Luxembourg 2018

ASSET SERVICING ROUNDTABLE: Getting ahead of the curve

An expert panel of asset servicers talk about how they are adapting to the digital challenge, and the effect of rising interest rates on their industry.

Participants:
Brian McMahon
 (managing director, business development, BNY Mellon)
Pierre Cimino (head of international development, member of executive committee, Caceis)
Jervis Smith (head of investor services, Luxembourg, Citi)
Sébastien Danloy (chief executive, RBC Investor Services Bank S.A.)
Olivier Renault (country manager, Societe Generale Securities Services)

Funds Europe – What do you anticipate will be the most in-demand areas for asset servicing firms in the year ahead?

Olivier Renault, SocGen – Asset managers have three main needs: passive management, alternative funds and loan funds.

Passive management is relevant as ETFs are booming. In alternatives, most of the bigger asset management firms are starting to run two departments – Ucits and alternative investment funds – and in the coming years these teams could even merge.

Loan funds are a part of alternatives though with different issues surrounding them, such as bank disintermediation.

In my opinion, one of the biggest business developments is that ManCos [management companies] are developing to service these kinds of needs.

Brian McMahon, BNY Mellon I agree that debt is one of the hot topics right now, with hedge fund managers going into this area. It is also reflected in commercial real estate infrastructure.

Debt is a huge part of the investment management business at the moment. The challenge is always around being able to successfully deploy the capital raised. But another development is around there being now more engagement between asset servicers and clients on data, in terms of how often clients receive it and how they receive it, among other issues. The often misused phrase of ‘acting like a partner’ is truly becoming the case now and strategic relationships are developing.

One final thing, I also think we will see the evolution of outsourcing in real estate strategies far more in the coming years.

Jervis Smith, Citi – Those are the main developments in asset classes, yes, and as asset managers adjust to that, they are doing so amidst globalisation and fee pressures. This creates pressures for them, and pressures for us the asset servicers.

For example, I agree there is more of a partnership around data but this really comes from an ability to keep pace with digitisation. Asset classes become more esoteric and the pressure to maintain infrastructure around them means the asset servicing industry has to be more efficient and more global - and that sees us all turning to technology for solutions.

Sébastien Danloy, RBC – Data is a highly important part of technology, but technology also goes beyond data.

Our clients have concerns around cybersecurity and they are interested in blockchain technology. Asset servicers have to work with them to see how these areas can develop.

But back to the topic of outsourcing, I would add that there are quite a lot of asset managers that have not necessarily outsourced as much as they could have done and will do so as they look more closely at operational risk.

Also, there are more opportunities with existing clients to expand the scope of services that we offer, including new services that asset managers are no longer keen to keep in-house and as their business model evolves, there are opportunities for asset servicing to go even further up the value chain than we have done.

For example, we can replace or provide some information to distribution teams that until now they probably sourced in-house or bought from third parties. And regulatory reporting, which as a whole has become more and more challenging, and asset managers who used to do this in-house are looking at outsourcing it.

Pierre Cimino, Caceis – The demand for data is highly significant and it means asset servicers have to create a very strong database model for quick delivery of information. This is a major focus for us now.

Funds Europe – Advances in technology and digital are taking hold in the asset-servicing world. What are the emerging skill sets necessary for investor servicing firms and in general, what are your approaches around technology?

Smith – In Citi’s markets and securities services business alone we have 10,000 technologists and what we call ‘innovation labs’ around the world, and that’s where a lot of those 10,000 people are positioned. They take ideas that have come from the workforce and then develop them using university resources or their own resources in those locations. We have them in places like Palo Alto, Dublin and Tel Aviv, as well as in established banking centres like Singapore or New York. And only a few weeks ago we opened a new Innovation Lab in London. So it’s a combination of the new with the old-fashioned banking sector.

Then lastly, but incredibly importantly, we’re involved in seeding fintech companies. This is another way of recruiting the skillsets into the business, by investing in start-ups that have some sort of vertical integration into what we’re trying to do. In just this last 12 months, we invested in a cloud-based communications company called Symphony, and an artificial intelligence company called Kensho.

McMahon – A great deal of BNY Mellon’s business is technology-based processing, so technology is at the core of what we do, whether it’s data provision to clients or providing transparency. More importantly is how tech is going to change the way we process data, the speed of processing, and how data as well as robotics and artificial intelligence impact the client experience.

A firm has to be in the right place to do all this. BNY Mellon is in Tel Aviv, Silicon Valley, Singapore, and we have technology leadership development programmes that delve into different parts of the organisation and expose management to it.

It’s all well and good to have a technology such as blockchain, but we have to be able to address the client needs and actually translate what we’re supposed to be delivering as a business to our clients. But, yes, technology is absolutely an enabler and we have to invest in it.

Danloy – In terms of skills, today asset servicers need people who have different experiences and backgrounds, people from other industries who have curiosity, are adaptable, and are agile.

As this is a Luxembourg roundtable, I am pleased to say that at RBC Investor & Treasury Services, we have innovation labs in Luxembourg, or ‘agile labs’ as we call them. The labs mainly focus on services that are very specific within the Luxembourg funds industry. When it comes to shareholder services or transfer agency activities, we believe that we have some of the most skilled people here in Luxembourg.

At group level, we also have centres of excellence for robotics, artificial intelligence and the use of blockchain. But when you have these kinds of technologies, you need to make sure you leverage them for the right reasons and with the people who actually have the technical knowledge of the activities we are referring to.

This is an area where we are investing but we are also working on market initiatives, such as the Fundchain blockchain initiative in Luxembourg, and working with some fintechs, such as Spallian, on a product called Fund Sales Intelligence.

Renault – IT represents roughly 40% of the costs within our industry. So efficiency in IT is key for global productivity. Societe Generale IT departments have been structured to work in what we call ‘tribes’.

Teams work in small groups of ten to 12 people and in close collaboration with operational departments, ensuring that IT development meets the business needs without producing unintended effects. The structure is efficient and flexible.

Staff recruitment has been with new technology and working methodologies in mind, and has included data scientists.

We also look for highly skilled people in accounting, for instance, due to the continuing growth of the alternative investment funds business, which requires specific competencies.

I agree that digital is key, because machines will talk to machines, but above the machines there will always be an element of human interaction. Having people dedicated to clients is a differentiating factor between asset servicers. We see that every day, because we have to be responsive and flexible to serve our clients efficiently.

So in summary we are looking for profiles of two types: technicians with accounting skills within the IT domain, and people with human skills and client focus.

Danloy – I agree about the importance of the human touch because another important skill or category of expertise is the control function. The regulator accepts technology and automation, but also wants organisation to have controls in place.

Cimino – Today, organisations all need to find a younger generation of IT people that basically are able to say that nothing is impossible. We no doubt all have some working group involved in blockchain technology. We cannot say how or when this will happen, but there are people in banking centres with a mindset familiar to five or ten years ago and they will say that blockchain will never happen. We have to find people that are creative and free of the usual constraints of the financial sector.

Smith – I think the Luxembourg government is well aware of this challenge, and one thing that I find very refreshing about Luxembourg is the encouragement to think differently, so the establishment of the Luxembourg House of Financial Technology, LHoFT, for instance, and encouraging start-ups in this space. Luxembourg probably does not have a reputation for innovation laboratories or agile labs globally, but there’s a lot going on here.

Cimino – That’s right, and Luxembourg has the advantage of being small. There are quite similar initiatives in France, but Luxembourg has the ability to move rapidly, which is important with this technology.

Danloy – There are 15 start-ups hosted in LHoFT and it will grow its capability to welcome up to 60, so that really shows that there is willingness there.

In addition to LHoFT there are also some very interesting opportunities to work with the University of Luxembourg, with the Luxembourg Institute for Science and Technology and the Fonds National de la Recherche, which also awards grants and subsidies to innovative projects that create value in Luxembourg.

But the regulatory framework goes beyond purely LHoFT. Luxembourg as a country has done really well in order to attract large players as well as small start-ups to come and establish research labs here.

Renault – Attraction is really the key word, because we struggle to find the engineers locally, so we have to attract them from abroad. Fortunately, as a French bank we have the ability to attract some French engineers.

Smith – Though that may change. If you consider that eight of the large Chinese banks have established their European headquarters here in Luxembourg, Luxembourg is starting to act as a truly multinational magnet of talent coming to the country rather than being imported. And perhaps with Brexit, this type of shift will be even more pronounced. The infrastructure of the country has to be developed, to increase the appeal of Luxembourg, but at least the appeal is there.

Cimino – Yes, and creating a landscape to be able to set up new technologies and processes has to be backed by the regulator, and fortunately the regulator is supportive. Without that, we would not be able to do anything.

Funds Europe – Can custodian banks with operations in Luxembourg easily get the support of their head offices abroad for fund-related projects in Luxembourg?

Danloy – In large global groups you will always have a lot of initiatives happening in head offices, whether they are in Canada, in the US or in France. But that combination of global knowledge with local expertise that exists here can really move things along.

Fintechs in LHoFT are mainly new initiatives that relate to either payments, or to the funds industry and regtech in general. Luxembourg needs to leverage its skills in the areas where today it is strong – and that means in the funds industry. That’s where we need to find the right balance between the local knowledge in the funds industry and the global knowledge that we have in our firms related to technologies. Combining the two makes Luxembourg successful.

Renault – Within Societe Generale, head office approval will be necessary at the end of the process, but locally we have the capability to participate to initiatives or to develop digital tools. We are part of a global organisation, and as with most global organisations, we need to get the green light from many people. Positively, it also works the other way around: if people in the head office want to set up a new tool or a new technology, they will ask Luxembourg to determine if it fits our needs.

Cimino – Generally speaking, we are talking about what are more idea-driven strategies. If there is something that shows potential, you need to defend it, you need to sell it to your head office, but afterwards you can develop it anywhere.

Caceis participated in an initiative on blockchain called TM that took place in Luxembourg, and we can use specialists from our Paris office if need be. But at least if the idea is initiated in one of our locations where we have a strong or sufficient presence, we can sell it, we can defend it, and we will go for it.

McMahon – A strength of a global bank is that it brings an operational model that can be applied to multiple jurisdictions. The key then becomes how to leverage global investment and global execution, and local requirements, and having a form by which all that product initiative and all that client requirement can be properly vetted and escalated, reviewed and approved.

We have people here in Luxembourg that are leading initiatives, such as in transfer agency, because we have that sort of skillset here, but we would always leverage our global strength, too.

Funds Europe – Will blockchain replace transfer agency?

Cimino – It will depend on the way we evolve. There will definitely be a shift in this business, but again there might be some movement in the different functions that we have today in TA, but you can also talk about this in relation to custody. There will be changes but it’s too early to say.

Smith – You should really look at it from the client-experience point of view where it’s a bit like Uber and what Uber has done to the taxi industry. There’s still a place for an ordinary black cab in London for people who want to have that experience; but if you want to have an easier way of ordering mutual funds, then it’s clearly better for you to be able to enter a marketplace where the KYC [know-your-client] process needs doing only once.

We hope regulators around the world will start to see the benefit of a one-stop KYC process rather than expecting every bank to do due diligence on the same clients that they all have, or every mutual fund company to do due diligence on the same client. Looking at it from the client-experience perspective, this has to be applauded.

Renault – Automation is not new in our industry and we have been working on more efficient operational models for years and that has in itself created new jobs. The question is less about blockchain replacing the TA, but more about what blockchain will bring to our industry. I agree that if it will improve the client experience and the way we work altogether, blockchain will be adopted across the industry.

Danloy – As a transfer agent, we know that there’s going to be an evolution of the role and what is a transfer agent today will not be what a transfer agent will be in a few years’ time.

Smith – It may help with this question to distinguish between processing and mining the data, meaning how the information that you’ve processed is used. I think the TA industry, as it pertains to simply keeping a set of records on people and maintaining a shareholder register, is going to move towards an actual understanding of the end investor. Regulations like MiFID II push us towards that anyway due to the need for fund manufacturers to understand how their products are sold by distributors. All of these things link in a value chain for which technology is the backbone.

Funds Europe – You all represent large administration firms. How do you view the rise of smaller admin players in recent years? Do they provide a challenge to you?

McMahon – To be fair, there is not a smaller player here to speak, but what I would say is that they have all grown off the back of the private equity and the wider alternative space, which we have already identified as booming right now, and so by definition their revenues are growing.

The fundamental element is around service and the challenge that the banks have had to address in recent years is the impression that a custodian bank may or may not understand the needs of alternative managers.

You often hear people talk a lot about a boutique administrator being flexible and understanding the alternative business more, but the market has evolved massively over the years and all the custodian banks recognise the need to invest in the talent that supports this business.

It’s not about having somebody that has done exception management on a traditional fund; you have to have accountants that understand why you’re processing something the way you’re processing it. People talk about debt funds, but the requirements for a securitised loan fund versus a commercial real estate fund, versus a distressed debt strategy are quite different. Whether in a boutique or a bank, it’s about understanding and delivery.

Do I think that there’s a challenge to the larger banks? I don’t think so, but there will always be a place for a boutique. That said, I think as people’s understanding of the depositary function under the Alternative Investment Fund Managers Directive (AIFMD) becomes more valued and understood, this lends itself to the global banks becoming the predominant players. A client of mine spends more on transaction costs every year than the balance sheet of some of the boutiques. That doesn’t mean anything about their service, their services can be fine, but I do think the investment dollars that global banks are putting into the space is going to outweigh what the boutiques are delivering, and the sophistication needs of both the asset owners and the asset managers is ever-increasing, and the challenge will be whether or not boutiques can keep pace with that. We’ve mentioned regulations, we’ve mentioned transparency, we’ve mentioned blockchain, there are so many different aspects that they need to invest in. This will most definitely be a challenge for boutiques.

Danloy – Small and mid-sized administrators come from a different angle than we do. They were servicing non-regulated structures but now see their clients under the AIFMD interested in setting up a regulated business, and so indirectly that has given them the opportunity to set up new services around management company services, fund administration and depositary services. However, this has been centred around a specific asset class, which is private capital.

That said, when you look at our business, two years ago we had 50 people servicing this asset class in Luxembourg, and today we have over 120, and it’s growing quickly.

The difference is that we are not necessarily targeting the same types of clients. The type of clients that we are dealing with want the backing of a bank as a depositary and often need the balance sheet because they want access to financing which smaller administrators may not be able to provide.

At the same time, Luxembourg is the only country where non-financial institutions in Europe can act as a depositary for specific asset classes, but my view is still that the balance sheet is important and these players don’t have this balance sheet power.

It can be argued that when there is a packaging together of management company and administration services, it results in a lack of independence. A depositary and management company should oversee one another, and this should remain key.

Renault – I agree but will also observe that a small boutique will normally want to work with a smaller manager because they are the same size and do not need to have a lot of internal procedures. That’s why, as this business is booming, we see the creation of a lot of boutiques like that and new businesses for them.

Cimino – In saying that some smaller managers may prefer to work with boutiques rather than larger banks, we also have to consider that some big banks may not want to work with certain smaller managers. This may be because of some regulatory or group issues the managers have, such as restrictions placed on them by their risk committees, and sometimes larger banks may not have the flexibility required by some of the smaller private equity or real estate players.

Funds Europe – What would upwards-moving interest rates mean for custody banks? Will that create a better revenue environment for them?

Smith – Broadly speaking, rising interest rates are good for banks, and you can see that in the increase in bank stock prices in the US. But after such a long period of low interest rates, clients have become much more sensitive about the individual pieces of what a custodian bank offers.

What I mean is, in the old days, a bank might price custody at a very low level knowing it would get large cash balances – or price low but get securities lending business or foreign exchange, for example. Now, though, there’s much more scrutiny from clients. It’s partly regulatory driven but mainly it’s commercially driven to see what are the returns.

So, in the past, rising interest rates would have been more beneficial to custody banks than they would be now.

I think there are more interesting implications of the rise in interest rates around some of the alternative asset classes. We mentioned bank loans earlier on, obviously bank loans will go up in value as well, because if the interest rate’s going up then the money that they make on the loans will go up. So, there are other aspects to this.

It will also lead to people being more interested in what returns they get on their cash, so the appetite for money market instruments and other ways of getting return on cash balances will be greater.

McMahon – You could say over the last couple of years, clients may have had a challenge finding a bank that was willing to take cash. With higher rates, banks will be more open around cash management. The fact that interest rates are going up is good for banks, but good for the industry overall, by virtue of the fact that we can probably offer more services. Doors will open again.

Cimino – I am definitely in line with these views. Rising interest rates will have positive impacts for the P&L, especially when you consider that in some cases banks don’t charge back negative interest. But the slope of the curve is extremely important as well. A very steep curve, even if the rates are negative on some troughs of the timeline, could already give the banks more breathing space. In a negative interest rate environment it may be difficult to make even small margins as clients are more focused on value.

Renault – Mechanically, higher rates will increase bank revenues – but there could be some side effects, such as on the bond market and therefore for corporates, where we could see some bankruptcies, jeopardising to some extent the benefits of the rate increase. However, overall, it would be positive for the banks.

Danloy – The current environment has certainly pushed all of us to review the way we operate and to ensure that our business is actually a sustainable business, even when the financials are not really in our favour.

In terms of higher rates, today you really have a very different situation depending on the currency. If you have clients holding US dollars or euros, you probably have a very different view of what your net interest and margin could be, but if you look at euros today, for me what’s very important is not so much the rise in interest rates, it’s more about how steep the yield curve is.

Today there is no curve, and that is probably one of the main challenges that a lot of banks holding euros have to face.

Funds Europe – What, if any, is the most evident effect of the UK’s Brexit vote on Luxembourg’s asset servicing landscape?

Danloy – Very simply, we see more and more asset management companies establishing a presence or at least more substance in Luxembourg, and jobs and opportunities being created.

Renault – Estimates are for 30 to 50 new asset managers coming to Luxembourg thanks to the Brexit, but starting with very small structures.

Danloy – However, the CSSF [Luxembourg’s financial regulator] is really pushing hard at management companies in Luxembourg to have greater substance, and those with two or three people are no longer accepted by the CSSF.

Renault – In the long-term perspective, I totally agree, but today we see that they are very small, and they start very small.

Cimino – Much will depend on whether it is a hard or soft Brexit. But there will be hot competition between Luxembourg and Ireland.
Luxembourg I think is well positioned, and where I see that Luxembourg has a very good opportunity to develop itself is in the private equity and real estate business.

McMahon – What asset managers want is certainty, and what Luxembourg has been able to deliver over the years is that certainty. So I think a lot of asset managers are making plans accordingly, and you can see that in the statistics. Real estate business has pretty much doubled in the last two years, and other assets are increasing dramatically.

Smith – You’ve seen some of the asset servicing organisations that previously depended on a UK entity having to establish European bank entities in order to be able to continue to service the industry as well, so that’s another direct impact, though most of the initial impact has been around management company structures and the inability of in-house ManCos to operate as a ‘super ManCo’ from the UK.

Going forward, the attitude of the politicians about delegation is going to be very interesting because we’re already seeing a polarisation of politicians about what will be allowed to be delegated to the UK, and what won’t. There is not unanimity in Europe about that, and then that impacts on the regulators as to their stance and their interpretation of what can and can’t be done in third countries.

That could have a far-reaching impact if it goes the wrong way because Luxembourg is a small country with a small population. We have to be able to offshore activity as asset servicing companies; we can’t do everything in Luxembourg, there aren’t enough people here to carry out activity that we’ve already spent the last decade moving to centres of excellence in other locations.

So at Citi, for example, we do all our pricing in Luxembourg for all our business globally, but similarly we do a lot of other activities in Poland for our fund accounting business, and I would be disappointed if one unintended consequence of Brexit was that it actually starts to make it very hard for organisations servicing funds to be able to do it in the best locations, and that they have to do it in locations that are imposed on them by politicians acting out of self-interest.

©2018 funds europe