Overall, 2014 has been another challenging year. The large players have seen a lot of internal turbulence and change of focus – for example, there have been several institutions exit the over-the-counter client clearing business.
Those organisations – such as investment banks, transaction banks and investor service businesses – that continue with their integration efforts are achieving very mixed results.
The integration of cultures, technology and people remains a challenge, particularly in their ability to provide fully-integrated products and services.
Revenue, profitability and capital constraints, resulting from regulatory initiatives and market conditions, have meant that banks are taking a hard look at client profitability and capital and liquidity usage.
Many organisations are redefining which entities they want to transact with and which markets and products they want to offer. The model for most service orientated banks will no longer be to offer all products, to all clients, in all markets.
This has led to the off-boarding of certain clients, or at least more stringent requirements placed on them. Market participants are quickly trying to establish their areas of proprietary advantage and relinquish cost blocks where they cease to achieve real and tangible differentiation.
The macro environment is such that overall market volume is not increasing and both regulatory compliance and cost containment are the prevalent areas of consideration for all players.
Regulations such as UCITS V, the AIFM directive, EMIR, Dodd-Frank and BCBS/ IOSCO as well as the harmonisation efforts of, for example, CSDR, T2S, T+2, are all continuing apace. Industry participants and clients are now really starting to see the impacts of these changes and regulatory requirements.
T+2 was largely a non-event in terms of issues created. Most participants are not experiencing a fallout, principally due to the preparedness of everyone concerned. T2S now in clear sight with wave 1 in 2015. However, there are still a number of issues to resolve as the project moves into the wider markettesting phase.
CSD pricing, and how they operate with one another, are also areas of focus. Most are reviewing whether they have proper documentation and indemnities, with a focus on whether custodians will provide the necessary protection and indemnities in times of crisis and stressed situations.
Delegated reporting and trade repository reporting remain challenges for many – there are still many inconsistencies in reporting and practical challenges performing these tasks. Regulators now have a tremendous amount of data on transactions – the challenge now is knowing what to do with it.
Clients, while becoming far more aware of the impact of all these changes, remain largely unaware of the impact that collateral has on them. The move to more exchangedriven activity as well as requirements in bilateral trading mean that collateral is increasingly becoming a hot topic in terms of both availability and mobility.
Being able to effectively manage and value derivative liabilities is leading to a whole series of requirements and considerations in the collateral market. There are significant ramifications for the market and clients are looking for help with this.
Service providers are trying to offer products relating to the outsourcing of components of the operation and the effective mobilisation and valuation of collateral, optimising available collateral pools around the globe.
The importance of having fully-integrated products and services is of paramount importance as clients are looking to make the assets/collateral available to them – often scattered across the globe – work in the most effective way. Service providers are focusing their efforts on helping their clients to seamlessly execute, clear, safekeep and service assets. The sheer cost of inefficiency has become too great.
In 2015 we expect wholesale innovation within the industry in order to cope with the upcoming margin requirements of non-cleared derivatives through the BCBS/ IOSCO directive. Successful institutions will be those that are able to further harmonise the process with cleared activities and offer clients seamless collateral solutions.
The other area of focus for custodians is designing innovative products and services in response to ongoing regulatory change and the resultant cost challenges for clients. The aim is to make sure they are getting paid properly relative to risk after the increased capital charges and regulatory changes they have to bear.
Again, this is leading many to review their client base and ensure that risk-versus-reward is properly understood. Overall, the fee pool may not increase but certainly new and innovative ways of charging, more evenly and readily, are applied to clients.
Finally, outsourcing will be an area of importance. It will be under review both by clients looking at attaining significant cost reduction and regulators analysing transparency concentration risks and systemic risk.
Organisations that have previously been proactive in offshoring are still challenged by high fixed cost blocks and very aged technology. The average age for most core underlying securities processing systems is between 18 and 25 years.
Outsourcing is nothing new, with history littered with failed attempts. But for the first time non-bank lead initiatives are emerging in the market. Accenture, IBM, Capco/FIS and the large service providers such as Tata are bringing to bear effective solutions in this area; the balance sheets of these organisations is as good if not better than those of some of their target clients.
Financial institutions now have effective recourse in the case of problems or noncompliance with service level agreements – they can access leading technologies and operational process and, significantly, attain cost reduction of about 40%. Those that follow this route also benefit from robust client-servicing models and the ability to transform large fixed-cost blocks to more variable-cost models.