DEEP LOOK | A schism has opened up between custody services providers over the future of traditional and emerging service delivery. Established custodians are adopting a variety of strategies to maintain relevance in a changing custody landscape. PostTrade 360° contributor Paul Golden shares an outlook.
A BNP Paribas client survey published in mid-2023 highlighted a number of interesting trends in the custody space, such as that collateral management is the emerging value-added service most likely to become more widely available over the next decade. The survey also referred to the potential for changes to the delivery of custodian services with only 20 percent of the global custodians who contributed to the survey expecting their business model to remain unchanged between now and 2033.
This has led some in the industry to predict a move towards the ‘custodian of the platform’ concept where there is a need for organisations to use a platform for best-of-breed providers.
An earlier Northern Trust report drew attention to the emergence of new market spaces and suggested that custodians and service providers would need to collaborate as members of a shared digital ecosystem. The report authors believed that custodians and other industry actors would start working together on platforms or shared infrastructure to create new revenue streams.
Providing an order and execution management system (OMS/EMS) is seen as basic for a custodian today. But just a few years ago, this was either handled by a separate vendor or maintained in-house above custodial services.
There have also been significant advancements in automated clearinghouse and automated customer account transfer services (ACH/ACAT), fraud prevention services, funding mechanisms, and enhanced services around know-your-customer and customer identification procedures (KYC/CIP). Most custodians have also developed rebalancing systems and established asset management marketplaces.
Asset servicing is another area expected to experience significant change. Fintechs focused on granular areas such as tailored servicing of a specific asset class are likely to emerge, creating a new competitive dynamic in niche areas such as fractional ownership and tokenised assets.
The importance of how custody services will be delivered in the future is amplified by the evolution of these services and specifically how markets such as settlement and asset servicing will be impacted by competition from fintechs.
The emergence of digital assets has also challenged the assumption that custody services can only be provided by large banks with long track records in providing asset servicing and settlement services.
Confident custodians
The major players are bullish about their medium term prospects though. Continued strengthening of the regulatory environment is enforcing the need for robust, well-capitalised organisations to hold assets and settle transactions. This – according to Gary O’Brien, global head of banks and brokers segment strategy at BNP Paribas Securities Services – means custodians are likely to be providing core functions for the foreseeable future.
“Capital requirements around the risk associated with settling transactions, or the oversight obligations around holding assets and monitoring sanctions frameworks and fraud controls, mean that these services need to be provided by well-established and robust parties,” he says.
Paul Maley, global head of securities services at Deutsche Bank, is also confident his bank will be fulfilling the same core functions (settlement, safe-keeping, asset servicing) in 10 years’ time.
“We hear from clients that they want numerous safeguards from their custody providers,” he says. “These include a strong balance sheet – overseen by the credit rating agencies – and the knowledge that assets are held in a well-governed jurisdiction with robust audit procedures. Clients also want the peace of mind of knowing that deposit insurance is also available, particularly retail clients.”
Amit Agarwal, head of custody securities services at Citi expects custody to continue to include traditional components such as local and global market access as well as credit and liquidity solutions.
“We also expect custody to remain a specialised and regulated activity for the foreseeable future,” he says. “Due to the regulatory barriers and network-based foundation of custodial activity, it is unlikely that pure fintech entities would obtain the necessary licences to act as custodians themselves.”
While accepting that the technology might change, Maley believes the barriers to entry are genuinely high when the payment processing, securities settlement, asset servicing and tax reporting services that are supported by banks are taken into account.
“Despite the fragmentation of regulatory requirements and market structure between countries, we expect services to develop that enable easier market access for clients,” he says. “In fact, multi-market access and multi-market custody is something we have helped to pioneer. Customers want to know that they can deploy capital in a seamless and integrated manner as quickly as the next investment idea occurs to them.”
Technology challenge
Around half of the custodians, exchanges, brokers and wealth managers surveyed by BNP Paribas expected to implement a major, market-wide system transition within the next five years, with integrating digital technologies into existing platform infrastructure seen as the biggest operational issue.
BNP Paribas anticipates growth in the custodian’s role from asset custodian to a broader data custodian, eventually overseeing platforms and validating and endorsing potential service providers and collaborators.
Gary O’Brien is firmly of the belief that the platform concept is the way forward for accessing custody services. BNP Paribas has also started to talk about the potential of being a ‘depotbank’ for platforms. The challenge here is that if investors or other intermediaries need to connect with third parties for a wide range of services, the number of agents they deal with could rise from 5 or 10 to 40 or 50, which is a significant overhead.
“If you can reutilise and refine the role of a depotbank where the custodian who is facilitating the platform has a level of oversight over the parties providing the services, that could make the life of the end user much simpler,” says O’Brien.
“We see ourselves as being on that journey towards platform custodian, facilitated firstly by the evolution in the way data and information is harnessed and then by the overlay services that some fintechs and other third parties can bring to extract certain aspects of that data,” Gary O’Brien adds.
When asked whether the future lies in the custody platform model where organisations use a platform to access best-of-breed providers, Paul Maley suggests this is already happening with many clients using different fund administrators, custodians and/or sub-custodians in individual markets.
“Position-keeping and back office systems are also distinct,” he adds. “The trend has been to offer clients an integrated ecosystem that makes the end user experience simpler to navigate – hence a shift back, towards an array of providers that need to be bolted together, is harder to contemplate. The custody business doesn’t easily translate into an app store model.”
Blended approach
BNY Mellon’s ambition is to create a digital ecosystem blending proprietary build and collaboration with fintechs and other technology providers such as order management systems and communication platforms developers.
However, Adam Watson, the bank’s head of commercial product custody reckons the market would not support a custody platform model.
“There is much value in having limited integration points with providers,” he says. “It is also worth noting that in the last 12 to 18 months, clients have shown increasing focus on resiliency and counterparty risk. Doing business with a provider that has a strong balance sheet, is well capitalised and has the size and scale to take some of the risks associated with a multi-provider model has clear benefits.”
According to Howard Rapley, global head of custody and securities services product at Northern Trust, the question of whether the industry takes this to the next level of evolution – where the custodian does not only provide traditional services but expands to offering a wider partner and service set – has not yet been answered.
“Considerations of scale and diversity abound, as well as ensuring a good value proposition for all parties,” he says. “In a number of areas fintechs may help us go to market faster and more effectively than in-house re-platforming and some are likely to emerge as ubiquitous to the point where they essentially become an industry utility. This can create new opportunities for efficiency that a fragmented ecosystem cannot.”
Standard Chartered believes the future of the custody platform model lies in an open architecture that enables flexible connectivity and allows clients a range of options in how they access that data, based on a consolidated data repository to ensure consistency and stability – essentially a ‘single source of truth’.
Diverse definitions
The definition of best of breed depends on clients and their own strategies, suggests Ying Ying Tan, the bank’s global head of custody and funds product.
“The key for asset servicing providers is in establishing a set up and solutions that can flex to the strategy a client has defined for their business and enable them to focus on growth and their core competencies,” she says.
“There can be a best of breed providers approach to the extent that services can be independent and ring-fenced as part of a value chain,” adds Tan. “For example, settlements are integrated with positions and voluntary corporate actions processing can be segregated. Therefore the approach is best of breed to the extent that functions can be productised.”
Thierry Janaudy, chief technology officer at Zodia Custody – which is owned by Standard Chartered, Northern Trust and SBI – acknowledges that the platform model presents some compelling advantages for institutions.
“But as with most things, moderation is key,” he says. “Taking on a mixed approach where some products are platformed while others take on different models is often what serves institutions best, depending on their needs and expectations.”
For those harnessing custody platforms for digital assets, a key benefit is cost effectiveness. By decoupling the authorisation layer from the underlying crypto technology provider, it means that there is increased competition among providers and institutions can take their pick. As costs fall for custodians, they can then pass those savings to clients.
“Our approach means we can provide institutions with access to a clear, compliant, and standardised platform that meets the highest level of regulatory requirements, security measures and risk management,” concludes Janaudy. “This enables institutions to operate from the robust framework they are used to working within, while also having access to key services and innovative technology.”