Prepare, adapt, overcome
29 May 2019
Industry participants discuss the European asset servicing market’s current trends and challenges, as well as how to prepare and adapt for the future
Image: Shutterstock
What trends are you currently seeing in the European asset servicing market?
Daron Pearce: We are seeing clients consolidating their service providers. Previously, multinational organisations would often choose asset servicing providers on a country-by-country basis, now they are looking at regional and even global mandates. It’s a trend that’s been picking up speed in recent years. For example, a sovereign wealth fund client recently reduced its custodians from seven down to four. I’m happy to report that we were one of the four. The reasons are straightforward. Using fewer asset servicers helps to streamline clients’ internal processes and gives them more leverage on price and service levels. But as long as we can demonstrate the quality and value of the services we provide, we see this trend as more of an opportunity than a risk.
An interesting trend is the divergent strategies being taken by asset servicing providers. With its purchase of Charles River, State Street is looking to provide a single, front-to-back office asset servicing platform. At BNY Mellon, we are taking an open architecture approach, enabling integration with the best of the financial services and technology ecosystem. An example of this is our alliance with BlackRock Solutions to integrate BNY Mellon’s data insights, accounting, and servicing tools into Aladdin, BlackRock’s investment and operating platform for investment managers.
Ulf Noren: Providers of services are changing following several dimensions, many of them mandatory due to regulation. We are also seeing risk factors, investment appetite, IT development and integration play a part in directing the market.
Another trend is the increasing liabilities for custodians meaning tighter controls, re-negotiation of financial and contractual terms. Clients spend considerable resources on these kind of activities—in addition to expanding audit and compliance areas as well.
It normally means a somewhat more expensive environment, a slight reduction of flexibility in what can be offered, but if, in the end, it leads to better controls, sophisticated asset protection and loss reductions, it is all for a good cause
We are also seeing custodians develop the role as a gatherer, holder and refiner of information. In addition, this, to a great extent, is driven by the trend of investments going into real estate, private equity, infrastructure and tokenised investments.
What have European revenue sources shown over the past 12 months?
Noren: For the past five years, shifts from standard models being dependent on transaction levels and asset values to models of more granular nature have been evident. We notice, though, that a comparable large portion of revenue streams are emanating from those two components.
Regulatory and prudency needs have definitely had an effect on revenues increasing in activities supporting those activities and activities that can mitigate risk exposure. We see rapid growth in collateral management revenues as one example of such activities but also tighter rules surrounding clearing in a broad horizon is developing positively. We would also like to mention that we see initial growth in insourcing non-core business components from third parties and also to measure flows and provide independent analysis starts to take off somewhat.
We see a definitive trend of increasing the cost from European infrastructure driven partly by (TARGET2-Securities) T2S and partly by the Central Securities Depositories Regulation (CSDR). It is difficult to increase fees towards clients even though the downward pressure has slowed down slightly. This will be a catalyst for further change, it will trigger further consolidation and we also think that pass-on cost models to protect against infrastructures cost hikes will be very common. There are befits and risks with the trends in this field and balancing those is one of the most important missions a quality provider is facing these days.
Pearce: Revenue streams for the investments industry are closely correlated to market values and transactions. So while last year was fairly strong for the industry, the falls in both market values and transactions since December made Q1 of this year one of the toughest for some time. The markets are showing some signs of sustained improvement, but it slow and fragile.
What are the biggest regulatory challenges facing European asset servicing right now?
Pearce: The Shareholder Rights Directive II (SRD II) is affecting many financial services companies right now. SRD II comprises a set of regulations that increase transparency and strengthen the position of shareholders through disclosure requirements. Where asset services act as intermediaries, they are in the scope of the obligations regarding the transmission of information both from the issuer to the shareholder—to facilitate the exercise of shareholder rights—and to the issuer—when it requests to identify its end shareholders.
Although not strictly speaking a regulatory issue, the ending of the London Interbank Offered Rate (LIBOR) brings significant challenges across the industry. Because LIBOR is embedded in so much documentation and systems, it is a major project to identify and then replace with the secured overnight financing rate (SOFR).
Noren: CSDR and SRD II are the two most important. Together with these in importance comes local tax initiatives and changes. We believe SRD II will be a very important and difficult regulation for both investors, issuers and intermediaries.
One of many issues in SRD II is that high-level design is available but the detailed market requirements and guidelines for practical implementation are not even near to finished. The demand for providing information, and the possibility, to act to investors will be demanding. For all participants in the value chain. It is also important for investors to prepare to be ready for a more active corporate governance function. The most challenging part might be for issuers, issuer agents and central securities depositories (CSDs). All communication should be in ISO format and our estimate is that no more than a handful of issuers in our region is ready to do that—the Nordics are normally far ahead in transparency matters and IT so there is a reason to raise the flag with a question mark on European readiness. As a provider, we plan to support ISO20022 for disclosure requests and responses, some of the proxy voting and meeting messages but what will come in addition will be market triggered and are in unknown territory right now. We do not foresee a supply of ISO20022 messages for corporate actions due to SRD II.
We saw the implementation of MiFID II last year and there are others approaching. What can members of the European asset servicing sector learn from MiFID II that they can apply to help them prepare for future regulations?
Pearce: The second Markets in Financial Instruments Directive (MiFID II), with its broad impact across all areas of asset servicing, demonstrated the importance of setting up a collaborative, cohesive, cross-functional programme. It showed the value of a change management programme encompassing expertise from operations, middle-office and front-office working together.
Noren: The industry as a whole and regulators should strive for an even closer and better co-operation to define, analyse and breakdown components in each and every upcoming new or changed regulation. MiFID II was very comprehensive and covered a lot of areas but it was not all that clear what was expressed in the regulations various phases it actually meant in practice. That is something the aftermath of the adoption and especially reporting levels and content is coloured by.
Last year was a big year for DLT/blockchain technology. How do you expect the pace of innovation to change in the coming years?
Pearce: We see blockchain as a fundamental part of the securities service industry because the technologies can sort out many of the inefficiencies in the securities and funds business. Progress is definitely being made, but there are two major challenges slowing that progress. The first is adoption. A fundamental problem with many process improvements is you have to do them in parallel with old processes. So you double up on the processes while the pay-off is only once there is a 100 percent shift to the new process, which could be some years off. This makes the business case for blockchain change harder. The second is standardisation: we live in a world of different regulations, market practices and interpretations, which is not a good match for the black-and-white of blockchain. Our industry has some way to go on standardising processes before we can take full advantage of blockchain technologies. There are lots of experiments and proof of concepts for blockchain processes going on right now—we are involved in many of them—but we may be a year or more away from real momentum in the mainstream adoption of blockchain solutions.
Noren: During the next few years a number of the distributed ledger technology (DLT)/blockchain initiatives will go live but it will not be the enormous change that has been discussed. Blockchain will be used in selective areas and over time will continue to grow. It will not be likely that it will change the major infrastructures like CSDs and central counterparties (CCPs) in a major way. In the whole value chain, we will continue to see IT-driven development continue with high pace. This is driven by customer expectation on better efficiency, both in processing and in cost. We do believe that machine learning will continue to play growing roles in importance, that robotics will replicate human interactions in inefficient processes and become tactical solutions in other more specific areas while root causes for issues are being fixed. We also see that IT development driving and securing better end client experiences, no matter who in the chain is the final recipient benefitting from improved reporting. Those aspects can be achieved by the use of application programming interface’s (APIs) and communicated via chatbot solutions.
What should the European asset servicing sector be doing to survive and adapt for the future?
Noren: Continue to invest in technology to decrease the total cost of operation for all investors, by doing so, the margin pressure becomes less hurtful and the end processing more efficient. The sector should furthermore never lose touch with the fact that this industry indeed is a true people’s business and only through its people can an asset servicing provider ensure accountability in front of its demanding client, the quality of the people working the relationship will secure alignment between organisations so that responsibilities towards all stakeholders are properly handled and participants in the sector viewed as the champion spearheads securing next generations and the society’s wellbeing.
Pearce: Asset servicing providers will need to transition into aggregated data service providers. This involves investing extensively in technology infrastructure, leveraging new platforms, network capabilities and technologies. The future will require a more data-centric ‘open’ platform approach in which providers offer access to a range of optional services. Pricing models will be unbundled, allowing clients to select and subscribe to services. In effect, the custodian becomes a hub for service provision and data flows.
How well-placed is Europe in the asset servicing market, compared to its main competitors, America and Canada?
Pearce: The European and North American asset servicing markets are markedly different from each other. What asset servicing providers—and their clients—can benefit from is in bringing the experience of one to the other. Europe is inherently complex—with different languages, different regulations, different currencies and different tax systems. Asset servicers active in Europe have had to learn how to deal with this complexity and deliver a scalable, efficient service within a heterogeneous environment. In place of complexity, the North American market has the experience of scale and volume. Asset servicing providers in North America have built processes that can routinely deal with volumes rarely seen elsewhere in the world.
The differences in the two markets offer providers such as BNY Mellon, with our strong presence on both continents, with an advantage as we develop services for clients. We can bring our experience of complexity to the North American market for developing solutions for clients for the servicing of new and complex asset classes. And we can bring our experience of dealing with scale and volume to European clients looking to consolidate their providers and extend the size of mandates.
Noren: Very well placed and are competing successfully with American players.
Daron Pearce: We are seeing clients consolidating their service providers. Previously, multinational organisations would often choose asset servicing providers on a country-by-country basis, now they are looking at regional and even global mandates. It’s a trend that’s been picking up speed in recent years. For example, a sovereign wealth fund client recently reduced its custodians from seven down to four. I’m happy to report that we were one of the four. The reasons are straightforward. Using fewer asset servicers helps to streamline clients’ internal processes and gives them more leverage on price and service levels. But as long as we can demonstrate the quality and value of the services we provide, we see this trend as more of an opportunity than a risk.
An interesting trend is the divergent strategies being taken by asset servicing providers. With its purchase of Charles River, State Street is looking to provide a single, front-to-back office asset servicing platform. At BNY Mellon, we are taking an open architecture approach, enabling integration with the best of the financial services and technology ecosystem. An example of this is our alliance with BlackRock Solutions to integrate BNY Mellon’s data insights, accounting, and servicing tools into Aladdin, BlackRock’s investment and operating platform for investment managers.
Ulf Noren: Providers of services are changing following several dimensions, many of them mandatory due to regulation. We are also seeing risk factors, investment appetite, IT development and integration play a part in directing the market.
Another trend is the increasing liabilities for custodians meaning tighter controls, re-negotiation of financial and contractual terms. Clients spend considerable resources on these kind of activities—in addition to expanding audit and compliance areas as well.
It normally means a somewhat more expensive environment, a slight reduction of flexibility in what can be offered, but if, in the end, it leads to better controls, sophisticated asset protection and loss reductions, it is all for a good cause
We are also seeing custodians develop the role as a gatherer, holder and refiner of information. In addition, this, to a great extent, is driven by the trend of investments going into real estate, private equity, infrastructure and tokenised investments.
What have European revenue sources shown over the past 12 months?
Noren: For the past five years, shifts from standard models being dependent on transaction levels and asset values to models of more granular nature have been evident. We notice, though, that a comparable large portion of revenue streams are emanating from those two components.
Regulatory and prudency needs have definitely had an effect on revenues increasing in activities supporting those activities and activities that can mitigate risk exposure. We see rapid growth in collateral management revenues as one example of such activities but also tighter rules surrounding clearing in a broad horizon is developing positively. We would also like to mention that we see initial growth in insourcing non-core business components from third parties and also to measure flows and provide independent analysis starts to take off somewhat.
We see a definitive trend of increasing the cost from European infrastructure driven partly by (TARGET2-Securities) T2S and partly by the Central Securities Depositories Regulation (CSDR). It is difficult to increase fees towards clients even though the downward pressure has slowed down slightly. This will be a catalyst for further change, it will trigger further consolidation and we also think that pass-on cost models to protect against infrastructures cost hikes will be very common. There are befits and risks with the trends in this field and balancing those is one of the most important missions a quality provider is facing these days.
Pearce: Revenue streams for the investments industry are closely correlated to market values and transactions. So while last year was fairly strong for the industry, the falls in both market values and transactions since December made Q1 of this year one of the toughest for some time. The markets are showing some signs of sustained improvement, but it slow and fragile.
What are the biggest regulatory challenges facing European asset servicing right now?
Pearce: The Shareholder Rights Directive II (SRD II) is affecting many financial services companies right now. SRD II comprises a set of regulations that increase transparency and strengthen the position of shareholders through disclosure requirements. Where asset services act as intermediaries, they are in the scope of the obligations regarding the transmission of information both from the issuer to the shareholder—to facilitate the exercise of shareholder rights—and to the issuer—when it requests to identify its end shareholders.
Although not strictly speaking a regulatory issue, the ending of the London Interbank Offered Rate (LIBOR) brings significant challenges across the industry. Because LIBOR is embedded in so much documentation and systems, it is a major project to identify and then replace with the secured overnight financing rate (SOFR).
Noren: CSDR and SRD II are the two most important. Together with these in importance comes local tax initiatives and changes. We believe SRD II will be a very important and difficult regulation for both investors, issuers and intermediaries.
One of many issues in SRD II is that high-level design is available but the detailed market requirements and guidelines for practical implementation are not even near to finished. The demand for providing information, and the possibility, to act to investors will be demanding. For all participants in the value chain. It is also important for investors to prepare to be ready for a more active corporate governance function. The most challenging part might be for issuers, issuer agents and central securities depositories (CSDs). All communication should be in ISO format and our estimate is that no more than a handful of issuers in our region is ready to do that—the Nordics are normally far ahead in transparency matters and IT so there is a reason to raise the flag with a question mark on European readiness. As a provider, we plan to support ISO20022 for disclosure requests and responses, some of the proxy voting and meeting messages but what will come in addition will be market triggered and are in unknown territory right now. We do not foresee a supply of ISO20022 messages for corporate actions due to SRD II.
We saw the implementation of MiFID II last year and there are others approaching. What can members of the European asset servicing sector learn from MiFID II that they can apply to help them prepare for future regulations?
Pearce: The second Markets in Financial Instruments Directive (MiFID II), with its broad impact across all areas of asset servicing, demonstrated the importance of setting up a collaborative, cohesive, cross-functional programme. It showed the value of a change management programme encompassing expertise from operations, middle-office and front-office working together.
Noren: The industry as a whole and regulators should strive for an even closer and better co-operation to define, analyse and breakdown components in each and every upcoming new or changed regulation. MiFID II was very comprehensive and covered a lot of areas but it was not all that clear what was expressed in the regulations various phases it actually meant in practice. That is something the aftermath of the adoption and especially reporting levels and content is coloured by.
Last year was a big year for DLT/blockchain technology. How do you expect the pace of innovation to change in the coming years?
Pearce: We see blockchain as a fundamental part of the securities service industry because the technologies can sort out many of the inefficiencies in the securities and funds business. Progress is definitely being made, but there are two major challenges slowing that progress. The first is adoption. A fundamental problem with many process improvements is you have to do them in parallel with old processes. So you double up on the processes while the pay-off is only once there is a 100 percent shift to the new process, which could be some years off. This makes the business case for blockchain change harder. The second is standardisation: we live in a world of different regulations, market practices and interpretations, which is not a good match for the black-and-white of blockchain. Our industry has some way to go on standardising processes before we can take full advantage of blockchain technologies. There are lots of experiments and proof of concepts for blockchain processes going on right now—we are involved in many of them—but we may be a year or more away from real momentum in the mainstream adoption of blockchain solutions.
Noren: During the next few years a number of the distributed ledger technology (DLT)/blockchain initiatives will go live but it will not be the enormous change that has been discussed. Blockchain will be used in selective areas and over time will continue to grow. It will not be likely that it will change the major infrastructures like CSDs and central counterparties (CCPs) in a major way. In the whole value chain, we will continue to see IT-driven development continue with high pace. This is driven by customer expectation on better efficiency, both in processing and in cost. We do believe that machine learning will continue to play growing roles in importance, that robotics will replicate human interactions in inefficient processes and become tactical solutions in other more specific areas while root causes for issues are being fixed. We also see that IT development driving and securing better end client experiences, no matter who in the chain is the final recipient benefitting from improved reporting. Those aspects can be achieved by the use of application programming interface’s (APIs) and communicated via chatbot solutions.
What should the European asset servicing sector be doing to survive and adapt for the future?
Noren: Continue to invest in technology to decrease the total cost of operation for all investors, by doing so, the margin pressure becomes less hurtful and the end processing more efficient. The sector should furthermore never lose touch with the fact that this industry indeed is a true people’s business and only through its people can an asset servicing provider ensure accountability in front of its demanding client, the quality of the people working the relationship will secure alignment between organisations so that responsibilities towards all stakeholders are properly handled and participants in the sector viewed as the champion spearheads securing next generations and the society’s wellbeing.
Pearce: Asset servicing providers will need to transition into aggregated data service providers. This involves investing extensively in technology infrastructure, leveraging new platforms, network capabilities and technologies. The future will require a more data-centric ‘open’ platform approach in which providers offer access to a range of optional services. Pricing models will be unbundled, allowing clients to select and subscribe to services. In effect, the custodian becomes a hub for service provision and data flows.
How well-placed is Europe in the asset servicing market, compared to its main competitors, America and Canada?
Pearce: The European and North American asset servicing markets are markedly different from each other. What asset servicing providers—and their clients—can benefit from is in bringing the experience of one to the other. Europe is inherently complex—with different languages, different regulations, different currencies and different tax systems. Asset servicers active in Europe have had to learn how to deal with this complexity and deliver a scalable, efficient service within a heterogeneous environment. In place of complexity, the North American market has the experience of scale and volume. Asset servicing providers in North America have built processes that can routinely deal with volumes rarely seen elsewhere in the world.
The differences in the two markets offer providers such as BNY Mellon, with our strong presence on both continents, with an advantage as we develop services for clients. We can bring our experience of complexity to the North American market for developing solutions for clients for the servicing of new and complex asset classes. And we can bring our experience of dealing with scale and volume to European clients looking to consolidate their providers and extend the size of mandates.
Noren: Very well placed and are competing successfully with American players.
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