Custody Business in the New Normal — Advantage: Custodians

Asset managers are outsourcing middle and back-office operations to custodian banks. Here's how custodians can make the most of this opportunity to move up the value chain.

Securities custodians historically focused on commoditized back-office services such as the safekeeping of assets and trade settlement, while asset managers worked to grow the value of the portfolios under their control. With revenues and profits for both groups under pressure, asset managers are looking to outsource more client-facing, middle-office functions such as transaction and information management to custodians. This will reduce operations and regulatory costs for asset managers and give them a more flexible cost structure to ride out tough times. However custodians must position themselves correctly if they want to move up the value curve through such outsourcing.

Competitive Pressures

Asset managers are finding their revenues under pressure from a decline in asset trading, while new legal and regulatory requirement increase their compliance and operating costs. The scope and scale of the Madoff fraud—and the resultant call for greater transparency and governance—are also forcing asset managers to re-examine how pricing, auditing and accounting functions are performed.

Given today's breadth of asset classes, complex products and regulatory changes, asset managers need to react faster than before. As a result, they are willing to outsource not only commoditized back-office processes but client-facing, middle-office services such as performance measurement and valuation.

For custodians, the drop in securities lending and near-zero interest rates have had severe affects on revenue, while new regulatory and legal requirements have raised compliance costs. Custodians are also facing increasing competition from Central State Depositories (CSDs), which is resulting in cannibalized margins and commoditized services. To meet regulatory and compliance needs, custodians and technology service providers must continue upgrading current platforms despite continued tough market conditions, as well as offer flexible solutions to differentiate and maintain competitive position.

Outsourcing Choices

Asset managers can choose bundled service offerings or cherry-pick specific stand-alone components.

• Bundled services are typically a cost play that includes multiple back- and middle-office processes at scale. Core activities such as trade processing, corporate action management, reconciliations, cash management and portfolio recordkeeping are commonly bundled together.
• Component services offer asset managers the opportunity to "try before you buy". It offers the shortest path to accessing new features and services critical to supporting complex investment types and new product launches.

We see outsourcing gaining traction in specialized functions such as OTC derivatives processing, collateral management, data management and client reporting.

Advantage: Custodians

While market and regulatory dynamics are forcing asset managers to outsource more investment management functions, custodians with committed human capital, scale and operating leverage are ready to move up the value curve.

Winners will be differentiated by continued investments in upgrading the platform infrastructure to offer flexible, componentized service offerings. The most successful will have a client-centric mindset and offer a differentiated client experience through a world-class service delivery platform. Service providers that can deliver material operational improvements, improved front-office support, enhanced performance reporting and higher quality data will differentiate themselves and get a leg up in this space.

Asset managers clearly see technology gaps in real-time reporting for the front office, reconciliations (lack of automation), data warehouse capabilities and management reporting. Many custodians are addressing the inadequacies of the current, often siloed, IT infrastructure. One example is building an integrated platform that can support both back- and middle office-functions. This increases accuracy and efficiency while cutting costs.

Starting with custody and fund accounting services, custodians have, over the last decade, gained a deep understanding of the investment management landscape. They now have the mature capabilities, scale and efficiency to take on the operational, regulatory and technology risk that asset managers seek to outsource. With the right investments in technology, process and service offerings, custodians can take advantage of this market shift to grow their businesses.

Read the white paper: Custody Business in the New Normal: Advantage Custodians or learn more about Cognizant's services for custodians.