Several universal banks have merged their global custody or outbound investor services with Corporate and Investment Banking. This suggests they have seen the value potential of an integrated proposition. But what is driving this development and how are these changes likely to play out across the industry?
Historically, banks have adopted and developed new technologies to derive information from client and market data. Some processes have been transferred, outsourced, or delegated, but in general, advances in technology and greater standardization of process have improved the efficiency of delivering financial services. Now, the Fintech revolution is pushing these developments even further.
However, expectations that agile start-ups, unencumbered by legacy infrastructure, will transform the market and replace banks are yet to be realized. Banks provide a credit interface between their clients and the market by application of their knowledge, experience, strength, and stability. The accurate, timely, and secure transmission and processing of data is, of course, vital, but it is the provision of credit which underpins the transfer of value.
Although the “sliced bread” predictions around Blockchain or distributed ledger technology appear to have been tempered by the realities of the market, there is no doubt the task of processing data and transactions will continue to be increasingly automated and efficient.
This presents the banking industry with a challenge, largely of its own making.
Custody – A Game of Skill, or a Matter of Scale?
Many banks chose to group their trade, cash, and securities businesses into a division called Transaction Banking, or similar. Specialist banks, by contrast, used the term Investor Services – focusing on their clients’ objectives with a wider range of dedicated products.
The term Transaction Banking elevated the importance of processing over the provision of credit, and the market and client knowledge, risk management, stability, and capital strength that underpins that credit. In a world of increasing self-service and straight through processing (STP), the case for restating the value proposition and changing the name is evident in the corporate restructuring in many universal banks.
Despite the changing landscape, fees for custody are typically charged based upon a proxy of value that was truer (but not perfect) in a pre-digital world. Today, as clients expect to benefit from the economies driven by technological advances, margins for custody business have been reducing. However, when margins were greater, revenues, costs, and risks were potentially misaligned, allowing the cross subsidization of clients’ more costly and risky exception processes by the economies generated by institutional scale business.
New technology provides far more clarity and detail around processing and the opportunity to identify and differentiate risk. Efficient markets have high levels of operational liquidity, failed settlements are rare, and information around entitlements is clear, accurate, and timely. Investors in these markets have the right to expect that providers will pass on the economies that come with scale and automation.
But investors also wish to participate in less efficient vehicles and markets where the potential returns, and risks, are significantly higher. Generally, this higher volatility will mean the actual value of the investment is relatively small.
Under pressure to both reduce and simplify fees, custodians tend to ignore the differential understood by the investor, bundling fees regardless of the nature of the individual investment, its value, or the risks assumed.
Profitability in Focus
In the face of reduced margins, banks need to improve the alignment of price and value.
The investment management industry understands this with different share classes and risk-related management fees. In the wealth management space, private banks are emphasizing their discretionary capabilities to stabilize their revenues and increase efficiency. By viewing custody through a similar lens, its value proposition and contribution to margins and profitability will clearly come into focus.
Enabling Value for Investors
Assuming the value proposition can be defined as the application of industry skills, experience, and resources (including capital) to provide credit, liquidity and to manage risk, then in this context, the phrase “disruptive technology” will be redundant. That which is of real value can only ever be constructive – technology is not an exception to this rule.
Banks may choose to acquire technology and operational infrastructure from different sources rather than building it themselves, but that will free them to offer more services to their clients rather than be challenged on their existence.
Those banks which currently do not use investor services as a medium for selling credit, liquidity, and risk management may find this powerful client proposition more compelling and accessible. In this case, we may see more banks offering custody rather than fewer, and investors will benefit from differentiated, value-aligned pricing.
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