A NEW LANDSCAPE.
Steve Smit, executive vice president, head of global markets Europe and investor services UKMEA at State Street explains how regulation is of the industry, and creating opportunities for a global investment servicing business.
Q. There has been so much regulation coming down the pipeline since the financial crisis but so much of it is yet undecided, is it difficult to plan?
A. It is true that the outcome is still to be decided in many cases. The one good thing though about the delays in the US is that the scheduled implementation windows between Europe and the US are getting shorter. One outcome is likely to be that asset managers and end-investors are likely to face higher costs, and therefore diminished investment returns, because of the increased capital requirements of their service providers.
Q. Which regulation do you think will have the greatest impact on your business?
A. Dodd Frank will have a major impact specifically in the area of OTC derivatives. The drive towards increased transparency will require many of these contracts to be traded on swap execution facilities and centrally cleared. The AIFMD (alternative investment fund managers directive) and UCITS IV and V are also going to have a significant impact. The biggest concern for custodians is the introduction of the strict depository liability. The language was softened in the AIFMD but we are still waiting for a final version of UCITs V (UCITS V aims to make depositaries fully liable for any assets held in custody and by an appointed third-party sub-custodian). If it goes through, I think it could lead to further consolidation in the industry and greater concentration, which could have implications for systemic risk.
Q. What about MiFID II?
A. I think the transparency that MiFID has brought has been beneficial to all market participants although it has led to the fragmentation of liquidity. The current review is intended to address perceived weaknesses, including, in respect of algorithmic and high-frequency trading, the organization of trade execution venues (BCNs and SEFs), pre and post trade transparency requirements, conduct of business practices and client categorisation.
Q. How do you see the asset managers responding?
A. The institutional investment industry is having to respond to a multitude of new and proposed regulation – Dodd Frank, AIFMD, UCITS, RDR, Solvency II – and is looking to institutions like State Street to develop appropriate responses and solutions. One of the major trends resulting from this is an increased demand for the outsourcing of services to providers such as State Street. These new regulations pose extreme operational challenges at a time when the cost base of many asset managers remains under pressure. Although the aggregated level of assets under management has returned to pre-crisis levels and the expense base of asset managers has returned to pre-crisis levels, revenues are only back to approximately 85% of pre-crisis levels. Consequently asset managers are looking for assistance in addressing their expenses challenges and outsourcing is an obvious solution. This allows the fund manager to focus on their core competencies of manufacturing and distributing investment product.
Q. How do you define middle office?
We tend to look at it as all activities that occur post trade but pre-settlement but where you set the bar is really up to the asset manager. We are talking with some asset managers who are interested in outsourcing their execution function. This tends to be more the case with smaller organisations and although it is just talk now, the day is fast approaching when it could be a reality. I think there are more opportunities now if you can provide demonstrable best execution on an agency basis.
Q. What type of outsourcing deals are you seeing – a total lift out or component based?
A. We are seeing both – total lift outs and transactions that are much more modular in nature. The primary modules are the traditional middle office functions of transaction management, derivatives processing, reconciliation and control, recordkeeping and accounting, corporate action processing, etcetera. These can be augmented with activities like performance and analytics, collateral management, and end client reporting to name a few. It really depends on the asset managers’ profile and requirements as to which activities they will outsource. The challenge is in structuring transactions that are commercially attractive to both parties.
Q. Do you foresee further consolidation in the industry and does State Street plan to participate?
A. Our CEO, Jay Hooley last year set out a number of strategic imperatives for the business – first and foremost of which was the goal to double non-US revenues over a five year period. We certainly anticipate further consolidation and we intend to actively participate in it. We believe that a number of the institutions currently offering securities services in Europe will likely exit the business because they determine that it is a non-core competence, that the required level of investment is unsustainable or that the required capital to support the business could be better deployed elsewhere. Last year we undertook two big significant acquisitions – Mourant International Finance Administration and the securities servicing business of Intessa Sanpaolo in Italy, which increased our market share to 30% from 3% in the country.
Q. What about Asia?
A. Asia is a dynamic and rapidly growing marketplace although it is still characterised by relatively few large pools of institutional assets. However, there are opportunities. For example, we are seeing a number of our global clients distributing their UCITS product into the region. There are also fewer local providers and we think that we have the global scale as well as the resources as well as on the ground expertise that will allow us to capitalise on these opportunities
Q. Looking ahead, is regulation the greatest challenge?
A. I think the changing regulatory environment creates both challenges and opportunities. Changing regulation has become a source of new product development for us. For example, we have become involved in developing solutions for the insurance industry to assist them in meeting their Solvency II requirements. We have also recently rolled out a new service for the production of Key Investor Information Documents (KIID) for UCITS compliant funds. Another perennial challenge is fee compression. We need to continually refine and enhance our operating model in order to extract greater efficiency and productivity. Finally we need to continually strive to meet the expectations of our clients – from the smooth and seamless migration of these clients onto our platform to meeting their daily requirements through the provision of exemplary levels of service. l
