Securities Services: Tougher times for providers
Securities services providers are having to raise their game in response to demands of clients who face both increasing regulatory pressures and a low-yield environment, finds Anthony Harrington
Securities services providers are under pressure as never before. Their institutional clients are responding to mounting regulatory pressures and a low-yield environment by demanding more detailed and more frequent and wide-ranging reporting. At the same time, these clients are becoming ever more sophisticated in their investment processes and are adopting more complex strategies across a broader range of asset classes.
This means that any provider that wants to stay in the securities services game has to be prepared to make a continuing and substantial investment in IT systems to support client requirements. However, as David Maya, a partner in the global management consultancy Oliver Wyman, notes, for a variety of reasons, profits in the securities services sector have fallen steadily since the 2008 financial crash, which makes it tough to keep making the necessary investment in systems.
Maya and a colleague, Hugues Bessiere, are authors of a paper entitled ‘Securities Services: The Good Times are Over, it is Time to Act’, in which they argue that securities services providers have suffered challenging times since the 2008 financial crisis.
Maya says that while the top 10 providers, who between them account for about 80% of assets under custody (AUC) and assets under administration (AUA), have seen revenue growth of about 8% a year each year since 2008, that growth is almost all accounted for by asset value appreciation, and does not translate into increased profits. In fact, operating margins (considered as a weighted average of the top 10 players) have fallen from 35% to 26% in 2014, in comparison with 2008, they say.
Many factors are behind this fall in profits. Maya says that many of the new deals, such as for middle-office services, may require high levels of customisation and low levels of straight-through-processing (STP) and automation, which make them expensive services to provide, pushing up operating costs. At the same time, the need to comply with regulatory requirements such as the Target2Securities (T2S) platform (see article in this report) or to develop new offerings shaped by new regulations such as the EU’s Alternative Investment Fund Managers Directive (AIFMD) is adding a further layer of cost without noticeably generating any immediate and proportional pick-up in profit.
Maya adds that from talks with pension fund managers and investment managers generally, the middle office is where the most pain is being felt. “What they are saying is that given the increased complexity of their investment environment, they have to find someone external who can solve the processing and reporting issues faster and more cost effectively than they can with their own resources,” he says.
At a glance
• Securities services providers have to step up their investment in systems despite years of shrinking profits.
• Clients faced with a ‘build-or-outsource’ decision for IT support are increasingly taking more from their providers.
• Providers looking to win both custody and investment business from clients need Chinese walls, but what keeps these walls solid?
Emmanuelle Choukroun, head of business development for pension funds and sovereigns at Societe Generale Securities Services (SGSS), says that a heavy investment in IT has become necessary for any securities services provider interested in retaining or increasing their market share. “This is something that any organisation setting out to be a major player in the securities services space has to accept,” she says. “If you want to be here, then you have to commit for the long term, and if you want to last as a provider, then you have to have an appropriate pricing strategy for your services and an investment horizon that is suited to the sector.” SGSS is committed and has ambitious goals, Choukroun says, but she predicts that the scale of the IT spending required and the tough conditions in the sector will cause some players to exit.
“We have set out a major investment and long-term strategy plan for the period from 2014 to 2017, to be a pan-European provider capable of accompanying our pan-European clients. Investment managers in various European countries are increasingly looking to find cross-border investment opportunities and we will be there to provide services to them wherever they invest,” she says.
Choukroun adds that it makes little sense for pension fund management teams to consider building systems in-house for specific functions, such as corporate actions and the like, or for specific regulatory reporting requirements. “The core skill of the pension fund is to implement decent pensions. We provide securities services. These are two very different skill sets and businesses, with very different goals, so it makes much more sense for them to rely on their depository bank. We support all the investments they want to make, from over-the-counter (OTC) derivatives and alternative assets through to fixed income and securities. This is a natural part of our business as a service provider,” she says.
Then, of course, there is the fact that the new regulations on occupational pension funds require the fund to appoint a depository bank. “It is their duty to appoint an appropriate provider and our business model is to invest in IT where we can see that it will add value for the client,” Choukroun adds, pointing to SGSS’s Passive Overlay offer. “We have built a currency overlay which allows the client to hedge against the currency risk on non-domestic assets. There we can offer them a passive or a semi-passive hedging tool which they can adjust to suit their strategy.”
Picking up on the theme of the increasing complexity that now seems to be a permanent feature of the sector, Sid Newby, UK head of pension funds sales at BNP Paribas Securities Services points out that today asset owners have to track risk in a more granular way than ever, and across a broader array of asset classes. “As a custodian, we think the answer to this growing complexity lies in providing our asset owner clients with powerful data visualisation and risk management tools. Our Data Navigation Analysis (DNA) platform enables asset owners to identify trends, support decision-making, manage third parties and find exceptions hidden in millions of data points. It is an intuitive tool that provides everyone within the organisation with a sophisticated and highly visual means to easily analyse complex scenarios involving high volumes of data. Furthermore, DNA includes powerful risk-simulation tools allowing asset managers and owners to prepare for every eventuality, and test attribution scenarios.”
He adds that the emergence of liability-based strategies, probably one of the most significant developments in pension fund investment in recent years, has also generated an increased need for a deeper understanding of the dynamics in various investment positions. “Understanding investment risk and exposure to asset and liability mismatches is crucial for pension funds. We have recently launched a new range of analytics enabling our clients to not only monitor their assets and liabilities after the fact, but also to actively manage their asset allocation across asset classes – including credit, property, equity and currency,” Newby says.
“Asset owners are increasingly asking for tools that would help them aggregate all aspects of risk – be it operational, credit or market risk. The next phase of risk management requires not just an understanding of regulatory developments and analytical techniques, but also a consolidated and shared view of risk throughout the organisation,” he notes.
Newby also points out that all the large custodians have been forced to look at their cost models. “Since 2008, with interest rates going through the floor, asset productivity is not what it was. Some revenue streams – such as FX [foreign exchange] and securities lending – have been impacted and there is downward pressure on core trust fees. We have seen a number of providers rationalising their offerings. Some have exited their alternative fund administration business, for example, while at BNP Paribas we have bought businesses, such as Credit Suisse’s hedge fund administration business. This sector is now really about scale – you have to have scale to be successful,” he notes.
Newby says BNP Paribas plans to expand its pan-European business. “We have very strong franchises in Italy, Germany, the Nordic countries and, of course, in France. European funds tend to be internally managed and buy the whole value chain from us. This is rather different from standard practice in the UK, where they tend to want the custodian and the investment advisory service to be entirely separate. European funds today are happy to appoint us as broker, custodian and valuation agent and to use our asset management capabilities. Our clearing capabilities are highly valued. Funds today are increasing the use of derivatives to immunise their portfolio, so our collateral management service comes into play as well,” he says.
With this extended commitment to depository banks both clients and the regulator need to know that there are the appropriate Chinese walls between the provider’s administration and investment arms. SocGen’s Choukron says SGSS achieves this by having a risk department that is fully independent of any operational division. “The risk department reports in a hierarchical way to someone who has nothing to do with heading up investment or custody services so, in addition to formal separation and rules, we have the risk committee policing matters to see that the Chinese walls remain solid. I see no problems here,” she concludes.