The Future of Custody – How the Winners Will Plan & Prepare to Win

As the industry pauses for reflection during the unprecedented times that the world now finds itself in, the role of technology and its potential to transform operating models becomes increasingly evident. Digitalisation was already at the forefront of the agenda for much of the industry, where leadership understood the transformational impact it could have upon the operating models of the future. And also recognised the need to evolve their business models to deliver value in the future.

“Moving forward, the primary differentiator for custodians will be their technology and data, and very little else”. [1]

But whilst the opportunity may be obvious, the complexity of successfully executing this type of transformational journey is ultimately where the challenge lies. For the majority of custodians, the operating model is developed around a core books and records platform – which is typically developed on in-house, legacy technology. And whilst this is in many cases old (30 years + is considered a norm for most), it plays a critical role in delivery of the core component of any custody offering – where security of both client assets and data is a fundamental necessity for any service provider. This creates a delicate balancing act for transformation agendas, as demand for innovation must be tempered by the need to provide protection for both client data and assets. It is this necessity that provides the high barriers to entry for any competition, but it also creates barriers to change where transformation efforts can be slowed by the age and complexity inherent within the architecture.

But as the capital markets industry emerges from a decade of restructure, the role of the custodian has become increasingly critical to clients in their search for an efficient and sustainable post trade cost base. The unique positioning that the custodian occupies within the post trade value chain makes them well placed to service this demand – but this must be tempered by a realisation of thinking differently around how to deliver value. And this must start with a fundamental rethink around both how value is derived and who delivers it. Traditional approaches to delivering value were dominated by in-house technology, complemented by low-cost service centres dedicated to providing core custody processing. But the pace of regulatory change over the last decade has made the post trade landscape significantly more complex, which when combined with margin pressure across the industry has led to increasing demand for innovation by clients searching for efficiency. Relying on old-world approaches to delivering new-world solutions will not provide this level of differentiation – meaning partnering and collaboration becoming critical to delivery of enhanced value to meet this demand.

“Both banks and fintechs today spend approximately seven percent of their revenues on IT; but while fintechs devote more than 70 percent of their budget to launching and scaling up innovative solutions, banks end up spending just 35 percent of their budget on innovation with the rest spent on legacy architecture” [2]

Custodians should be looking to new entrants not as threats but as partners to support development of new services and capabilities that they lack bandwidth or skills to create internally. This will support their ability to deliver best of breed offerings, enabling them to maintain the robust, ‘safe’ services at their core but bringing in innovation alongside them to deliver differentiation. The winners in the battle for differentiation will be those that are able to re-imagine the service proposition in the world of tomorrow, not today. And they will recognise that delivery of this proposition relies on partners and service providers delivering their core competences into it, to truly provide best of breed.

Here are 3 key considerations for senior leaders around how to win:

 Understand what you do and how you do it. In a world of fragmented operating models, bespoke requirements and unstandardized processing, the start point for the journey has to be to understand what you are trying to solve for. This continues to be repeat theme in transformation failure, bad processes are at best merely speeded up through technology transformation – and at worst, fail completely.

“While RPA can transform the economics and service level of current manual operations, we have seen as many as 30 to 50% of initial RPA projects fail” [3]

Acknowledging the complexity of operating models equates to failure for many, who continue to persist in throwing technology at the problem they don’t fully understand. But recognising how value is currently delivered to clients is a critical first step in re-imagining how it can be delivered.

 Technology is an enabler, not an outcome in its own right. By adopting a ‘tech-led’ approach to transformation, many leaders make a fundamental mistake in thinking that technology choice in itself is the transformation. Technology is there to deliver a business outcome, it is not the outcome in itself – and where technology decision making leads the discussion, the result is solutions looking for problems rather than the other way round. Business leaders must bring technology to enable strategy, not assume it is the strategy.

 Change governance ultimately decides success or failure. Viewed by many as the most ‘boring’ part of the transformation exercise it is ultimately the most critical to success. Success here is time consuming and requires investment but continues to be under appreciated by senior leadership. Ultimately you get what you pay for in this regard, but assuming a complex transformation change  happens as a by-product of the day job is a fatal (but common) mistake where good intentions are derailed by poor execution.

So, whilst technology and data are core to the differentiation of the custodians of tomorrow, it is strategy definition and execution that will ultimately separate the winners and the losers.

[1] SECURITIES SERVICES: NO TIME FOR COMPLACENCY, Societe Generale Securities Services July 2019

[2] McKinsey Global Banking Annual Review 2019: The last pit stop? Time for late-cycle moves

[3] Get ready for robots:  Why planning makes the difference between success and disappointment. EY 2016