Where do you see custodian fees at, post-AIFMD?
It’s clear that fees will move from a bundled to an unbundled approach. My biggest fear is that, as an industry, we have done ourselves a disservice over the years in our pricing methodology. I think that we were too reliant upon net interest income (NII), securities lending, and cash management to subsidise the custody product. The model was probably wrong from the get-go, and we are now in a position of having to revamp it. The question is whether the industry has the will to do it.
The industry has been on a downwards spiral for the previous 12 years, and activities such as NII have almost completely vapourised. In the recent past, global custodians and custodian banks received the bigger chunk of securities lending profit, and now it’s completely the opposite. The ratio used to be 80:20, and now it’s around 20:80 or worse—and there are fewer institutions participating in it now after the crisis because of risk considerations.
Further, we saw that after the Financial Transaction Tax (FTT) was introduced into the French market, volumes went down appreciably. Now that you have 11 countries looking to impose an FTT on 1 January next year, there are significant concerns about volumes. Given the balance of our books, it affects us less than other competitors. Those who are more heavily reliant upon broker-dealers for their book of business may suffer. Investors may turn to synthetics to avoid the FTT, but this will have balance sheet implications.
What were some pertinent topics for you at this year’s NeMa conference?
Two things struck me in the panels at the NeMa conference in Poland. The first was the network managers relationships, and the other was the regulatory environment.
There was much discussion about the Alternative Investment Fund Managers Directive (AIFMD), both in terms of what it means, and who is going to bear the cost. It is interesting to see who ought to pay the cost and who will end up paying, and these may be two different conversations.
I was having a conversation with a client about fees in general and the direction in which they’re going. It seems as though costs are going up, and the regulatory costs are a hugely significant part of this.
In Tim Faselt’s opening comments, he said that in the US alone, there have been 106 new regulations put into place over the last 12 months, which has increased costs of the industry to $46 billion. Who’s going to pay that, and who should pay that? It’s almost fashionable for politicians and regulators to appear tough on banks, which in turn are viewed to have deep pockets, and to have gotten fat off of taxpayers through the events of 2008 to 2011.
The audience heard another statistic, which stated that the US SEC has been one of the most profitable enterprises going, due to the significant fines levied for any number of violations.
How has the environment changed since you first came into the business?
In the early days, regulations were coming out faster than we could process them. Some, such as the US Dodd-Frank Act, are 1800 pages long. It’s one thing to just make it through to the end, let alone understand what’s actually going on.
The fear from a legal and compliance perspective is one of, do we know what we need to know? To counter that, banks have hired small armies of people to do that analysis and tell us what regulations mean for the industry. The analysis part has already been a huge cost, and now it’s the implementation cost we have to contend with. AIFMD kicks in right now, and UCITS V is not that far behind it. The sheer cost of these will likely push some players out of the market.
Currently, Deutsche Bank has many different workstreams going on internally to ‘future proof’ our business. One of the things we will do is create a TARGET2-Securities (T2S) hub in Frankfurt and we’re spending a lot of money on its creation.
Because the T2S environment will mean that settlements will be largely harmonised, it doesn’t makes sense to have 26 bespoke models. There is a significant cost in creating a hub, but it is a lot less expensive to keep up one solution rather than 26, going forward. We’re investing in that because we believe in the future of the industry.
Obviously, looking at the statistics on the instant polls at the NeMa conference this year, not everyone has such a rosy outlook, and I think those that don’t are probably small or single market providers struggling to compete with the bigger players.
When will the hub be ready?
Our Frankfurt hub will be available by mid-2015, so ahead of the first wave of T2S being implemented. It will give clients a single entry point for settlements, but it will also give them a single law under which a contract is governed, a single operational methodology. This saves them money as well, because they can streamline their internal operations. There are benefits at both ends. We hope to pass back that benefit to them through lower fees, but at the same time we’ve got all of these administrative expenses. With Basel III, the cost of capital is increasing, and collateral is becoming scarcer. I have never seen the industry with so many events coming together at the same time. So many solutions have to be developed, which is why we’ve got, conservatively, about 50 people working on our T2S strategy.
As for whether regulatory activities take away from our core business—I don’t think that is an issue. Deutsche Bank has project management, IT and systems staff; their book of work changes every year, and right now they’ve just got a big book of work that specifically pertains to T2S.
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