Depositaries facing new challenges

The face of the custody business has changed as much as any other area of the financial services over the last 10 years and will continue to evolve rapidly.

The European securities industry is, more than ever, facing a major transformation of its landscape as a result of the market needs for more transparency, control and cost diminution of front and back office services. These changes are currently taking place in the European securities industry, driven by the market itself, countries initiatives and a new regulatory framework.

It is clear that custodians have to gear up for significant changes ahead, dealing both with increased market competitions and legal requirements issued from the recent and forthcoming directives / legislations: UCITS IV, AIFM, Depositary function, FATCA,…

The business model is also under pressure with the decrease of key revenues issued from safekeeping and/or securities lending services, the new segregation of business duties.

These current challenges should also be put in the perspective of more competition with the local Central Security Depositary (CSD) and the arrival of the Target 2 Securities (T2S) Settlement platform.

Custodians face challenges that require service innovation and investments as well as clear definition of their roles and responsibilities. These issues include request for more transparency, more due diligence, more handling of complex instruments, greater follow up of corporate events and at the end of the day tight management of their profitability.

In this context, custody providers face critical business decisions regarding business strategy and investment.

Custodians and their clients are grappling with the fact that business models and platforms that have served them well for a decade or more will be insufficient to either maintain or enhance their market positions in the coming years.

Continued success requires the ability to cost-effectively meet the needs of traditional clients as well as the alternatives/prime services and other marketplace demands. Addressing the unique needs and risks of servicing the alternative asset managers and prime services industry has driven much of the need for planned improvements in reporting, products and organisation services and standardisation of processes.

As a result of the rapid cost reduction, sparked by the financial crisis, providers had to optimise the cost effectiveness of existing platforms and infrastructure to maintain margins and/or support key planned investments.

Despite difficult market conditions, custodians must continue to upgrade current platforms to keep their competitive position.

>Both traditional firms and alternative asset managers will continue to source what they perceive as peripheral functions to focus on core competencies. Through increased outsourcing and offshoring, custodians will have the opportunity to pick up fund accounting, corporate actions, tax processing and other back- and middle-office functions, adding large predictable revenue streams to their existing base. As the custodians have often similar processing, reporting capabilities and pricing models, those who craft creative solutions with their clients while excelling at the on-boarding of new clients/services with minimal “pain” and providing the best ongoing service levels will turn out to be the key differentiator.

In order to be ready for these future opportunities, custodians need to have a comprehensive analysis of their current stage and a vision of their future target business model including a good understanding of their capital requirements, roles and responsibilities.

It is also necessary for custodians to come up with precise ideas of their most likely cost structure and how they can make a difference. All the value chain needs to be analysed carefully to know how it will be affected. We recommend using an innovative approach to determine the appropriate business and operating model. Moving to a new business model involves the definition of the following key pillars:

• Blueprinting (target model) for success,
• Pricing that matches business reality. Moving away from transaction pricing to a more performance-based pricing,
• Positioning as a centre of excellence,
• Acquiring, developing and retaining the right talents in the right places,
• Relying on well established governance, good risk management and compliance,
• Setting up comprehensive policies and standards,
• Defining an IT architecture strategy,
• Managing clients, business reporting, analytics and KPIs as clients are increasingly willing to understand how their processing, accounting and services are being delivered.

The bottom line is that custodians need to rapidly review their business models, market focus and client segmentation strategies in light of a changing marketplace.

In a number of organisations, efforts will continue to enhance the integration of infrastructures. What’s more, new platform architectures and migration roadmaps continue to be executed in critical areas (e.g. reporting, portfolio accounting, transfer agency) seeking to move over time to more efficient and effective platforms.

Tomorrow’s market leaders and all those who will increase their market share are the custodians being able to demonstrate their capacity to invest in new service creativity and product differentiation while mastering the costs related to the required maintenance and production.

This includes maintaining a proper level of flexibility but also executing a new game plan that accelerates cost reduction efforts (economy of scale) while preserving critical investment funds needed to create/maintain the world class platforms necessary to be successful in this space.

Today, Luxembourg custodians who will proactively anticipate those challenges will be able to transform them into new business opportunities and leverage on the new integrated market environment and regulatory framework.