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“At the outset let me begin with an apology to those few readers who may take offence to the title, as it (kind of) challenges the existing steady state. However, let me also acknowledge that the true purpose behind penning down these thoughts is to challenge the status quo, and re-wire some of the beliefs surrounding value creation in the post trade space”.
Inorganic Growth cannot be the silver bullet.
"Life is what happens to us, while we are busy making other plans. While this expression can be traced back to a 1957 Reader's Digest article by Allen Saunders, it has subsequently been used at many places including a John Lennon song that practically immortalized the line. And it wouldn't be far from truth, if we used this as a metaphor today, to explain what's happening in the post trading space, specifically in the securities services business related to custody operations and fund services where margins have progressively declined in the face of growing cost of processing. At reduced margin, volume becomes the only savior and therefore this is leading to consolidations which are happening at a rapid pace on both sides of the Atlantic. This article deals with a line of thought that negates economies of scale derived from acquisitions or consolidations as the only key strategy for survival in the long run.
Consolidation is definitely important, as Bloomberg mentions that an entity needs to be at least at a critical level of ten billion euros in assets under management to be profitable as a custodian in today's market condition. Most market participants are below that limit and ultimately, organizations who don’t reach this critical size will not sustain in the long term. However, there is no silver lining for entities which are only growing inorganically big without a road-map of how they will adopt to the changing landscape of post trading space which is evolving exponentially faster than what may be visible normally.
If we were to consider the complete business chain that securities services support, the hard fact is that, much of value creation lies with the asset managers, while other intermediaries (custodians being one) are only living on the crumbs. The irony is, in today's market custodians don't make money (any more) out of providing custodial services, and the margin from other services are thinning rapidly. However, scale can only create value for shareholders in the medium run, who become the beneficiaries of reduced fixed cost that can be spread over a larger asset base. It doesn't warrant survival in the long run unless there is a vision to create growth assets from innovation that will redefine the way how custodians shall operate in the future. In hindsight, let us consider some key changes from the past which have redefined custody operations during the last few decades.
When we talk of growth, we consider different ways in which a entity can grow and we often tend to make the mistake of treating them all as equivalent. But data has emerged over time, that looks at which growth approaches are most likely to create value and which ones may fall short. Studies on corporate valuation models and previous researches which have looked at companies adopting different growth strategies over time, have ranked the value strategies from best to worst?
So taking clues from the past and building on top of some of the technological advancements, the roots of which have already been laid in the post trading services space, in the following section we shall discuss as how the future of custody services may evolve for large players in the securities services sector.
Whether the realization comes now or later, the truth is that the post-trade market is currently being shaken by fundamental changes with the emergence of new technologies. And this article rests on the premise that some of these changes, may radically alter the landscape. Intermediaries who shall lead the transformation will be the ones who will survive the change. Finding an answer to the question, as how will the world post-trade market look like in a decade from now is a complex challenge, however action needs to be taken at the right time and here are a few strategies that may be key to creating value.
While the above 5 may be just the few ways how post trade can evolve, there is no denying the fact that custodians have to look beyond consolidations to bring real value to post trade services. There are often questions raised on the applicability of technological disruptions (DLT being just one) in Capital Markets in the absence of well laid out regulatory norms. However, it’s not entirely true that all of them continue to be wholly unregulated. Numerous state agencies in different countries, are trying to fast regulate applications for these technologies in some fashion. But the diverse approaches taken by different countries remain a challenge and this will need to converge at some point. Having said that, I am myself strongly convinced that while cryptocurrencies will find it difficult to gain acceptability under any form of regulation as possible replacements to fiat currencies (and rightfully so - https://www.thebtn.tv/exclusive-content/article/liberate-libra-currency-war-and-let-it-find-its-meaningful-place-sto), however application of DLT is here to stay, and regulations will fast evolve surrounding their adaptation. Therefore, taking shelter on this reason alone, and not innovate will only catch incumbents on their wrong foot in times to come.
The post-trade market is becoming smaller, not by volume but by players, as the existing old structure continues to fragment as a consequence of fast evolving technological innovations, permitting new approaches to securities processing and information dissemination, allowing newer entities to enter the market. The days of plenty are numbered as the size of the industry declines and innovation is now in the hands of FinTecs that operate at the technological front-line. The key strategy for the incumbents to succeed in this scenario is to work in consortiums, remove some of the barriers to entry and partner with FinTechs who have more viable ecosystems to innovate, than their own floors. The real synergy is in multiplying on a foundation that gets build on technical competencies of FinTechs and domain expertise of incumbents. And we see this marriage already happening amongst the smarter post-trade players and FinTechs. Having been at the convergence of technology and business in the post trading world for last 2 decades, I am fairly convinced that markets will self-evolve and entities will come together to partner and play this game well.
Have never been a fan of dead diagrams (myself), without a discussion to support what's being laid out, and therefore not clogging this space with a set of complex flows to ponder on, as how may the future of post trade look like in paper. However if this triggers enough curiosity to explore more, do feel free to connect for a discussion or debate.