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Impact Investing

IPE special report May 2018

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Upstaging the locals

Continental Europe may be on the cusp of an investment revolution, but it seems increasingly questionable whether many of those banks that make up the (already much depleted) ranks of the region’s local custody providers will still be around to reap the coming bounty.
In recent years only the UK has seen new custody providers emerging, as various players – notably NAB/ Clydesdale and KAS Bank – seek to carve a niche servicing the UK pensions funds marketplace. But the UK is once again the exception that proves the rule, its sophisticated investment landscape not yet mirrored on the continent. There an intractable decline in the number of providers has been under way since the mid-1990s, and the indigenous banks that traditionally acted as local agents for the big global custodians whilst offering custody services to their own domestic client bases are now a dying breed.
“Consolidation at the local agent bank level started a few years ago and continues today, albeit at a lesser pace,” says Jon Lloyd, head of sales and relationship management at BNP Paribas Securities Services (BNPPSS). “Whereas typically there used to be four or five strong indigenous providers per market, now there are just one or two, so the choices for both investors and global custodians are more and more limited.”
Pedro Matthynssens, partner at global financial services and technology solutions provider CapCo, notes that custodians that are part of continental European universal banks are threatened on a number of fronts. “In using them as sub-custody vehicles to access the local market infrastructure, the global custodians are essentially playing a couple of agent banks in each market off against each other,” he says. This has led to downward pressure on sub-custody margins, in the process making the business increasingly uneconomic.
At the same time these indigenous banks have struggled to retain local institutional clients, such as corporate pension funds, to whom they had been offering custody services. “The level of service they can offer these institutional clients is simply not sufficient anymore,” says Matthynssens. “Accordingly those clients have drifted off into the arms of the US custodians who have invested heavily in the technology and operational efficiency that enables them to offer basic core custody services in numerous markets.”
Indeed, the imperative to continue to invest extremely large sums of money in the business – not least in the technology sphere, where a big US player such as The Bank of New York will typically allocate upwards of e600m annually to systems spend – has not gone away. In fact, it is probably more marked than it was in the five years or so since consolidation began.
“Whereas the provision of corporate actions processing and income collection and tax reclaim was perhaps once seen as a value added to settlement and safekeeping, today they are merely part of the core custody offering,” says Patric Foley-Brickley, European sales manager at Citibank Global Securities Services. “Now the emphasis is on non-commoditised services such as fund accounting, performance measurement, risk analysis, internet-oriented products and the ability to furnish the client with information from across all of his portfolios.” Needless to say, such sophisticated functionality is beyond the ken of your typical local custody provider.
The inexorable diversification of portfolios across the continent, in respect of both the type of instruments held and geography, puts local banks at a clear disadvantage, argues Foley-Brickley. “Take France, a market that is moving towards significant off-balance-sheet funded pension plans but which has historically invested largely internally and furthermore has been very bond-oriented,” he says. “If organisations are going to spread their risk and meet their funding requirements they will require a far more significant equity base and a more cross-border profile, but the traditional providers in individual markets are perhaps less well equipped to meet that need as the big custodian players.”
Adds Lloyd: “As the game becomes more regional clients are coming to the realisation that their ability to leverage a relationship means it makes sense to consolidate with one provider in Europe.” The advent of the Euronext exchange alliance underlines this point – after all, for institutions operating in France, Belgium, the Netherlands and Portugal, what today is meant precisely by the term ‘local’? “If you are a Belgian provider, being committed to the Belgian market is no longer enough – you have to be in those other markets as well,” says Lloyd. “The goalposts have shifted, and will shift again should Euronext add another market. What if it extends to cover the Athens stock exchanges next? Where does that leave an indigenous Dutch custody provider?”

Rather than maintaining an expensive network of 24 agent banks scattered across the continent, global custodians would prefer to use just one or two regional players – or even just use a couple of gateways in the shape of ‘hybrid’ exchanges like Euronext to allow direct market access. “At this point in time as a member of certain exchanges and clearing houses you can already access markets remotely,” says Foley-Brickley. “The approach adopted by SIS SegaIntersSettle the Swiss_CSD is a good example – if you have a Swiss banking licence, you don’t have to do any processing there at all. That helps those banks – like Citibank – that have a local presence but which have centralised their processing, as we have done in Dublin.
“Entities like Euronext may allow global custodians to sidestep the agent banks and instead go direct and process remotely – that is a strong possibility, and as we move towards STP and greater levels of automation across the board, the easier it will become to cut out the guy who has to sort things out when it all goes wrong, simply because less will go wrong in the first place.”
And what of the national and international depositories? It has long been suggested that the CSDs would ultimately seek to move up the value chain to begin offering basic custody services such as safekeeping and settlement, corporate actions processing and tax reclaims, in the process supplanting the agent banks. That concept has gained credence as Euroclear and Clearstream have moved to set up rival pan-European clearing and settlement solutions through full-blown mergers with national depositories – Brussels-based Euroclear with France’s Sicovam, Belgium’s CIK and Necigef in the Netherlands, Luxembourg-based Clearstream with Germany’s Deutsche Börse Clearing. The fear among European banks is that the ICSDs will develop portfolio servicing capabilities and establish the dominant position in respect of equities processing that they already enjoy on the fixed income side.
Lloyd, while sceptical that the national CSDs pose much of a threat, concurs that the ICSDs have far more serious ambitions. “Euroclear, in particular, following the withdrawal of operator Morgan Guaranty in 2000 and its reconstitution as a fully-fledged banking entity in the shape of Euroclear Bank, has already effectively positioned itself as an agent bank. It sees equities custody as being where the growth is and is therefore looking to compete head-on with local players.”
Foley-Brickley says some broker-dealers may prefer to go direct to a depository, consolidating execution, settlement and clearing in one location “assuming they want to maintain their own back office and still deal with a large number of different depositories”. “But I just don’t see that as being attractive to an investor client base, which wants more than just a bare-bones service,” he adds.
But if things look bleak for the local banks, the situation is not hopeless. Matthynssens identifies a “vacuum” when it comes to providing value added services around onshore funds – which will become increasingly important as the reform of the European pensions landscape precipitates a massive upsurge in private and occupational pension assets – and believes local players are well placed to fill that gap. “The focus for the bigger players has mainly been on the offshore business, in Luxembourg and Dublin specifically, so the indigenous banks have an opportunity to position themselves as niche providers servicing local investors.”
Indeed, those smaller indigenous European players that remain do still possess valuable experience of their particular market and local relationships, regulations and operational idiosyncrasies. As Lloyd points out, their problem is that – while they are generally good at retaining existing clients – their failure to keep pace in terms of investment and innovation means local custodians will face challenges when it comes to winning new ones. Joint ventures with external players could therefore be the lifeline they are looking for.
“Those local providers that realise they are running out of steam could look to exploit their local knowledge and distribution clout through partnerships with other firms for whom the custody business is a core competency,” says Matthynssens. Foley-Brickley agrees: “Again, look at France, where we are unlikely to see the US players driving out local players as happened in the UK,” he says. “France, like many continental countries, is much more difficult market to break into, so what you may see as a result is far more joint ventures and pooling of skill sets.”
timjsteele@btinternet.com

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