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The promise and peril of fintechs
The impact of fintechs is being felt and they could present solutions and a challenge to sub-custodians’ survival
Roger Harrold 28 Jun 2018

In part two of a three-part series, Roger Harrold of AlfaSec Advisors believes the impact of fintechs is being felt and that they could present solutions and a challenge to sub-custodians’ survival.

Where in the sub-custody value chain should you not be? Let me give some examples. If you are a service provider focussed primarily on services to financial institutions, more than 40% of your revenue comes from these clients today and you have aging technology and investment constraints, then that is not good.

The large clients have huge purchasing power and the small clients do not give enough revenue. Growing top line revenue is difficult. You can go and steal a client but this is not easy as no one likes to give up a large relationship. Most custodians are motivated to make calls and offer to fly around the world for tea with clients when large mandates are threatened.

Added to this are the know-your-client (KYC), stringent anti-money laundering (AML) requirements, plus country and geopolitical risk. Custodians also have to face up to regulators who also are increasingly focussed on client holdings – and especially shaky omnibus accounts. And then there are the fintechs that will make significant further inroads into custodians' business model.

Fintechs, in particular, are helping clients to get a better deal from banks. They are able to offer superior client reporting or adding value in terms of regulatory reporting, sanctions screening, creating real global risk pictures and demonstrating technology solutions that work through integration with the banks. Soon, custodian banks may lose product capability.

If you lose too much product capability to the fintechs, you erode your product range to offer to your end-clients. You start to lose the ability to bundle product (cross-subsidy of products) and in the worst case, you are left servicing the most intense and expensive part of the business. If you then start to lose clients, you lose volume and your own cost base increases.

Meanwhile, large investments are required to create automation and artificial intelligence to help reduce repairs. If this is the model, then board executives should be contemplating what the future is in that type of a model.

It is difficult to see how local banks and single or double market service providers can cover the investment and compliance expenses to produce attractive shareholder returns. A bank offering sub-custody service that is not a focus is taking a risk. The regulatory burden and opportunity for investor loss is huge. If not mitigated, this can cost big sums of money. Niche provider is a special category: it depends on what the niche is. If it is just you and one other provider, that is not good. Why did the others leave?

If the niche is that you can create a differential by having the best vault or some service that others do not have (you need to question why), then maybe a niche provider has an extended lifespan. Niche providers need to balance big operational risk with niche profit returns. If profits drop, it is a poor model.

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