Custody is dead. Long live custody.
The results are in and, predictably, market observers are focused on the wrong thing. First things first: the banks that have a serious custody/inserv business did well in 2021, generally reporting good revenue growth against the continuing backdrop of low, zero or negative interest rates. Can you hear the sound of one hand clapping?
You should know what’s coming. Whilst the custodians did a good job overall, one thing is abundantly clear: the custody business is becoming a zero-sum game. Here’s how it works. You add more custody assets, but your associated revenues don’t accelerate at anything like the same rate.
A five-year review of core asset servicing fees (Q4 2016 vs Q4 2021) demonstrates the extent of the problem. J.P. Morgan has become the industry’s bottom feeder, and it shows in the numbers. Over the review period, AuC increased by 62pct, but reported securities services revenues by just 20pct. Citi fared no better: AuC up 66pct, revenues up just 25pct. Now, you could make a case that, with these two universal banks, there are plenty of other factors at play, especially on balance of trade and reciprocity considerations.
Yet the trust banks are not immune from the same challenge. State Street’s AuC/A grew by 52pct, but asset servicing fees by just 7pct. BNY Mellon actually saw asset servicing revenues fall by 7pct over that period, whilst AuC rose by 56pct. And Northern Trust reported an AuC rise of 91pct, with a revenue rise of 51pct.
There are all sorts of mitigating factors that help to partially explain these discrepancies – a new way of accounting for AuC/A, the lag between asset onboarding and expected revenue generation, for example – but perhaps the most important explanation is this. The inserv providers, more explicitly than ever before, see custody assets as key to selling other, higher value services. Yes, that’s always been important, but in the old days there wasn’t much else to sell: a bit of performance measurement, some securities lending, and even some largely uncompetitive FX and money market services.
Just as they had to adjust after the great securities lending reset of 2008, custody banks have been reshaping their product portfolio in ways that would have unimaginable – and, in any case, undoable – five years ago. Even when State Street bought Charles River in 2018, few outside the bank understood what it would mean for the inserv industry. Ron O’Hanley, State Street’s CEO, did. He predicted that, ultimately, State Street’s main competitors would not be banks, but fintechs and information providers like Bloomberg, SimCorp, SS&C and, of course, BlackRock.
And so it has come to pass. But it isn’t just the front-to-back proposition where the trust banks are moving into new spaces. BNY Mellon is currently working on a unified traditional/digital asset custody solution, and has invested in numerous fintechs, like Fireblocks, to help it get there. Northern Trust has moved into the investor behaviour space, and is building an investment data science business, as well as blazing a trail with its front office solutions franchise. It’s the same story in Europe. The bigger banks – HSBC, BNPP and SG – have been at the forefront of innovation, and have frequently turned to fintechs to enhance, or help to launch, products.
Everywhere you look, there’s innovation: ESG, data analytics, predictive analytics (BNY Mellon has a very neat solution for distribution), regtech, digital assets, CBDC, even securities finance and collateral management. None of these has much to do with banking or asset servicing – but it certainly helps when you’re a GSIFI bank, rather than a two-person business with a nice dog operating a software start-up out of a garage in Sheboygan, Wisconsin. Doors open more easily, which is why so many fintechs end up doing deals with the big banks, who can wholesale the product and offer resources. It’s a symbiotic relationship, and BNY Mellon’s deal with Milestone is a perfect example.
Celebrating the growth of aggregate AuC/A in 2021 – as much of the trade media have done – demonstrates a complete lack of understanding of where the inserv market has been heading. Custody remains important, but not in absolute terms. Client assets can be made to sweat much harder if all those other products and services can be sold around them. In many cases, fintech/regtech has delivered the underlying capabilities and know-how – hardly disruptors. And, don’t forget, not all assets are created equal, a lesson that a growing number of custody banks have learnt over the last five years.
N.B. All revenue & AuC/A numbers were taken from quarterly earnings statements. Comparisons are between Q4 2016 and Q4 2021.