While custodians have been around for nearly as long as asset management, the last decade has seen a number of elements of the custody market changing.
Technological developments, demand for data from regulators and the public, and a strengthening regulatory spotlight on the superannuation industry have all seen the expectations super funds have of their custodians’ service provision increase.
Their existing requirements haven’t lessened either, with the need for efficient trades still there and growing cross-border investments adding pressure on custodians to provide access to global markets.
So, how are custodians responding to these demands? With the size of the $3 trillion superannuation industry only growing (it’s expected, for example, to account for half of funds invested in the Australian Securities Exchange (ASX) within a decade), it’s in custodians’ interests to ensure they remain competitive.
And from growing their global teams to improving their data sharing and protection to investing in blockchain, custodians are working hard to provide what super funds need.
Technology and funds’ positions within an increasingly global world are obvious harbingers of the development. Digital advances are both changing the offerings of custodians and increasing the depth of service people within those businesses need to provide.Then from an international perspective, growing demand for global investments means custodians need to ensure they can meet the needs of cross-border investors. Around 35 per cent of assets under custody are invested offshore, and there’s a continued trend for investment in direct assets abroad such as infrastructure.
These could include the ability to offer access points on the ground in China or to operate as a market participant in India, chief executive of BNP Paribas’ securities services business for Australia and New Zealand, David Braga, says. Providing the latter, for example, has allowed BNP Paribas to “give our clients immediacy of access into the Indian market and to people who know it intimately”.
So, funds need to decide whether having their assets managed domestically or the agility offered by global custodians matters more.
Northern Trust country executive, Australia, Angelo Calvitto, points to the ability to both process and deliver information globally on a 24/7 basis as a benefit of being an international custodian, as there are offices across various time zones, as well as connections to global infrastructure.
“It means we’re effectively bringing to the client a full global view of their investments, or investments they’re thinking of making,” he says.
On the other side, Nab Asset Servicing executive general manager, John Comito, says that NAB is proud to provide all its custody services onshore, particularly in an environment where there’s a heightened focus on asset safety and growing regulatory oversight.
Changing nature of clients
The main change in the custody landscape is coming from the nature of the client – superannuation funds – changing in themselves, which Braga labels as a “increasingly prevalent” development in the state of the market.
“Super funds are obviously going through a lot themselves as a sector,” he says, pointing to regulators’ narrowing focus on the best interest duty. “So, in terms of the types of services we need to provide, that’s changing.”
Comito, too, has observed the post-Banking Royal Commission spotlight on trustees acting in members’ best interest, and believes custodians can help funds meet this growing responsibility,
“There has been an ineffectual balance between the direct costs of providing custody services which is disclosed to regulators and periodic reporting by a fund, to the indirect costs to funds of tax leakage, sub-optimal interest rates, and foreign exchange margins,” he says.
“We have spent considerable time working with our clients to develop a product suite that assists in providing transparency and addresses these opportunities to optimise member returns.”
There’s also growing emphasis on mergers as far as regulation is concerned after the Royal and Productivity Commissions’ reports in the last 12 months, and this too will impact the nature of superannuation funds.
The critical mass of funds is now a key determinant of whether mergers are needed, with Australian Custodial Services Association (ACSA) chief executive, Robert Brown, saying that regulators will be asking funds yet to achieve that mass hard questions as to why they haven’t.
ACSA chair, David Knights, believes that the push for critical mass will open up the potential for internalised investment teams and expanding mandates, again holding opportunity for custodians: “As a consequence, the sector’s need for robust investment administration, information, and control continues to grow.”
Brown backs up the idea that the nature of clients is changing: “The increased sophistication of clients is a major factor driving changes in the investment administration and custody sectors,” he says.
“For example, direct investment raises additional challenges through the often-bespoke nature of legal title, reliable valuation and performance data, cash flow management and hedging through the ownership lifecycle, jurisdiction specific tax and regulatory treatment and access to other asset-specific information.”
Demands for data
The sheer volume of data held by custodians on super funds mean it’s unsurprising that both access to and dissemination of this information is key to what funds are demanding from them.
To start, members and regulators alike are becoming increasingly aware of their super funds’ responsibilities and demands to see both information on investments and queries about data protection may follow.
Then on top of that, Calvitto says that funds want access to the data produced by custodians both to manage risk and then to make decisions on the back of that.
Regulators too, want access to data, in line with the emphasis on best interests, performance, and fund scale outlined above. While this growing demand represents a challenge to custodians, Brown says it’s also “an opportunity for the industry to work with regulators to utilise standards, avoid duplication and encourage efficiency”.
There’s a responsibility for custodians here – as Braga says, “we’re very aware we have all the asset data and it's challenging for super funds to access that information other than through us … [meeting that] reflects our core values as custodians”.
But that doesn’t mean funds just want the raw numbers. As Brown observes, “they don’t want a vast data ocean that [they’re] just swimming around in”.
To help resolve this issue, BNP Paribas is focusing on improving the visualisation of data, aiming to improve how clients can see across it.
Further, data needs to be immediately accessible – Calvitto says that both clients and the market in general are looking for access to data in real time, meaning custodians’ underlying technology needs to be integrated and highly automated.
The operating model used is also vital, as “that determines how we capture and deliver that information”.
The use of technology to deliver data won’t be at the expense of other parts of the business however, according to Calvitto. Rather, the role of people and human expertise will become more important in working out how to respond to both market and regulatory demands and change rather than just acting on it.
“We’ve got a lot of complexity that our clients want us to support, and we want [people’s role] to be less about knitting that together and more about having trust in the underlying system … and then being able to apply that [expertise] to benefit clients,” Braga says in support of this.
This extends to artificial intelligence’s (AI’s) role in custody provision more broadly, as well.
According to Northern Trust’s head of market advocacy and innovation research for Asia Pacific, Danielle Henderson, AI will be crucial to the full maximisation of the potential of data and analytics to super funds: “AI is the enabler of the potential development of improving decision-making and that broader client experience and driving efficiencies throughout our [custodians’] organisations”.
Adding to Calvitto’s point, Henderson says: “We hope to use AI to take some of the low value-add tasks from our key people and ensure that we use them instead for some of the high value-add tasks for our clients.”
Robotic process automation, which drives efficiency in operational processes, is one such use of AI – “it’s dramatically improved productivity of some of our core teams,” Henderson says.
There’s more areas under development too, with Northern Trust currently researching more advanced AI capabilities that could apply to superannuation clients such as conversational interfaces, Amazon Alexa-style tools, chatbots and digital assistants that could become future interfaces for clients, and the use of document analysis and ingestion tools to improve efficiency around processing.
Further, as written elsewhere in this magazine, a key test for financial institutions in the next few years is going to be how they protect clients’ data. Custodians are no exception. Indeed, Calvitto says, safekeeping data goes back to what custody traditionally was – the guarding of assets.
The conditions for protecting data aren’t easy, though. “We are living in interesting times, with geopolitical tension and cybersecurity threats giving rise to a heightened focus on asset safety,” Comito says. “This is seeing a drive for greater regulatory oversight on disclosure, transparency, and data security, [such as] CPS 234.”
Then on top of that, custodians need to work with data that’s held outside of their own systems, which brings about issues with security of systems and data sharing.
An inefficient market?
Unsurprisingly, a core aspect of custodians are working to provide for super funds are trades that are as efficient as possible.
ACSA flags inefficiency issues with the ASX as an ongoing concern. Brown believes that the Australian market is historically weak when it comes to corporate actions, for example, citing a lack of automation and standards. Improvements could come from the adoption of best practicing within proposed changes to the ASX listing rules and the ASX Corporate Actions STP Phase II initiative, both of which ACSA is supporting.
The domestic clearing and settlement landscape is changing, which is also of deep importance to the custody industry, particularly where the ASX CHESS Replacement Project is concerned.
“This major initiative by the ASX is of fundamental importance to the sector domestically and the standing of the Australian market,” Brown says, labelling the industry’s response to both the opportunities and change it offers as “critical focal points for the year ahead”.
Despite the popularity of managed funds to institutional investors, they remain inefficient in Australia, with excess risk and frictional costs. ACSA is targeting this as another area of focus for custodians, facilitating a taskforce approach with asset owners, fund managers and specialist providers.
“Working groups are focused on areas of industry standards, investor on-boarding, fund data and reporting, together with automation in orders and transfers,” Knights says.
He anticipates pilots and market place changes to roll out in the next few quarters, in what should be welcome news for investors.
Risk minimisation around trades can also improve efficiency, and artificial intelligence (AI) tools could help. Where there’s potential for failed trades, Braga says AI could proactively predict which trades may fail before they do so, and then catch them beforehand.
Then there’s blockchain, which the ASX and custodians alike are working to integrate into their trading processes.
“Blockchain initiatives really can provide opportunities for industry-wide impact and change, particularly in improvements in the way financial transactions are conducted,” Henderson says. Reducing transactional friction and increased transparency of and access to real-time data are two benefits.
The superannuation industry is open to exploring blockchain too, which is welcome news in an industry where the sheer volume of funds under management often makes it slow-moving.
“There’s a genuine interest in understanding how the technology will be deployed and how it will lead to benefits,” Henderson says, noting, however, that it’s taken time to take clients on the journey to understanding how blockchain will impact the financial services industry.