Funds Europe speaks to leading Luxembourg industry figures about the growing regulatory demands on asset servicers and how to remain profitable in spite of major investments in technology.
Jervis Smith (head of investor services in Luxembourg, Citi)
Brian McMahon (senior Alternative Investment Services business development executive in Luxembourg, BNY Mellon)
Olivier Renault (country manager, Societe Generale Securities Services Luxembourg)
Sébastien Danloy (CEO, RBC Investor Services Bank S.A.)
Funds Europe: We are in a low-return environment. Are cost pressures from clients getting worse? And if so, why?
Jervis Smith, Citi: The answer is yes, there are cost pressures on the asset servicing industry in general from clients. These emanate from two areas. One is that asset managers are all facing a squeeze on their margins, from their clients. The second is the rise of passive management, and a low return environment anyway, so that if somebody is charging 1.5% for their services, in a 15% environment, that’s very different to charging 1.5% in a 2% environment.
Brian McMahon, BNY Mellon: It’s not just the cost of investment management or the cost of administration. When investors are looking at funds, they’re looking at the cost of the overall fund. There is pressure on the management fees and other costs, and while some of these costs might be pushed into the fund, a lot of sophisticated investors are sitting back and going, “That’s fine, but this is the cost of running the mandate.” As you’re also looking at aggregation in the industry, and your various funds being amalgamated and the shift from active to passive, the main thing investors are looking at is, what return can I get from the cost of this operation?
Olivier Renault, Societe Generale: I wouldn’t say that the environment is worse than before. It’s complex, but it will remain so, like in every industry. From what I have seen, the pressure is slightly different than before. For instance, when it comes to RFPs [requests for proposals], there are a lot of deadlines to meet. It leads to competition between market players, and we have to lower prices. In terms of day-to-day business, I feel less tension than before. When we mention regulation, we could also think about negative interest rates, which can sometimes be a challenge with some of our clients. On the whole, however, I’d say that our clients understand that we are under pressure as well. It is easier to discuss these issues than before as they understand our constraints as well, particularly large clients.
For smaller clients, the challenge is to justify our fees. Because of regulation, we have to charge a minimum of fees and smaller clients need to address this with us. In a nutshell, there are two kinds of clients: the big ones and the small ones. The big ones give more priority to the RFP process and the smaller clients focus more on market competition and price negotiations.
Sébastien Danloy, RBC: We should not forget that cost is only one element; today, clients don’t take decisions purely based on cost alone. There is also a great deal of pressure driven by the competitive environment in which asset managers themselves operate, particularly the battle between active and passive portfolio management. Active managers tend to be more cautious about their total expense ratios [TERs], with some players implementing a fixed TER, and they can be very transparent towards their clients as to what are the total fees and costs allocated to the fund overall.
Naturally, as they try to reduce their fixed TER, they put a lot of pressure on all the different vendors, including asset servicers. And how do we respond to that? The world has changed, and continues to change. When you talk about Ucits V for example, there are additional responsibilities for depositary banks, and asset managers understand that with those increased responsibilities, there are some associated costs that need to be covered. Negative interest rates are another case where clients understand the pressure that we face. It is to be expected that on some of the core fees, there are at times ‘robust’ negotiations, but at the same time, clients acknowledge that on the other side, there are new services being introduced. A long-term and profitable client relationship needs a pricing approach that make sense for both sides and for many clients it is reasonable for them to participate in many of the additional costs that are being borne by their asset servicers.
Smith: Gone are the days where people might price their custody very low in the hope of getting the ancillary foreign exchange, securities lending etc. Now, because there’s scrutiny and unbundling of that model, if people are looking at how much you’re charging on FX, how much you’re charging on securities lending, it’s impossible to do that bundled type of ‘finger in the air’ pricing and making those assumptions. A sort of ‘funds in a box’ for the core service to the smaller clients, with minimum fees because they’re just starting out, that’s one end of the spectrum, and then at the other end you’ve got the ‘partnership’ or long-term approach. Those are very important considerations, which I’m not sure always register with regulators, for example, or any independent observer of what’s going on.
McMahon: Our clients are sophisticated, understand our business and know we have to make money. If we’re not being profitable in what we do, then they will probably be concerned that we’re not going to give them the care and attention that they need.
Renault: But it does play into the decision- making process when the weight of our cost is significant in their TER. With passive management, it’s very important because we’re talking about ten basis points of the overall total, so the TER is ten basis points and of course if we charge two basis points, it represents 20% of the TER. Nevertheless, if we charge let’s say three basis points or four basis points in a TER of 50 basis points, the weight is lower and the pressure is lower as well. That’s why I said I feel that there is perhaps less pressure than before, because our prices are so low now.
Funds Europe: What is the best way to deal with growing regulatory pressure? Do you handle post trade regulations such as T2S totally separately or is there an aim for standardisation of reporting?
Smith: There’s the impact of regulations on us as a bank. We have to invest in our business, effectively to keep the lights on, in terms of technology, and what represents a significant part of our technology investment every year is keeping up with the regulatory environment. And then there’s the impact of regulations on our clients, and the requests that they come to us for, on reporting and benchmarking, which is almost a case of the regulators being our friends. Because the more regulations they pass, the more business there is for us.
Danloy: I don’t think it’s a growing regulatory pressure. Instead, it is a case of adjusting to the evolving regulatory environment; something we have been doing with greater frequency and scope since 2008. We are all still in this business because we have been able to manage these changes, some of which required changing the way we operate. The pace of change may not necessarily increase, but it will continue.
Renault: I disagree on the consequences of the ongoing pressure. We are entering a more complex world. We are well positioned to face this pressure as we benefit from expertise within the bank regarding regulations and I know we can rely on our compliance department to accompany and inform us on the changes we will need to make. They are well informed on all of the regulations, which allows us to have a global vision of the impacts these regulations have or will have.
McMahon: You can’t look at any regulation in isolation. You have to look at the overall operating framework. You have to look at whether this coincides, contradicts, is in parallel, harmonises, disrupts your other technologies and your other initiatives. I’d anticipate that everybody at this table has groups that look at the overall regulatory framework. It’s estimated that the IT spend by all banks globally will grow to $241 billion in 2016, and a large proportion of this will go on maintenance and just adhering to the regulatory changes.
Smith: There’s a ripple effect as well, so having just come from Hong Kong, I’m much aware of the difference in sophistication in terms of the awareness of the regulatory impact in different countries around the world. So you start in New York typically, or in Washington more precisely when it comes to regulatory matters, and then it hits London and Brussels, and then it goes east. And sometimes it fades out. I mean, RDR [retail distribution review] as a concept is sort of unheard of in Taiwan, for example. So some of this regulatory pressure fizzles out. Other bits just gradually gather pace, and then hit the countries almost at the point where Donald Trump might be repealing Dodd-Frank before it’s even been implemented by regulators out in Asia. So there’s a sort of ripple effect going on around the world, and I feel that we may have plateaued in terms of the increase in regulation.
McMahon: The regulatory landscape will continue to evolve. The push for harmonisation and emergence of fintech will force people to think about different things. If you’re going to be having digital currencies and blockchain coming through, how are they going to be monitored? So as much as some regulatory trends will dissipate, they’re going to be replaced by others. Every bank and financial institution has to continue to invest and will have to continue to invest, to address these changes.
Danloy: Coming back to regulation, we also have to be aware that, even when we talk about European Directives, and MiFID II is a good example, local implementation of the same Directive can end up with a completely different solution from one country to another.
Coming back to local market knowledge, that’s also very important when it comes to global or regional regulation. Local implementation can be very different from one country to another and having a local presence definitely helps.
McMahon: We compete with different players at different levels, and it’s interesting to hear the views that others have around risk. The impact of the regulation hasn’t been fully felt yet, because it hasn’t been fully tested yet. AIFMD, for example, is still a recent regulation and undoubtedly will be tested. How such events may change approaches remains to be seen.
Renault: There are still some grey zones and different interpretations. We see that in different banking associations, here locally and at a different level. First of all, it’s not black or white, so there is still some room for interpretation, in particular regarding the formalisation.
Smith: Sitting in Luxembourg, we probably have a more global view around this table than our peers would do in other regions of our organisations, where they’ve been much more focused on local interpretation of the regulations, local impact on clients. Here in Luxembourg, by virtue of the fact that it’s basically a global centre for the mutual funds industry, we have to be much more aware of what the impact is in different jurisdictions, not just with the CSSF here.
Funds Europe: Looking at technology, how is this being used to benefit your clients? Is there a way of getting more value from existing data?
Renault: I used to build a lot of expert systems, before joining Societe Generale, in particular modelling and optimisation. When I arrived at the bank, I thought it would be great, managing a lot of data. What I discovered is that if you want to use data, it needs to be in the same format – what we call data clean-up – which is very important. Today you often hear the term ‘big data’ in the web environment, but this is simply lots of data. What people don’t take into consideration are the costs that are generated when the data needs to cleaned. In order to do this, we need to address the question, ‘how will we use the data?’ before assessing how to set up data warehouses needed to store the data. Once it’s been cleaned, data is quite easy to use. In our business, the challenge is getting this clean data.
It’s easier in private banking and in retail banking, but in securities services, because of the number of systems involved, it’s not that easy. In terms of IT development, we invest in three areas. The first one is regulation, which is increasingly important, and represents between 40%-60 % of our IT developments, so it’s a quite significant portion of our development each year. The second area is dedicated to developing new services for our clients and the third is operational efficiency.
McMahon: BNY Mellon is launching the biggest technological transformation in its history with NEXEN, our new open-source, cloud-based technology platform. NEXEN is designed to empower clients to change the way they operate to be more flexible, client-responsive, efficient and fast. Central to this is the ability to provide data-driven insights to enable our clients to make evidence-based decisions faster. Our clients want different tools, different product sets, more transparency and as the phrase goes, the era of fintech is here. So the question is, how do we adapt? And how do we deliver against it? And for us, the way we view it is, we have to be able to provide data faster. We track the time for data queries now in milliseconds.We provide trend analysis about distribution, and how cash and investments are flowing on a global basis. This helps our clients manage risk and investor relationships.
Smith: The ability to look after their clients, so data mining from the point of view of what can they discern about the investors in their products, which is more on the TA side of the business, and then the data that we provide to people to help them improve their performance of their actual product. Those are very different applications. So in the one where it’s affecting the clients’ clients, things like blockchain are going to be very relevant because these are universes, so there’s a transfer agent, there’s a distributor, there’s the underlying investor, there’s the manufacturer. There’s a number of other people probably in the middle as well. All of that can much more readily be captured by blockchain-type technology because it’s an exchange. It’s not just a bilateral activity.
Danloy: On our side, we have a multi-year investment programme in place that focuses on technology and the client experience. We are increasingly adopting the ‘data lake’ concept, where data is stored in its raw, unstructured form to make data streams potentially more agile than when stored in a traditional ‘warehouse’, as data can be amended and extracted as needed and according to differing criteria or applications
Today, with the quantity of data that we possess, we have the ability to access, extract and present that data to our clients in a way that is meaningful to them. We launched our Fund Sales Intelligence product, which provides asset managers with real-time data, day after day, not only on your own distribution channels and what you’re collecting and subscribing, through which country and which kind of investment strategies, but we also benchmark you to the rest of our client base.
Funds Europe: To what extent is automation crucial in third-party private equity fund administration?
McMahon: One of the questions we’re often asked is, to what extent is your private equity automated? Clients want their entries to come in and permeate through the system, so if you’re looking at the SPVs [special purpose vehicles], that data comes up into the fund. This means you can monitor the transaction and help your depository. But if you’re keeping data in digital form so you can create data rooms, this helps asset managers if and when they’re exiting transactions, it helps you satisfy your other requirements. There are means to make this far easier than the days of doing it on Excel. And everyone we’re working with now asks, how can we help? How can you make this faster? How much more data can you provide? The automation of the transaction will always be challenged. But the automation of the actual process thereafter, making sure of your valuation and how can you benchmark your performance in private equity?
Smith: It’s a different emphasis. So when you say how important is it, it’s important because private equity is becoming more mainstream as an investment allocation. So whereas before, we would have all have thought of PE [private equity] as being something separate, and the admin of it being equally separate. Now it’s coming into the mainstream, we’re finding a lot of asset owners wanting aggregated performance measurement, so then you have to be able to show how is the performance in your PE book or your real estate book, or your fund of hedge funds book? How can you make that seamless in terms of looking at the overall performance of the portfolio? It’s less important in the asset management space because they’re more siloed against individual asset classes, so it’s less relevant there.
Funds Europe: What predictions do you have for asset servicing over the next 12 to 18 months?
Smith: One of the predictions for the future is that the security of the data is going to become increasingly important. Because one of the disadvantages that having so much technology floating around has... is that the fraudsters are only one step behind, the hackers and so on, that brigade are only one step behind. And so cyber security is something we’re investing a huge amount in. We hired the Homeland Security cyber security head to run our cyber security business globally.
Danloy: I believe the consolidation that is happening will continue, not only among asset servicers but also asset managers themselves. As an asset servicer today, you want to be servicing those clients that are going to be acquiring and growing tomorrow. It is important to look at your client base, and the market in general, and ascertain who are going to be the acquirers of tomorrow…
Smith: The Janus Henderson deal of last year.
Danloy: That’s a good example. Or Amundi acquiring Pioneer.
Renault: Concentration isn’t only seen through mergers. If you compare with the asset management market a few years ago, our clients have become more concentrated with bigger American asset managers. This is not only because of mergers, but also due to the fact that big asset managers are increasingly growing. They also have impressive sales forces. So the concentration of our clients is definitely the current model and the one that will most likely last. This will inevitably have an impact on our business as well. Moreover, our clients will also be facing a very volatile or uncertain environment, in part because of political changes that may come about as a result of Brexit, the election of Donald Trump or the upcoming elections in Europe.
McMahon: There are currently a number of global uncertainties, both political and economic. Allied to this, you have investors sitting in a low interest rate environment, having to change their asset allocations, having to try and get their cash to work, which has led to the continued rise of alternatives. How do we address alternatives? The asset managers need to be able to originate the transactions in order to be successful. Investor cash is available to go into these asset classes, but you need to deploy it successfully.
Smith: Another prediction is that the focus in our industry will be on clients rather than products. The asset management industry has always been a product-led industry. So, people sold interesting asset classes or interesting investment ideas. Now, with all the pressures that we talked about, people are really looking at the outcomes. So rather than saying, “Well, my large-cap equity product performed against the other asset managers, but it still underperformed by minus ten at the end of the year,” people will be saying, “Look, you want to save towards retirement and you need to have $30,000 a year to live off in retirement. This is how we can get you there.” Outcomes become important.
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