[ M A R K E T
R E V I E W
|
C U S T O D I A N
N
otwithstanding the sharp revenue
plunge in 2009, securities servic-
es’ profits – despite the soaring
global asset prices and trading volumes
– have been limping along for nearly
a decade. According to McKinsey, the
securities services’ industry has grown
on average by 3% each year since 2010,
with most of the new incremental income
streams coming from dynamic Asian
markets, in contrast to North America
and Europe, where margins have been
lethargic and negligible respectively.
Custodians are all too aware that their
industry is in an increasingly perilous po-
sition. The nominal expansion at custody
and fund servicing businesses has been
dented by the continued doggedness of
low interest rates and declines at other
profit centres, such as securities lending
and FX execution. Regulators have also
not been gracious to custodians impos-
ing tough new liability provisions under
post-crisis rules such as AIFMD and
UCITS V, in addition to other operation-
ally demanding compliance requirements
enshrined in the CSDR, MiFID II and
EMIR.
The threat of regulation has been in-
terspersed with the dramatic entrance of
disruptive technologies like blockchain
and ICOs (initial coin offerings), which
have the potential to eliminate a lot of
the intermediation between issuers and
investors. Another irrevocable devel-
opment has been the whittling down of
“Such consolidation provides
substantial operational
cost benefits to European
providers.”
custodians’ fees by institutional clients,
who themselves are under serious cost
pressures. Despite acquiescing on fees,
many custodians are also being instructed
by clients to provide more customised
and bespoke services, exacerbating their
cost imbalances even further.
Custodians on the defensive
Against this tough backdrop, many
market participants are questioning the
sustainability of the existing custody
model and whether assertive cost-cut-
58
Global Custodian
Fall 2018
M & A ]
ting, automation and offshoring are blunt
enough tools to counter the industry’s en-
demic problems. M&A is viewed by some
insiders as a possible solution. Consolida-
tion has served asset managers and fund
administrators relatively well since 2008,
enabling providers to rationalise their
businesses, create economies of scale,
offer different services and access new
markets which they may have historically
struggled to penetrate.
Despite the prolific M&A elsewhere
in financial services, there have been
very few major custodian mergers since
“Doubt has also been called
on the possibility of shotgun
marriages between sub-
custodians and CSDs, citing
their inherent cultural and
business differences.”
2008 to speak of, excusing State Street’s
acquisition of Intesa Sanpaolo’s securities
services division; Standard Chartered’s
purchase of Barclay’s African custody
business, and Citi’s takeover of ING’s cus-
tody operations in Central and Eastern
Europe. Corporate transactions – at least
on the scale and ambition of the $16.5 bil-
lion mega merger between Bank of New
York and Mellon in 2006 - certainly feel
like a very distant memory nowadays.
Europe: Ripe for consolidation
The region arguably most susceptible to
further consolidation is Europe, where
the custody market is fragmented and sat-
urated, allowing for potential synergies to
be realised through M&A. “Through ini-
tiatives like CMU and post-trade harmo-
nisation, the EU is becoming increasingly
homogenised,” says one expert. “This
creates M&A opportunities as banks
can operate multiple markets in differ-
ent countries off a common technology
platform and out of a centralised process-
ing facility. Such consolidation provides
substantial operational cost benefits to
European providers.”
Many local or smaller regional custo-
dians are already beginning to feel the
strain from Target2Securities (T2S),
a pan-European settlement platform
which will enable market participants to
settle securities transactions in central
bank money bypassing domestic custo-
dians. T2S also makes local European
sub-custodians more vulnerable to CSDs
encroaching on their core activities, a
development which some have suggested
could result not just in M&A between
local sub-custodians themselves, but at
sub-custodians and the CSDs.
Not everyone is convinced M&A is inev-
itable at the local providers. Supporters
of the local sub-custodian model argue
providers have had ample time – name-
ly more than a decade - to change their
business strategies in anticipation of T2S’
disruption, and many are starting to veer
away from plain custody and clearing, di-
versifying instead into new products such
as collateral management. Doubt has also
been called on the possibility of shotgun
marriages between sub-custodians and
CSDs, citing their inherent cultural and
business differences.
Roadblocks to consolidation
While M&A may be a solution for some
European providers, it is broadly accept-
ed the US custody market cannot consol-
idate much further than it already has.
“The likelihood of further M&A among
US custodians is low as they have already
consolidated per say,” explains another
industry expert. “The custody market
in the US is heavily concentrated in the
hands of a select few very large partici-
pants. I doubt the US regulators would
entertain or support the idea of two major
domestic custodians merging for whatev-
er reason, citing anti-trust issues, concen-
tration risks and SIFI concerns.”
As banks – at least in Europe – look to
meet their Basel III capital requirements
and offload problem assets, disposals
of custody operations could prove to be
quite attractive. But with custody facing
so many existential challenges, and a
number of banks guilty of not properly
investing in the business, finding a willing
buyer could be tough. In extremis, some
banks may decide to exit custody without
even finding a new buyer or simply ap-
point a third party as their global service
provider while retaining a client interface
- a decision, however, which may antago-
nise customers.
Don’t forget about the customers
Clients are sympathetic to M&A between