While securities services have traditionally been viewed as unexciting, back-office, post-trade administrative activities, emerging technologies are giving providers an opportunity to move up the value chain. Joy Macknight reports.

Demi Derem

Demi Derem

Securities services, which includes custody and asset servicing, collateral management and fund administration, is a stable business. Since 2010 it has averaged 3% revenue growth year on year, according to McKinsey.

This is impressive given the regulatory onslaught the industry has faced since the global financial crisis. The Markets in Financial Instruments Directive II, European Market Infrastructure Regulation, Central Securities Depositories Regulation, Securities Financing Transaction Regulation and Shareholder Rights Directive II (SRD II) – to name just a few – have a common aim of increasing transparency, accountability and safety in the financial markets.

An era of innovation

Yet these regulations have resulted in increased costs, depressed margins and greater reporting requirements for both securities services providers and their clients, such as asset managers, pension funds and corporates. In response, providers have made incremental improvements, continually working at reducing their cost base and winning new accounts through organic growth and mergers and acquisitions.

But now that the regulatory pressure has begun to ease, a new period of innovation has opened up in the industry, according to Jason Nabi, global head of innovation at HSBC Securities Services. “This pivotal moment has been sparked not only by new technology but by new entrants and new ideas,” he says.

A recent McKinsey report, titled ‘A calm surface belies transformation in securities services’, predicts: “Over the next five years, the global securities services industry will face more change than it has over the preceding 10 or even 20 years, as it adapts to dramatic shifts in the structure of markets and incorporates new technologies, such as automation and robotics, advanced analytics and distributed ledger technologies [DLTs] at scale.”

According to the report, DLTs have the potential to disrupt several points in the securities services value chain. “In theory, DLTs can turn control over transactions directly to the institutions and asset managers involved, increasing the speed and reducing the cost of transactions and – with real-time transaction reporting – eliminating the need for numerous services that today are offered by custodians, central securities depositories [CSDs], international CSDs and other post-trade firms,” it says.

However, the report acknowledges that the full-scale disruption described is not likely to occur in the near term. “There are many participants in the established ecosystem and to move them all to a new technology will take time,” says Matthias Voelkel, a partner at McKinsey and co-author of the report.

“The biggest challenge of blockchain is that not everyone can move at the same time, so the technology will have to co-exist with existing technology, which creates complexity in the short term,” adds Demi Derem, general manager of investor communication solutions, international business, at financial solution company Broadridge. Valerio Roncone, head product management and development, SIX Securities & Exchanges, adds: “[Co-existence] will give the community latitude to adopt blockchain solutions over time, instead of a big bang implementation.”

DLT experiments

Full-scale disruption also brings with it the threat of disintermediation. To address this fear, Broadridge included all stakeholders in the investment communications value chain in its blockchain pilots. “We have worked with custodians, infrastructure providers, institutional investors and corporate issuers to see how they could co-exist, while reducing risk and cost from all of our processes. [We are creating a] world where everyone is a beneficiary of blockchain, rather than a casualty,” says Mr Derem. In March, Broadridge and Santander completed a blockchain-based investor proxy voting pilot, in collaboration with JPMorgan and Northern Trust as custodian banks.

Many securities services providers are experimenting with DLT to experience the potential benefits first-hand. Standard Bank, for example, is piloting a corporate action solution on blockchain in Nigeria, working with the local market infrastructure. “There are multiple uses of the data in a corporate action lifecycle and we can put that in a blockchain environment where people can use pieces of the information in their processes as and when they need to,” says Charl Bruyns, head of investor services for Standard Bank Group.

Mr Derem believes that more opportunities will open up as new processes are introduced that can be put on DLT, for example SRD II’s shareholder identity requirements. “While it may be time consuming to get the market to move to DLT for a legacy process, new processes will continue to emerge that could be built on DLT,” he says. “New requirements driving new solutions is where I see DLT having the potential to hit the ground running.”

However, Matthew Davey, managing director and head of business solutions at Société Générale Securities Services (SGSS), believes that the industry is a little jaded by the blockchain hype and a lack of tangible production deliverables. “Many feel we have been led a bit too much by the new technology and not by the business requirements,” he says. “We need to look at the business requirements, focus on what we are trying to achieve and then decide what is the most appropriate technology.”

Automation and AI

In contrast to the buzz around blockchain, Mr Davey points out how artificial intelligence (AI) and robotics are quietly being introduced and already delivering value. “It is often the case that AI can be applied to an existing business model and used to develop new products,” he says.

On the operational efficiency side, he reports a big drive in robot process automation. Likewise, Mr Bruyns reports the use of AI and robotics in the African context is creating greater efficiency and automation for clients. “AI is being used to remove some of the manual processes that still exist and circumvent some inefficiencies in the market,” he says.

In its report, McKinsey estimates that automation and robotics could reduce the industry’s costs by more than $20bn, if applied at scale by securities services firms. “That has potential to get the industry on the next bend of the cost S-curve,” says Mr Voelkel.

In addition, the technology can be deployed at the customer interface. “Banks can leverage AI and data analytics to support the asset manager community, for example, more broadly than they did traditionally,” he says.

Becoming a data and analytics powerhouse is a new value proposition for securities services providers, according to the McKinsey report. “These firms will generate significant revenue streams from their insights on markets, investor behaviour, risk analytics and regulation. This value proposition requires the willingness to make data an absolute strategic priority, and to invest accordingly,” it says.

However, this should not be confused with applying advanced analytics to the “data exhaust” and producing new standalone data products, according to Mr Voelkel. “Creating new data products and unique intellectual property, which can be monetised to the broader capital markets, has a very high bar – so it lends itself to players with truly large data pools and cutting-edge advanced analytics capabilities,” he says. “But applying AI and advanced analytics to relationships and enhancing them with new services – that is something every player should do.”

Outsourcing opportunities

Many securities services providers report an increased interest in outsourcing, as clients are also facing regulatory reporting requirements, risk management and margin compression. But whereas previously clients looked to outsource classic middle- to back-office activities, today the trend is towards broader outsourcing, according to Mr Voelkel. “Clients of securities services are evaluating their core competencies and outsourcing activities that are not seen as strategic differentiators to a stable and reliable provider,” he says.

Mr Bruyns agrees. “Clients are looking for sizeable organisations that can invest in the capability and technology because the risk – including reputation – in that environment for getting it wrong is large,” he says.

This presents an opportunity for security services providers to broaden their spectrum of offerings along the value chain. “These new services are also what clients are willing to pay for,” adds Mr Voelkel. He uses the example of a provider who started offering regulatory services because its clients were asking for them and the provider could do it at scale – “and at a pretty good price point because that area is not yet commoditised”.

This tallies with the results of SGSS’s Global Investment Management Survey 2017/18, which interviewed 100 senior executives across European buy-side industry category. Sixty-four per cent of respondents consider the outsourcing of services to be a key element of their operational strategy, setting middle-office or regulatory reporting at the top of their list.

In April, SGSS launched CrossWise, a solution that provides front-, middle- and back-office services to asset managers. “Whereas 10 years ago it was the big players that were outsourcing their operations, today we see smaller firms looking to take a similar approach by outsourcing multiple functions,” says Mr Davey. “They are looking for an integrated product package, from trade execution to front-office services, through middle office to custody.”

Greater collaboration

In addition to looking for a broader securities services offering, many clients want to reduce the complexity – and cost – of their environment. Hence, they are moving away from sourcing multiple best-of-breed solutions to outsourcing to a large provider. “The pick-and-choose set-up in the past, combining best of breed, is something they have realised is cumbersome to manage,” says Mr Roncone. He reports that clients are asking for more efficiency of scale and the ability to aggregate more volume within one platform.

According to the SGSS survey, a large proportion of outsourcing supporters (28%) would like to consolidate their relations with one or a small number of global providers, when this is possible (one per asset class or one per region).

Yet clients still want access to the innovation coming out of the fintech community, without necessarily having to manage those relationships. This is where another emerging value proposition that McKinsey has identified, called ‘ecosystem orchestrators’, comes into play. These are securities service providers that leverage new technologies and partner with fintechs in an open platform approach, effectively curating the best-of-breed solutions for their clients.

This relationship can be beneficial to both the securities service provider and the fintech, according to Mr Voelkel. “The relationship can be very symbiotic. Fintechs are more innovative, agile and faster by definition than most incumbents, whereas incumbents still own the customer relationship and can ensure the overall solution delivery.”

According to the McKinsey report, more than 70% of securities services-oriented fintechs are developing products and services for incumbents, rather than targeting the industry’s end customers and striving to disintermediate incumbents. As such, securities services incumbents should view fintechs as partners rather than competitors.

HSBC, for one, is very much in that mindset, working with fintechs as well as co-creating solutions with clients, which is another emerging trend. According to Alexis Meissner, global head of banks and broker dealers at HSBC Securities Services, clients are more focused on collaboration and are searching for strategic partners, vendors and service providers, with whom they can co-create to develop new solutions for the future. “What we are trying to do with them is balance what we refer to ‘the day after tomorrow’ – what does that long-term horizon look like – with leveraging new and emerging technologies and concepts to help solve problems today,” she says.

The new crypto world

On August 23, the World Bank launched Bond-I, a blockchain-based new debt instrument that raised A$110m ($79m). This is the first bond to be created, allocated, transferred and managed through its lifecycle using DLT and heralds in a new world of digitally native assets, also called cryptoassets. What role will securities services providers play in the custody of cryptoassets?

Bruno Campenon, head of financial intermediaries and corporates at BNP Paribas Securities Services, reports that many discussions are taking place around the tokenisation of assets, where there is no longer a centralised depository. “But there will still be a need for vaults to manage the security of digital assets,” he says. “Therefore, we are seeing a burgeoning of [crypto] vault offers and more appetite from banks, asset managers, asset owners and buy-side as well.”

Yet there is hesitation in the cryptocustody arena, especially around cryptocurrencies, because of the cautious approach taken by most regulators.

BNP Paribas is interested in the new digital asset world “as long as there is regulation on the back of it”, says Mr Campenon. “We are a custodian and want to guarantee the security of assets, so we need to operate in a contained, regulated world. This is something that we are looking at, as well as where the asset management and buy-side community is going – not just for today, because the market is not yet mature enough, but for what will come tomorrow. But tomorrow can be in the near future.”

Likewise, HSBC Securities Services is examining the practical realities of the emerging cryptomarket on the back of seeing some hedge fund clients set up separate cryptofunds. “Our policy today is that we don’t offer cryptocustody, but we are seeing this emerging trend with more progressive institutional investors stepping into the cryptoasset space,” says Mr Nabi. “It is a case of watching this space.”

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