The global custody market is at a crossroads in its development, beset by thin margins in a difficult economic climate, but also on the verge of technological developments that could bring substantial efficiency savings and regulatory changes that could open up new opportunities.
“There is a large volume of confirmed or potential regulatory initiatives which will influence custody banks’ business models over the coming years,” says William Slattery, executive vice president of State Street Corporation, head of the global services business in the UK, Middle East and Africa.
These initiatives include the Alternative Investment Fund Managers (AIFM) directive, Target2-Securities (T2S), Ucits V and new client money and securities rules in the UK – to name but a few.
“In many cases, they impose increased obligations on custody banks – perhaps the most important being the provisions around strict liability for depositaries stemming from the AIFM directive and potentially Ucits V,” says Slattery.
In addition, T2S will completely change the settlement landscape in Europe by enabling participants to operate centralised securities settlement and cash pooling, with implications for global custodians, their custody networks and central securities depositories (CSDs).
Some of these rules will require custody banks to examine the business case for further self-custody. They also encourage custodians to fundamentally re-examine their contractual obligations and oversight models applicable to the more than €9trn ($11.9trn) held in Europe-regulated fund structures.
By applying a common depositary model across all European jurisdictions for the first time – including those markets not previously requiring a depositary – these new regulations allow opportunities for economies of scale.
“But given the level of responsibility demanded, a very detailed understanding of local regulations and clients’ operations is required to carry out the contracted services effectively.”
The AIFM directive, which came into force for new funds in July, and will take effect for existing funds from next July, establishes a framework for supervising unregulated funds, and the requirement for a depositary for the post-trade work, including position recordkeeping, cash monitoring, and asset oversight for each investment fund. It also sets out provision for the restitution of assets.
“If you want to offer depositary services, you had better be a custodian bank given the liability on the assets,” says Florence Fontan, head of client segment, asset managers for BNP Paribas Securities Services.
“We believe that AIFs should choose a depositary that has experience, has the backing of a Global SIFI, is well rated, and hence will still exist when the investor comes looking for their funds.”
The second element is the question of the custody chain.
“The global custodian will want to ensure it has control of the chain of custody because it will be responsible for any asset loss. All custodians have undertaken a full review of their network in the light of the AIFM directive, and BNP Paribas currently holds an average of 90% of clients’ assets in its proprietary network.”
A new era
The current raft of regulations is primarily focussed on risk, compared with previous eras when regulation centred on harmonisation and level playing fields. It means new obligations to undertake functions that reduce risk, ultimately creating opportunities for custody firms to grow their businesses by monetising these additional functions.