Is the Custody Industry Doomed?
The next 10 years will no doubt be a fascinating phase of development for the industry, whether we call this Custody 2.0 or 3.0.
Changes have always been the norm in the history of the custody industry’s development. Custody was regarded as the “sleepy backwater” of the financial industry when I started out in the 1980s. But over the years as the financial industry underwent changes, so did the custody industry, supporting new types of financial transactions and investment instruments. The industry has been evolving in tandem with the rest of the financial industry and has thrived over the years.
If we look at the full suite of services provided by a custodian today, we would be amazed by the multitude of ancillary value-added services that have been developed and even those core services that bear the same names have taken on very different forms and dimensions.
The next 10 years will no doubt be a fascinating phase of development for the industry, whether we call this Custody 2.0 or 3.0. New technology has been the driving force behind all changes, as it has always been over the past years. Nonetheless, the pace at which new technology is emerging and being applied to the financial industry is alarming and unprecedented.
Many experts have forecast that new technology like blockchain, artificial intelligence, the “internet of things” and edge computing would revolutionize and drive further consolidation of the financial industry in the next decade.
But this time the competition will not necessarily just come from within but also from technology companies such as Amazon, Alibaba and others looking to strengthen their grip on big data to expand their service offerings to customers. They are already dominating consumer payments and have tipped their toes in mutual fund distribution, so it might not be too far-fetched for them to expand their ecosystem into asset servicing.
I am not a futurist with a crystal ball who can foresee whether these technologies will ultimately conquer the financial world. However, I would think the following global trends will continue in the next 10 years that will be favourable for the custody industry:
1. Asset growth will continue exponentially;
2. Investments will become even more global;
3. Explosion of data will become unmanageable for many investors;
4. Mobile execution and delivery will become the norm;
5. Regulatory requirements will become even more challenging.
These trends mean that customers’ need for custody services will continue to grow in their current and new forms. There is no reason why the custody industry will decrease as long as it continues to deliver on its fundamental values and remain an integral part of the financial value chain.
There are three principal values that I suggest the industry needs to hold on to.
The first is integrity in serving customers. The concept of “custody” arose from the need for a neutral party’s oversight to protect customer’s interests in financial transactions and asset holdings. The manifestation of this critical value has been evolving with the emergence of new technology impacting how investment decisions are made, transactions are executed, assets are maintained and information are delivered.
Over the last 30 years, the custody industry has evolved from a business of physical safekeeping of bond and stock certificates, to asset servicing such as corporate action, tax reclamation and portfolio valuation, to information services such as data consolidation and warehousing or risk analytics. The industry has had a good track record of leveraging technology to adapt its products and services to serving customers while rejuvenating itself.
However, we saw that greed for profit had overtaken the financial well-being of customers for some industry players as their main priority during the global financial crisis in 2008. Several have gone out of business as a result, and a number of others have ended up in massive lawsuits resulting in huge financial and reputational losses in breach of maintaining the financial well-being of customers.
Another principal value is customer focus. The industry has continued to add value over the past few years because it has been able to focus on customers and continuously come up with solutions to address their pain points, from delivery versus payment and netting of transactions, to contractual settlement, cash sweeping and cross margining, to back- and middle-office outsourcing.
While new technology will revolutionize the investment process in the next 10 years, I believe there will inevitably be new pain points that customers would experience, and hence the opportunities for custodians to provide value through new product and service innovation if they are customer-focused.
The third principal value is trust. Banking is built on trust because of its intensely personal nature. This may seem paradoxical given the many predictions out there that robotics and artificial intelligence are going to replace human beings in the custody business and the financial industry. Surely, robotics and artificial intelligence supported by big data look very likely to take over many of the industry’s manual and repetitive processes, generate analysis and synthesis of text documents, and provide predictive capabilities through machine learning to support decisions.
Custodian banks will have to adapt their operating model to these new technologies, but at the same time they can leverage these technologies to support their professional staff in servicing customers more efficiently and competently, creating a better customer experience and further developing personal trust with customers.
Over its history, the custody industry has continually been challenged by new technological disruptions such as advancement in computerization or the rise of the internet. Many low-end jobs were lost in the process but many new jobs were created to provide higher value in the chain. The industry has actually grown much bigger globally in line with asset growth.
The custody industry currently has close to US$100 trillion of assets in aggregate under its oversight globally because customers have a high level of trust in custodian banks in keeping their assets safe, understanding their risk/return priorities, having their best interests in mind, and acting as their trusted partner in financial decisions. It will be hard, at least in the near term, for robotics and artificial intelligence technology to replace human beings in developing that very special relationship with customers, and the trust and confidence in each other.
The winning providers of the next decade will need to embrace changes and smartly deploy new technologies to meet the evolving social economic changes impacting customer financial behaviour. But more importantly, they need to enshrine those principal values that have always been the cornerstones of the custody industry and continue to build and strengthen that trusted partnership with customers.
Lawrence Au, co-founder of ZiAsset Consulting Services, is the former Asia Pacific CEO of BNP Paribas Securities Services. He is the author of Asia’s Financial Industry, 1986-2016.