it’s easier for them to have fewer providers and it also means they get the economies of scale.”
“So I’ve been investing in new electronic foreign exchange capabilities, in collateral and derivatives, in our outsourcing capabilities and – even though I might not be able to reprice custody and core asset servicing they are willing to do more business with firms like BNY Mellon.”
BNY Mellon is repricing the core of its asset servicing business to where it is getting a reasonable level of return, says Keaney. “I see my competitors following suit, and I think it’s about time and I personally hope that this trend continues.”
The bank has stated publicly that its current 8.5% return on equity (ROE) will be 10% by 2015. “Our investment services business is about 75% of the firm,” says Keaney. “So even though we don’t break down the ROE between businesses, our whole company is very focused on getting to the 10% ROE target.”
Given the unprecedented levels of regulatory change, Keaney says technology and people will help to create value going forward. “Firstly, it’s going to require institutions to invest enormous sums of money in technology. I spend $2 billion U.S. a year on technology – and some would argue that that could be more. The world is becoming more global, more real time. Providing information to clients in a useable format is an on going challenge and you hear a lot of people in our industry, including ourselves, talk about risk, for example. That is an extension of real time information being packaged to a client, in this instance in a way that allows them to take action to lower risk while understanding the impact on return.
“The second thing is pretty straight forward: clients demand expertise and knowledge. The people who win in this game are the ones that understand insurance companies, banks, advisors, investment managers and asset owners. Post Lehman, the challenge is that – while they recognize we may have all the tools in our tool kit –an insurance company, for instance, wants someone to sit across the table from them that understands what an insurance company does, that understands the difference between a life, casualty, property and a reinsurance firm and who understands their specific challenges.
In conclusion, Keaney believes that the future of custody lies in the delivery of services that help clients in the front office. “Clients don’t say, come in and tell me about custody. They say, help me variabalize my costs, help me comply with clients, help me distribute my products, help me launch products more quickly, help me assimilate acquisitions, help me be more capital efficient. So the dialogue has changed. We were one of the first to change the way we faced out to clients, the way we organized around segments.
“So it’s a combination of those two things: the technology, to make the world global and real time and to leverage information in areas like risk; and then its people. If you have those two things then you’re still going to be here in five years. If you don’t, I think you run the risk of delivering sub-optimal returns for your shareholders and you will end up becoming an industry statistic in that five year time frame.”
The Future of Custody: BNY Mellon’s Tim Keaney on Repricing and Regulatory Change
Tim Keaney, vice chairman and chief executive officer of Investment Services at BNY Mellon, says financial services regulation, which was designed to address risk in the system following failings of Lehman and Madoff, has enabled the custodian to offer more services. However, he says, for too long, the industry has been guilty of "silly pricing" and urges a "wake up call" among its participants to re-price these new services in order to meet the heavy investment they require.
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