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Future of Custody Business

Future of Custody Business
April 21, 2020

The custody business and that of custodians in the financial market have seen considerable changes in the last few years and these are expected to increase going forward. Earlier, an efficient custodian would offer basic services like position keeping and management, settlements, corporate actions, and tax processing services. Now, these services are seen as basic ones, expected from all custodians, preferably with value added services like foreign exchange and cash management, portfolio performance measurement, investment compliance monitoring, risk management and fund administration.

In addition to the above services, the custody business will evolve further, significantly impacting the business models of the custodians as well as the technology used. In the financial markets, the role of custodians will be segregated into processing and servicing.  

Processing would be more of a low-end job with low margins, providing little value addition to clients. Such operations can also be outsourced to specialist providers who can derive benefits through economies of scale by providing services to multiple custodians and banks. Such transactions can involve settlement processing, corporate actions processing, cash management, regular tax processing and fund administration. For the custodians, these would translate to lower costs and reduced operational risk.

One aspect which is expected to play a significant role in the service functions of a custodian is data management and aggregation. Custodians will process data from various sources and act as data integrators. This will be for assets not only under their purview but also external to their network.

The concept of data integration as a centralized record keeping function is already in vogue using the Distributed Ledger Technology (DLT). In the current process various market intermediaries like brokers, custodians, clearing houses, depositories, exchanges, and clients set their own standards of data management, often conflicting with each other. Under DLT, relevant data integration will be held in a central database with each intermediary described above having access to the necessary data to carry out their functions. In this context, custodians engaged in necessary data integration from the central database for better client servicing can enable clients to access and extract data as per their needs using DLT. Clients will value custodians who can aggregate and normalize data from various sources to provide them relevant market reports.

Another aspect where data management comes into play for custodians is their role of being knowledge providers in view of increased cross border trades and asset allocations. Clients investing in emerging markets would need a deep understanding of such markets, specifically on local and cross border regulations, tax, foreign exchange, and market structures. Custodians having presence in such markets either as global custodians or through a network of local custodians would enable them to have deeper understanding of such markets and translate data servicing into relevant information for clients. Examples of relevant information which would enable the custodians in advising their clients to take informed decisions would be cash inflows into different products and market segments, regulatory and compliance changes, foreign exchange, market efficiency, and market volatility. This would involve data collection, consolidation, normalization, data mining and data analysis to identify investment patterns and trends which would be passed on to the clients, hence delivering more value.

Artificial Intelligence (AI) and digital solutions can be the basis for more efficient data servicing on the part of custodians, especially for clients based across different time zones with respect to the custodians. Delays in information dissemination due to different time zones may affect trade decisions, leading to possible losses. AI and digitization will allow most client requests to be handled automatically without any manual intervention. A central database of client queries need to be maintained combined with workflow solutions with real time access to the database for clients.

AI & digitization can be the basis for more efficient client service on the part of #custodians, especially for clients based across different time zones with respect to the custodians. Read More #custodybusiness @hclfs

The changing roles of a custodian would also mean a difference in their pricing structure. As of now, custodians charge their clients mainly on the value of the assets being held as safekeeping and transaction charges for settlement processing. Going forward, it is expected that pricing will be based on a model where custodians will charge for services like knowledge transfer, intelligent reporting, cash management and risk management in addition to the existing pricing structures of position keeping, corporate actions processing, and settlement processing. The challenge would be to quantify the charges against the new services, especially for data servicing and knowledge transfer which will rely on technologies like AI and digitization.

The custody industry is going through a period of transformational change riding on digital solutions and AI.  However, the requirement from a custodian, which is safety of assets, locally or globally will remain unchanged. Risk management is a highly regulated activity with a minimum requirement of infrastructure and net worth and such functions cannot be outsourced easily. While the range of activities may change, causing them to develop new capabilities, custodians will remain an integral and valuable participant in the functioning of the financial markets.