The Future of Custody

 

The custodians of tomorrow will thrive by taking advantage of technology to provide high-value services, while becoming less reliant on commoditised processing.

 

Nearly a decade after the global financial crisis, the financial industry is still dealing with its aftermath. The different parties that form the post-trade value chain have adapted to a new regulatory environment, changes in market infrastructure, and enhanced risk awareness among investors.

 

But by focusing on the problems that contributed to the crisis, the industry has not yet fully realised the immense opportunities that technology and innovation could bring in the coming years.

 

How the custody business could change in the near future was the subject addressed by John Van Verre, HSBC Securities Services’ Global Head of Custody, during a keynote address presented at The Network Forum hosted in Hong Kong in November. He shared a vision where the industry will shift away from the focus on traditional functions, such as processing, towards more value-added activities in the servicing space that take advantage of the latest technology.

 

The value of technology

 

Processing is a high-volume, repetitive activity with low margins. It has all the characteristics of a commodity in which different providers cannot differentiate their offerings – an investor will simply go to the most reliable solution at the lowest price.

 

Servicing, said Mr Van Verre, has a much brighter future. This is in part due to the fact that investors in the US and Europe are allocating more capital to a broader range of complex markets – such as emerging economies in Asia and the Middle East.

 

Custodians can therefore add value by providing their clients with globally consistent experiences regardless of where they invest – mitigating the complexities generated by the different tax models, legal systems, and regulations that vary from market to market. Technology will play an integral role in how custodians meet the evolving needs of their clients.

 

Take robotics for example. An investor in the US might need some relatively simple information about an Asian market they invest in. Under the current system, they will contact their local customer representative, who will send the request to their colleague in Asia. Due to the time difference, the investor has to wait at least until the following day before an answer arrives.

 

A robotic solution, however, is much more efficient, as it is able to quickly provide the information to the client via a much shorter and quicker process than the process mentioned above.

 

“A multitude of emerging technologies have made these otherwise imaginative ideas into potential reality.”

 

Reducing inefficiency is a consistent theme in any discussion on how technology can help the custodians of the future, which will result in a better customer experience for clients, said Mr Van Verre. The post-trade value chain is made up of multiple constituents – investment managers, brokers, custodians, exchanges, and central securities depositaries etc. – that have developed in silos with very little integration. Inefficiencies abound, as can be seen in the repeated reconciliations that are made for the same transaction.

 

The latest innovations give a picture of how a more integrated model could be at hand. Distributed Ledger Technology (DLT) and smart contracts have the potential to make changing ownership an administrative action within the central depositary, with no external settlement in terms of exchanging money and securities as we know it today. “A few years ago, DLT looked an incredibly long way away. Now we see proof of concepts, sandboxes, exchange planning,” said Ian Banks, head of HSBC Securities Services Asia, who also addressed the Network Forum on the topic of innovation. “Some people see threats, some see opportunities. The way I see it is that there is the opportunity to offer a huge amount of value-added services to our clients.”

 

A multitude of emerging technologies have made these otherwise imaginative ideas into potential reality. Application Program Interfaces enable monolithic infrastructures to share data real time and offer an enriched service to clients. The ‘ever-reducing’ cost of data and the possibilities we could achieve using Artificial Intelligence could help transform client experience exponentially. Probably for the first time since the invention of the steam engine, we are seeing all these emerging technologies proliferate at the same time.

 

Adapting to a new environment

 

It might not be obvious what the role of a custodian will be in this new integrated model. Mr Van Verre highlighted a number of reasons to think that custodians will continue to add value in the future-state industry model.

 

For a start, new technology can be complex, and investors will likely find it useful to have an external party managing the new processes. DLT, for example, brings benefits in the form of an objective record that everyone can rely on. An investor investing in many markets might find that there are DLTs for every function – proxy voting, corporate actions, settlement, holdings, etc – with different standards, regulations and security methods in each jurisdiction.

 

“The challenge for banks will be to keep up with the unprecedented level of technological change.”

 

An investor could therefore face the situation managing hundreds of different DLTs, a logistical situation that might be more complicated than the current market infrastructure. A custodian could add value by administering the DLTs for their investor, allowing them to focus on their core business activities.

 

Another reason that custodians are not likely to go away cited by Mr Van Verre relates to liabilities. Ever since the financial crisis, there has been an emphasis on investor protection, so it is hard to imagine that regulators could tolerate a situation where there is no party that takes the responsibility for the protection of client assets. This requires the backing of a balance sheet, which will likely come from a financial institution.

 

The challenge for banks will be to keep up with the unprecedented level of technological change. Over the last 50 years, each decade has presented a new invention that allowed for the introduction of a breakthrough product – microprocessors led to credit cards, while mainframes paved the way for portable tablets and mobile devices. The current wave of change stands out because there are so many new technologies that are on the cusp of widespread implementation – biometrics, cloud computing and robotics, are just some of the samples.

 

“Technological developments are outpacing what we are doing on the business side,” said Mr Van Verre. “There are many business challenges that we need to answer. We will have to work closely with all industry participants and regulators to address the new questions.”

 

Whether or not custodians have a role in the future depends on how well they can integrate new technology into their business model. Mr Van Verre concluded that the industry will have to redefine the idea of value in the post-trade ecosystem. Only then, he said, will be able to bring an improved customer service to clients in an increasingly interconnected world.