What will the market look like when the current leadership group of 40 -50 year olds retire? Will the largest custodian bank be an American or a Chinese one? What will their product range be? How will technology support their business model? What infrastructure will be around? And will custody actually continue as a product? One month into the New Year, it is worth thinking forward to the 2030’s before they actually loom into the long term planning horizon.
Change is inevitable. And change can be dramatic. My custodian lifecycle started in the late 1980’s and continues today – a span of some twenty five years. In the late 1980’s we had just received the earth shattering G30 report urging us to opt for dematerialisation, or even immobilisation, in CSDs, to promote the first securities ISO standards, adopt a same day payment convention for settlement or support that new visionary product of stock lending. Custodians were primarily domestic with a small segment of their assets in international securities. The fiduciary role existed but was truly nascent and often embedded in a distinct trust company. Compare that world to the globalised, consolidated, infrastructure rich, product diversified, and highly regulated environment of today to understand the likely scale of change to come. Momentum alone will create change, but regulation, demographics, risk appetite, technological revolution, and economic growth patterns will make such change even more vibrant.
The geography of investment is likely to change. Economic growth forecasts indicate that China will have a larger economy than the US in the not too distant future, although equality at the per capita GDP measure is still generations away. More importantly, China and other BRIC or quasi BRIC economies are likely to continue to operate trade surpluses with a labour force that will be still in the wealth accumulation phase. Conversely, much of the West will be operating net trade deficits and a large segment of its populations will be in a wealth realisation phase. Assuming a capitalist style economy persists in China and other people intensive growth economies, new capital demand will be substantial. But supply will increase exponentially and it is likely to continue to increase ahead of local demand; thus those states will be exporters of private capital to allow individual wealth creation, just as today they are exporters of state based wealth to allow them to deploy the product of trade surpluses.
If the new economies become the prime drivers for surplus private sector capital flows in this fashion, they will undoubtedly follow a classical custodian lifecycle. Phase one will be essentially domestic with investment in former state enterprises or entrepreneur style corporations. Phase two will be investment overseas using a global agent to learn about markets and products; that generally is where we are today. One suspects, for the future top ten custodians from outside the current magic circle, this phase will be shorter than many believe and it will lead to self-sufficiency either through organic growth and development or a future acquisition of one or another of the then declining titans of today’s markets. In reality, it is safe to assume that the top ten players of the future will not be based around anything like the current incumbents from the USA and Europe. And that ignores the potential for alliances across distinct segments, technology centric institutions, infrastructures, and banks as examples.
Products are also likely to be different. One suspects that this will be driven by two key trends. First, there can be expected a material change in risk allocation and secondly a change in market infrastructures. The regulatory approach to risk allocation is going to impact the capital required to support custodian, and administrator, services. Quite simply the concept of risk absorption enshrined in regulation such as AIFMD is unsustainable. The fragmented nature of market infrastructures, both in terms of duplication of function and complexity of interlinking, within asset classes and across them, is also unsustainable. The major question is what is likely to be the design in the future? It is not illogical to assume that many more investors could be direct holders of their assets at end of line CSDs, whilst custodians or administrators will continue to be independent fiduciaries, albeit in a less opaque legal environment, and record keepers or validators rather than legal owners.
At the same time the number of CSDs will contract and there could develop a series of hub CSDs across the world acting both as feeder CSD to smaller ones and infrastructure operators for some of them. CSDs will focus on their notary function and core asset servicing, although this will be broader than implied by today’s definition to include aspects such as collateral, asset finance, transaction matching, or standardised asset servicing.
There should also be a sharp decline in settlement activity which will be more and more consolidated into CCPs which will be capable of handling agent as well as principal flows in the future. The custodian or administrator will operate much more integrated platforms, somewhat akin, although broader in product and functional reach, to those of the leading prime brokerage houses of today. This would allow them to accommodate investor demand for access to a wider based infrastructure covering a range of classical listed, unlisted, collective, derivative, and special purpose investments. And the surviving private sector suppliers will differentiate themselves by the quality of their information and analytics as well as their ability to react fast to changed demand rather than through the efficiency of their processing, for the latter will be a given.
It would take a really brave commentator to identify the technology platform of the future. Indeed many in the market are still dependent on technology that is aged, archaic, and sub optimal. That, indeed, is why there is likely to be revolution across providers, for a like for like replacement of that delinquent set-up, within a modern IT architectural design, allied to the needed development of new services, is beyond the financial reach of the majority of firms. Thus the technology footprint of the future will be materially different.
At a guess, it will be much more cloud based with pricing moving to usage based models. Bandwidth and storage will cease to be an issue and latency will be seen as a challenge of the noughties rather than an issue of the time. Time to market will be much reduced with highly modular environments, but user knowledge will be a material challenge. However, the true cost of technology will increase from today despite the structural improvements to be expected as the cost of security will increase with a likely material growth in cybercrime.
The world of the future is not an evolution from the world of today. It has to involve a dramatic and revolutionary metamorphosis of the current distributed, duplicated, risk tolerant, and fragmented environment to become a streamlined, process automated, integrated business straddling financial instruments and facilities. The key people will continue to be focused on production, delivery, and development, but their skill set, by comparison with those of today, will be as different as that of space technologists to the inventors of the original internal combustion engine.
The people with the real challenge are those at the start of their careers in this industry for they need the adaptability to move their skill sets accordingly. And they should not emulate the management generation of the early 1980’s. Many of those retired early as they struggled, and failed, to understand why paper should be replaced by data. Tomorrow’s generation will need to resolve how data can really be managed in a global, interconnected, same day process with more instruments, more structures, more liability as well as more analytics, reporting, and information management.
John Gubert
Chairman
Global Securities Services
Executive Committee