A flight to quality. If there is one phrase which recurs time and again in discussing the asset services world and comparing it to a year ago, a flight to quality is that phrase. It is a form of words that is usually more associated with the investment management side of the equation, but has become ever more important over the past 12 months to those servicing that industry as the fallout from the credit crunch has continued to spread.
“The credit and liquidity crunch that we have all faced have made counterparty risk more important in recent months,” says Jay Hooley, president and chief operating officer at State Street in Boston. “There has been a flight to quality as investment managers and hedge funds look to the safety and soundness of their counterparties. People want to make sure their counterparties are well capitalised, and we have seen increased demand from hedge funds to act as custodian for their assets, as concerns grow about their prime brokers.” Jacques-Philippe Marson, president and chief executive officer at BNP Paribas Securities Services in Paris, says his bank’s AA+ credit rating is a key criterion in attracting new business.
The safety and soundness elements go beyond the creditworthiness of a counterparty. There has also been a flight to quality from an operational point of view, adds Tim Keaney, co-chief executive at BNY Mellon Asset Servicing (BNYM). “The past 12 months have spawned a number of interesting challenges for us that have raised the bar for our industry,” he says. “We all face new and more complex demands from clients, and operational excellence has become a prime requirement for new mandates alongside flexibility and price.”
Liquidity, too, is a major factor, where counterparties are concerned, making the availability of credit a major issue in the industry. “We are being approached by clients who are having difficult conversations with some of their existing providers of liquidity,” says Satvinder Singh, Managing Director and Head of Citi’s Direct Custody and Clearing business in Europe, Middle East and Africa. “Large broker-dealers use a lot of liquidity, and our commitment is worth more than before.”
The renewed focus on risk and risk management is highlighted, and welcomed, by Philippe Carrel, the Geneva-based executive vice president in charge of business development for Thomson Reuters. “Risk is being reviewed from scratch,” he says. “It is a number one priority for everyone.” Value at risk, which had a faithful following for a decade or so in financial services as a way of identifying and measuring risk, and allocating capital to that risk, has had its day in the sun and is now obsolete, he declares. People are leaving their ivory towers, accepting that things have changed, and that the answers to life, the universe and everything do not lie in obscure economic models. Risk management needs to become an everyday task, embedded in corporate culture, rather than an extension of the audit function.
The new environment has brought into the limelight a method he tentatively describes as valuation risk, a common sense, hands-on and proactive approach to measuring market risk and credit risk together. “Market risk and credit risk are very closely linked,” he observes. “The way the market has evolved, your market risk becomes my credit risk, and this has funding implications. A single miscalculation can affect confidence, sending funding costs through the roof.”
There is more, of course, to asset services than just numbers and systems, although the numbers are large, the systems increasingly sophisticated, and interoperability between multilateral trading facilities, central counterparties, custodians and central securities depositories also high on the list of priorities. People still matter in an industry where there remains a strong emphasis on ‘high-touch’ contact with clients. “People and talent underpin everything in this industry, ” says Citi’s Satvinder Singh. “We need to attract, retain and nurture it.” A looming lack of talent in the traditional centres does not bode well, he says, and could lead to an increase in the outsourcing and offshoring by asset servicers of certain functions in the processing chain. Part of Citi’s own solution to the talent problem has been to open for business in Belfast, a move that has been much more successful in a number of ways than it had expected.
The likelihood of a renewed wave of consolidation as smaller players decide to exit asset servicing rather than invest in the technology they will need for the business to remain viable is another key theme that industry participants expect to see develop further. “We are prepared for more opportunities to make acquisitions or forge partnerships to fuel growth in the US and elsewhere,” says Jim Palermo, co-chief executive at BNYM, which is still in the throes of its post-merger integration. “As an asset servicer you establish very close relationships with clients, often talking to them several times a day. Clients want to maintain those kinds of intensive relationships, but that commitment requires significant resources A catalyst of change could be the current economic downturn. We don’t know how long it will last, but if you can’t weather it, you are unlikely to maintain a market presence. So over the next six to 18 months we expect some providers to exit and those franchises to become available.”
In Asia, market liberalisation, the growth of the mutual fund industry, the greying population across most of Asia all augur well for the custody and fund administration business over the next few decades, says Neil Daswani, Global Head Securities Services at Standard Chartered Bank in Singapore. “A number of international asset management companies and insurance majors are entering the Asian arena. These new entrants do not want to invest in large armies of people and are prepared to outsource non-core functions such as custody, fund administration and transfer agency.”
The future does look bright, then, at least for some, and the final word, for now, goes to Tim Howell, global head of HSBC Securities Services, pondering the reckoning that many expect to see. “Asset services has developed very much along the lines I predicted a year ago, in this very spot, albeit much more rapidly than anyone could have expected at that time,” he says. “Today we have a much more grown-up business, in which people are playing more to their individual strengths than has been the case in the past. Our industry is not only very profitable but also has much more growth left in it. People cannot afford, though, to spend hundreds of millions of dollars only to find they’re a loser three years later.”
A version of this article appeared in the FTFM asset services supplement of the Financial Times on September 8 2008.