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Impact Investing

IPE special report May 2018

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Innovation: State Street's Beacon Project

Christopher O’Dea looks at the efforts of State Street to digitise every aspect of its financial services business through its Beacon Project. Is it the model for others to follow? 

At a glance 

• Despite appearances, the asset management business remains anchored to the past.
• State Street has launched a programme, known as Beacon, to digitise every aspect of its financial services business.
• The new technology will simplify the core business processes of asset management, speed up delivery, provide insight and improve accuracy.
• Some of the changes are fundamental to asset management and will require orchestrated release.

Institutional investors have long hankered for portfolio information and risk reporting as dynamic as the markets in which they invest. However, delivering those services in real time has proved beyond the capability of securities services providers.

From the outside, asset management looks high-tech – computers devise and implement complex investment and trading strategies ranging from risk parity and factor investment, commodity trading programs written by maths PhDs execute thousands of transactions a day. The progress of all that effort is tracked against benchmark indices and reported to institutional investors by sophisticated software.

But at its core the business remains as anchored to the past as the frigates and lighthouses featured in the logos of asset management firms and the service companies that provide managers with everything from custody to accounting. In fact, the most basic function of the asset management world, calculating the daily net asset value (NAV) of a portfolio, depends on manual processes in which staff engage in a daily scramble akin to raising the mainsail to generate thousands of NAVs at the precise time stipulated in prospectuses and management agreements.

State Street is set to change all that, and it has adopted the lore of lighthouses – with their connotation of safety before the days of global positioning systems (GPS) and navigational certainty – as the brand identity for an ambitious campaign to transform the company, and the practice of asset management and asset servicing along with it. Dubbed Beacon, the initiative is State Street’s programme to digitise every aspect of its financial services business. Beacon aims to increase efficiency, improve client service and profits by materially shrinking its cost base over the next five years.

State Street executive vice-president and global chief information officer, Antoine Shagoury says that Beacon is a “third wave” of technology innovation that will recast securities services for institutional investors and asset managers. This hinges on the digitisation of the myriad accounting and verification processes that underpin the investment management world as the NAV calculation. 

Enabled by computing power, software and advances in data science, the securities servicing industry is scrambling to meet client demand for portfolio analytics and market data insights. This will simplify and condense the core business processes of asset management, speed up delivery of critical performance and governance information, engender the creation of new insights about risk and valuation, and increase the accuracy of portfolio information. Even as it helps to keep pace with client needs, digitisation is shaking up the firm’s culture. It is leading to job losses as the consolidation of functions trims the need for supervisors. The company announced 600 layoffs last October and several hundred more during the first quarter of 2016. 

“This is the third wave of a series of transformations,” says Shagoury. The first focused on optimising basic technology and operations, and the second aimed to create a “total digital enterprise”, leading to such service offerings as State Street Global Exchange. Like a lighthouse beam, Beacon focuses externally. “Beacon is more than a cost programme,” Shagoury says. “It’s a structural change in the way we look at the service we deliver to a client and the way we deliver service to a client instead of focusing on a business or a product.” While maintaining operating efficiency is essential, he adds, “we’re building an engine for business growth”.

It is an ambitious effort and the stakes could not be higher. Like all service providers, State Street faces a challenging revenue environment. But the Boston-based company tends to derive a higher proportion of its servicing business from equity-related assets than peers; that makes operating revenues more sensitive to the direction of global stock markets, enough so, one rating agency says, that State Street did not generate a return sufficient to cover its cost of equity capital in the first quarter of 2016.

State Street is targeting $550m (€447m) in pre-tax net run-rate expense savings by the end of 2020 from the application of Beacon. The near-term focus is expense management through reduction of managerial layers and broadening the span of control in remaining jobs. State Street expects to generate about $100m in annual pre-tax net run-rate savings in 2016, with another $125m in 2017. It projects pre-tax non-operating restructuring charges related to Beacon of about $300m to $400m from 2016 through 2020. All told, Beacon will help “achieve and maintain a pre-tax operating margin of at least 31% by 2018 and 33% by the end of 2020”, according to State Street’s 2016 Investor Day presentation.

The depth of the implementation is commensurate with the results expected. Previously, products and services were built within State Street’s four main business divisions, in which each interfaced with a client system. “We’re turning that on its side,” says Shagoury. Beacon requires a “decomposition of how we create and deliver our products and services, and rewriting the platforms to enable us to do it – we can use the term ‘digitally’ – in a way that’s automated and then build the capability to take that automation to create new products and services.” For example, he adds, “when we have the source data of a transaction, a valuation or a calculation, those things are broken down into their constituent parts. That’s where we find the commonality that allows us to rewrite the software for the process.”

To stay at the forefront of data science, State Street last year made a research grant to establish the Consortium For Data Analytics In Risk, at the University of California at Berkeley. The centre conducts research on issues concerning financial markets and risk management. “Real-time risk and position information is incredibly valuable,” says Shagoury. “Especially in today’s volatile markets.”

Many of the changes under Beacon will not be rolled out like new product launches. But some are fundamental to asset management and require orchestrated release, Shagoury says. One such is a suite of improvements to State Street’s services for the calculation and oversight of net asset values for funds. Slated for release this summer, the NAV oversight upgrades are expected to reduce the time needed to strike an NAV while increasing the accuracy of the calculation.

Capabilities developed through Beacon have already proven valuable in the outsourced chief information officer (OCIO) business of State Street Global Advisors, Shagoury says. In one case, State Street devised a single OCIO system for a large US utility saddled with multiple defined benefit pension plans acquired through acquisitions, with limited staff and a costly, decentralised structure. The OCIO solution improved the funded status of the plans, helping reduce the company’s balance sheet volatility. 

While Beacon has helped bolster financial strength of some State Street clients it might do the same for the company itself. The weak global equity markets in the first quarter resulted in State Street posting an 8.4% return on equity for the quarter on an operating basis, which adjusts for a $62m net after-tax restructuring charge related to Beacon, according to Fitch Ratings. “This is below Fitch’s range of estimate for STT’s [State Street’s] cost of equity of between 10% to 12%,” the agency said in a note on the results. Beacon “should significantly aid in” expense management, Fitch said, and to the “extent that longer term this initiative permanently reduces [State Street’s] cost base, it could help the company’s returns to potentially exceed its cost of equity.” 

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