Keeping up with custody

Custodians are diversifying product offerings and seeking new target market segments in a bid to keep ahead of the game, says Ajit Khare, group product manager, securities services at Standard Chartered Bank.
Custodians, the traditional back office for institutional investors, have over the past years undergone dramatic changes in the way they conduct business.

In the days of physical securities, a custodian had huge vaults and used massive manpower for safekeeping and settlement of transactions in physical securities. For both local and international institutional investors doing large numbers of transactions, appointing a custodian made economic sense as compared to the costs of doing the same in-house. For international investors, the custodian provided the added advantage of a provider who guided them through the local rules and regulations for investments in a market. Moreover, for institutional investors, a custodian was often mandated by law.

As markets moved from physical to scripless, settlement processes became more efficient; custody processing shops became more lean and efficient. The processing costs came down drastically. As the product became more commoditised, custodians started looking at more value added services for their clientele. Credit based product offerings like contractual income and settlement were introduced in order to enable the custody clients to manage their cash flows more effectively. The quality of value added services like market information û accurate, timely reporting with impact analysis for instance, became one of the many distinguishing factors by which a custodian was judged.

For targeting the domestic mutual fund segment, custodians started offering fund accounting services along with custody û arguably the custodian already had a significant portion of the information for computing the fundÆs NAV. Some custodians started offering Transfer Agency as well. Some organisations also offered Trustee services.

Retail appeal

As markets develop and become more efficient, a question which comes to mind: Why have the custodians always focused on the institutional segment?

From a custodianÆs viewpoint, if they were to look at taking on retail clientele, the first item which requires high operational involvement once a retail client is on board, is the receipt and processing of instructions. The majority of the custodianÆs institutional clientele send instructions via SWIFT and custodians have developed their back office systems to accept and process these SWIFT instructions with minimum manual intervention. Communication (instructions receipt and reporting) with a retail investor will often be paper based and hence require the activities of signature verification, input into the processing system, physical statements generation and posting, etc. However, with the advent of internet based channels, this issue can be effectively addressed so that the operational effort at the custodianÆs end is minimal.

Another area is that of corporate actions. Corporate actions notifications can be easily sent to all classes of investors, be they on SWIFT or using other channels e.g. internet, physical statements, etc. However, voluntary corporate actions, even today, require manual processing and are a high operational risk area for custodians in most markets. It is possible that custodians may decide to exclude this value added service offered to the larger retail segment, if they were to target the same.

However, servicing of the retail segment has begun to gain traction. Examples would be the wealth management businesses of banks and prime brokerages with high-net-worth individuals as their clientele who seek custodians for their underlying client investments.

As competitive pressures grow and revenue targets increase, custodians will need to seek new target market segments, whether retail or corporate and develop, possibly, a stripped down service offering for these target market segments.

Other changes afoot

Clearing and settlement are another area seeing change. To date, clearing and settlement of derivatives and commodities investments by institutional investors has largely been the domain of the broking community. As interest in these asset classes by institutional investors grows, the question that will often be asked is whether a custodian can offer a one-stop-shop to service the various asset classes. A case in point is the Indian securities markets.

Regulations have necessitated that foreign institutional investors and domestic mutual funds in India appoint a Professional Clearing Member for the clearing and settlement of their exchange traded derivatives transactions. Here custodians have taken the opportunity to become professional clearing members and offer derivatives clearing and settlement in direct competition to the brokers. Appointment of a custodian for clearing and settlement of these trades has found widespread acceptance within the institutional investor community, given the convenience of a one-stop-shop which the custodians represent.

As market regulations evolve and similar clearing and settlement structures get adopted in other markets, one will find custodians exploring development of product offerings to service these asset classes as well. Apart from derivatives and commodities, the other asset classes in which similar demand is being seen is real estate (property funds/REITs),

To grow a highly commoditised business like custody, apart from the introduction of various quality, value added services, custodians in future can be expected to seek diversification of target market segments as well as expand product offering to offer a one-stop-shop catering to the different asset classes in which institutional investors would like to invest.
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