Custody in a digital world
03 Apr 2024
Demand for reliable data to support a front-to-back digital operating model are being superimposed onto longstanding requirements for efficient safekeeping, analytics and trade lifecycle management
Image: siarhei/stock.adobe.com
Effective custody arrangements, which can adapt quickly to changing circumstances and client needs, are key to the smooth running of institutional investors’ business. There has been no shortage of change for institutional investors and their custodians over the last few years — all against a backdrop of geopolitical uncertainty, a global pandemic and a volatile macroeconomic environment.
As US Bank noted recently: “The pace of change impacting the custody industry is unprecedented, and improvements that used to take months or years can now be accomplished in days or weeks.”
Client expectations of their custodian partners are transitioning too. The rapid advance of technology is one of the main contributing factors, with investors wishing to take advantage of its transformational qualities, including greater speed and efficiency, as well as enhanced data generation abilities.
The extensive changes experienced by custodians and their clients are reflected in Deloitte’s 2023 Asset Servicers Survey. This reports that 74 per cent of respondents identify a client requirement for more detailed analytics and data among their top-three priorities. Deloitte points out that this shows a considerable shift in approach from 2021, when only 40 per cent of asset servicers prioritised the delivery of a seamless customised experience and access to real-time portfolio data.
The report also revealed that 80 per cent of respondents are investing in building integrated technology platforms to maximise cloud capabilities and provide data insights for their clients. In addition, regulation remains high on the agenda: 60 per cent of contributors said that adaptation to regulatory requirements is one of their main priorities.
Reflecting on how institutional investors’ custody needs have been changing, Amit Agarwal, head of custody, securities services at Citi, comments: “Reliable data is a key enabler of a front-to-back digital operating model and we are seeing requirements for real-time data grow, along with increased data-centric regulatory requirements.”
He adds: “Leveraging cloud capabilities and modern data infrastructure is essential to deliver a modern scalable platform for growth.”
Adam Watson, global head of commercial product for custody at BNY Mellon, also points to investors’ increased need for data. He explains: “We sit on a wealth of data. Our clients most want collaboration and partnership to contextualise, analyse and ultimately deliver actionable data insights to help them deliver on their strategic outcomes. The biggest demand is for richer and more meaningful data.”
AI, digitisation and regulation
As in other business sectors, artificial intelligence (AI) is becoming integral to custodian operations. Agarwal says: “The potential of AI to change the way that market participants and investors operate and interact is accelerating. Usage is increasing, with examples of early use cases including document processing and support for client onboarding, deal management and regulatory change. These also include automated query responses, smarter, automated reconciliation processes, predictive analytics and steps to reduce risk and improve efficiency.”
Other innovation is also playing a key part in meeting the changing custody needs of institutional investors. As Agarwal explains: “Digital assets and tokenisation are becoming increasingly prominent for institutional investors, whether that is new types of assets on blockchains or the implementation of distributed ledger technology (DLT) by regulated financial-market infrastructures, to enable the issuance, trading and custody of digital securities.
“Custodians are building solutions to integrate with these networks and providing access alongside more traditional market infrastructure, with associated technological and operating model changes.
“Potential benefits include greater transparency, smart-contract process-driven automation, and potential for settlement compression extending to instant and atomic settlement. These also include steps to reduce risk and the ability to explore novel use cases.
“Custody can also be an enabler for tokenisation of existing assets, immobilising traditional securities and creating digital representations of these on blockchains. This has the potential to be a significant catalyst for the adoption and scaling of digitisation of capital markets.”
Chris Rowland, executive vice president and head of custody, cash and depositary bank services at State Street, takes a similar view about the influence of new technology: “There continues to be a focus on front-to-back operating models, digitisation and efficiency from the institutional-investor community. This has been driven by a rapidly evolving technology landscape that is pushing the need for data insights to the fore.
“As a custodian, we are part of this journey, as we digitise processes from account opening to settlement in the market.
“Against this backdrop, the need for real-time processing is continually increasing, as markets shorten settlement cycles and interest in tokenised assets grows.”
John Kirkpatrick, vice president of securities services at Broadridge, also highlights the changes introduced by digital assets: “Investors are looking to leverage the growing opportunity to invest in digital assets. Investors need their custodians to prepare and be ready for providing safekeeping and asset-servicing solutions for these assets.
“As the digital-assets markets continue to grow, the need for custodians to provide secure safekeeping for institutional clients becomes increasingly important. The challenges to this are maintaining the benefits derived from holding assets digitally, without compromise to regulatory risk and pristine controls.”
While technology may be taking centre stage, the impact of ongoing regulatory and other challenges must be taken into account to meet investors’ changing custody needs. Stéphanie Gaudoux, head of coverage, continental Europe at Société Générale Securities Services, observes: “The trickiest issue right now for institutional investors is to navigate their way through both regulatory and interest-rate pressure at a fast pace, while mitigating the risk on their investment.
“Market uncertainties like geopolitical tensions and economic fluctuations make generating return an even harder task. Regulatory requirements such as MIFID II, PRIIPs, AIFMD, GDPR and CSDR, as well as T+1 remain a burden, in addition to truly embracing digital transformation and now also complying with the Digital Operational Resilience Act (DORA).”
While T+1 starts to shorten settlement cycles in North America’s securities market from T+2 — on 27 May in Canada and Mexico and 28 May in the US — DORA is also drawing nearer. Its rules for the management of cyber risks take effect from January 2025, aiming to further strengthen IT security at investment companies and other financial businesses. The goal is to make sure that the sector, in Europe, could effectively cope with incidents that might cause severe disruption: “When we talk about cyber risks, the mindset has moved from whether it will happen one day to when will it happen,” says Gaudoux. “Institutional investors are expecting their custody-service providers to be ready to cope with this possibility.”
The biggest change of 2024
J.P. Morgan’s recent custody industry and regulatory developments report says: “The move to T+1 settlement has been, and will remain, a key focus as it is fast becoming an important global trend.”
Considering what is likely to be the biggest change to institutional investors’ custody needs this year, Rowland also highlights T+1: “In 2024, the biggest changes impacting all institutional investors that have a bearing on custody services will be the shortening of settlement cycles and the support models required globally to support this.”
He adds that this will have considerable impact on investors’ custody needs: “The challenges created by T+1 in the US market range from changing operating models to dislocation of operating models, including the potential need to have cash available to support settlement on T+1.”
Stephane Ritz, partner at Capco, comments: “With the adoption of T+1, institutional investors are facing the need for accelerated services and an increase of straight-through processing (STP) footprint to streamline key functional areas, such as transaction processing, cash and currency processing, reporting, record keeping, position and liquidity management and asset servicing.”
Agarwal adds: “Removing one day from the settlement cycle creates timing challenges for allocations, affirmations and securities lending due to the reduced number of hours for cut-offs. Clients need to understand their current technology capabilities and how they will need to change their processes to accommodate the earlier cut-off times.”
John Oleon, managing director of clearing and settlement operations at Clear Street, also reflects on the breadth of its impact: “The shift to T+1 settlement will reverberate across various financial products, affecting equities, ETFs, prime brokerage and more.
“The primary financial burden resulting from the transition is expected to fall on broker-dealers, clearing firms and prime brokers. However, industry research shows that many buy-side firms are unaware of the breadth of internal implications of T+1 on their businesses, let alone the impact on their clients. If they are not already doing so, institutional investors should work closely with their buy-side counterparties to ensure that they are making the necessary preparations for T+1.”
Despite the scale of the changes, it is crucial that investors will be able to trust that custody operations will continue to flow smoothly. “Custodians will need to provide stability through this period,” concludes Rowland.
As US Bank noted recently: “The pace of change impacting the custody industry is unprecedented, and improvements that used to take months or years can now be accomplished in days or weeks.”
Client expectations of their custodian partners are transitioning too. The rapid advance of technology is one of the main contributing factors, with investors wishing to take advantage of its transformational qualities, including greater speed and efficiency, as well as enhanced data generation abilities.
The extensive changes experienced by custodians and their clients are reflected in Deloitte’s 2023 Asset Servicers Survey. This reports that 74 per cent of respondents identify a client requirement for more detailed analytics and data among their top-three priorities. Deloitte points out that this shows a considerable shift in approach from 2021, when only 40 per cent of asset servicers prioritised the delivery of a seamless customised experience and access to real-time portfolio data.
The report also revealed that 80 per cent of respondents are investing in building integrated technology platforms to maximise cloud capabilities and provide data insights for their clients. In addition, regulation remains high on the agenda: 60 per cent of contributors said that adaptation to regulatory requirements is one of their main priorities.
Reflecting on how institutional investors’ custody needs have been changing, Amit Agarwal, head of custody, securities services at Citi, comments: “Reliable data is a key enabler of a front-to-back digital operating model and we are seeing requirements for real-time data grow, along with increased data-centric regulatory requirements.”
He adds: “Leveraging cloud capabilities and modern data infrastructure is essential to deliver a modern scalable platform for growth.”
Adam Watson, global head of commercial product for custody at BNY Mellon, also points to investors’ increased need for data. He explains: “We sit on a wealth of data. Our clients most want collaboration and partnership to contextualise, analyse and ultimately deliver actionable data insights to help them deliver on their strategic outcomes. The biggest demand is for richer and more meaningful data.”
AI, digitisation and regulation
As in other business sectors, artificial intelligence (AI) is becoming integral to custodian operations. Agarwal says: “The potential of AI to change the way that market participants and investors operate and interact is accelerating. Usage is increasing, with examples of early use cases including document processing and support for client onboarding, deal management and regulatory change. These also include automated query responses, smarter, automated reconciliation processes, predictive analytics and steps to reduce risk and improve efficiency.”
Other innovation is also playing a key part in meeting the changing custody needs of institutional investors. As Agarwal explains: “Digital assets and tokenisation are becoming increasingly prominent for institutional investors, whether that is new types of assets on blockchains or the implementation of distributed ledger technology (DLT) by regulated financial-market infrastructures, to enable the issuance, trading and custody of digital securities.
“Custodians are building solutions to integrate with these networks and providing access alongside more traditional market infrastructure, with associated technological and operating model changes.
“Potential benefits include greater transparency, smart-contract process-driven automation, and potential for settlement compression extending to instant and atomic settlement. These also include steps to reduce risk and the ability to explore novel use cases.
“Custody can also be an enabler for tokenisation of existing assets, immobilising traditional securities and creating digital representations of these on blockchains. This has the potential to be a significant catalyst for the adoption and scaling of digitisation of capital markets.”
Chris Rowland, executive vice president and head of custody, cash and depositary bank services at State Street, takes a similar view about the influence of new technology: “There continues to be a focus on front-to-back operating models, digitisation and efficiency from the institutional-investor community. This has been driven by a rapidly evolving technology landscape that is pushing the need for data insights to the fore.
“As a custodian, we are part of this journey, as we digitise processes from account opening to settlement in the market.
“Against this backdrop, the need for real-time processing is continually increasing, as markets shorten settlement cycles and interest in tokenised assets grows.”
John Kirkpatrick, vice president of securities services at Broadridge, also highlights the changes introduced by digital assets: “Investors are looking to leverage the growing opportunity to invest in digital assets. Investors need their custodians to prepare and be ready for providing safekeeping and asset-servicing solutions for these assets.
“As the digital-assets markets continue to grow, the need for custodians to provide secure safekeeping for institutional clients becomes increasingly important. The challenges to this are maintaining the benefits derived from holding assets digitally, without compromise to regulatory risk and pristine controls.”
While technology may be taking centre stage, the impact of ongoing regulatory and other challenges must be taken into account to meet investors’ changing custody needs. Stéphanie Gaudoux, head of coverage, continental Europe at Société Générale Securities Services, observes: “The trickiest issue right now for institutional investors is to navigate their way through both regulatory and interest-rate pressure at a fast pace, while mitigating the risk on their investment.
“Market uncertainties like geopolitical tensions and economic fluctuations make generating return an even harder task. Regulatory requirements such as MIFID II, PRIIPs, AIFMD, GDPR and CSDR, as well as T+1 remain a burden, in addition to truly embracing digital transformation and now also complying with the Digital Operational Resilience Act (DORA).”
While T+1 starts to shorten settlement cycles in North America’s securities market from T+2 — on 27 May in Canada and Mexico and 28 May in the US — DORA is also drawing nearer. Its rules for the management of cyber risks take effect from January 2025, aiming to further strengthen IT security at investment companies and other financial businesses. The goal is to make sure that the sector, in Europe, could effectively cope with incidents that might cause severe disruption: “When we talk about cyber risks, the mindset has moved from whether it will happen one day to when will it happen,” says Gaudoux. “Institutional investors are expecting their custody-service providers to be ready to cope with this possibility.”
The biggest change of 2024
J.P. Morgan’s recent custody industry and regulatory developments report says: “The move to T+1 settlement has been, and will remain, a key focus as it is fast becoming an important global trend.”
Considering what is likely to be the biggest change to institutional investors’ custody needs this year, Rowland also highlights T+1: “In 2024, the biggest changes impacting all institutional investors that have a bearing on custody services will be the shortening of settlement cycles and the support models required globally to support this.”
He adds that this will have considerable impact on investors’ custody needs: “The challenges created by T+1 in the US market range from changing operating models to dislocation of operating models, including the potential need to have cash available to support settlement on T+1.”
Stephane Ritz, partner at Capco, comments: “With the adoption of T+1, institutional investors are facing the need for accelerated services and an increase of straight-through processing (STP) footprint to streamline key functional areas, such as transaction processing, cash and currency processing, reporting, record keeping, position and liquidity management and asset servicing.”
Agarwal adds: “Removing one day from the settlement cycle creates timing challenges for allocations, affirmations and securities lending due to the reduced number of hours for cut-offs. Clients need to understand their current technology capabilities and how they will need to change their processes to accommodate the earlier cut-off times.”
John Oleon, managing director of clearing and settlement operations at Clear Street, also reflects on the breadth of its impact: “The shift to T+1 settlement will reverberate across various financial products, affecting equities, ETFs, prime brokerage and more.
“The primary financial burden resulting from the transition is expected to fall on broker-dealers, clearing firms and prime brokers. However, industry research shows that many buy-side firms are unaware of the breadth of internal implications of T+1 on their businesses, let alone the impact on their clients. If they are not already doing so, institutional investors should work closely with their buy-side counterparties to ensure that they are making the necessary preparations for T+1.”
Despite the scale of the changes, it is crucial that investors will be able to trust that custody operations will continue to flow smoothly. “Custodians will need to provide stability through this period,” concludes Rowland.
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