Over the next five years, the global securities services industry will face more change than it has over the preceding ten—or even 20—years, as it adapts to dramatic shifts in the structure of markets and incorporates new technologies such as automation and robotics, advanced analytics, and distributed ledger technologies (DLTs) at scale. An influx of innovative applications and services from fintechs seeking to partner with industry incumbents, or in some cases attack and disintermediate them, will further complicate the strategic choices that incumbent firms face.
While global asset prices and trading volumes have soared in the years since the financial crisis, for one of the financial markets’ crucial partners—the securities services industry (see sidebar, “Six core elements for securities services”)—the business picture since 2010 has been stable, although unexciting, with average annual revenue growth of 3 percent (Exhibit 1). Firms have responded to the recovery by controlling costs and making changes to their business models, but only in small ways—at least until recently, when the industry began to undergo a major structural change.
Performance has been uneven in geographic terms: three-quarters of recent revenue growth came from Asian markets, with marginal growth in North America and no growth in Europe. Firms are feeling pressure on their revenues from tighter regulation, and on costs, due to asset manager clients’ concerns over their own bottom lines and profitability.
Over the past decade, the core securities services businesses of custody and fund administration have experienced continuing margin pressure (Exhibit 2). However, for the next several years, rising asset values and increasing net interest income will offset this pressure, and industry revenues will continue to grow at approximately 3 percent per year (Exhibit 3). Asian markets will likely continue to contribute most to revenue growth, benefiting firms with significant Asian exposure.
In the climate phenomenon known as La Niña, shifting currents in the Central Pacific Ocean create an enormous transfer of thermal energy that cools the ocean by several degrees, and alters weather for the entire globe—and yet there is little change to be seen on the ocean surface. For securities services, the next five years will be much the same: top-line growth will remain moderate, but market structure and the balance of power among firms will shift, driven in large part by technological innovation. Success will require heavy investments in advanced analytics, automation and robotics, and other new technologies, as well as innovative services in data transparency, risk management, and regulatory reporting. Firms that fail to take clear strategic stances, and continue to squeeze out only small and tactical gains in efficiency, will be left behind as the industry transforms.
— The wave of mergers and acquisitions that shaped the securities services industry in the United States and Europe until about five years ago has subsided in recent years. Regional differences remain, presenting M&A opportunities in the higher-growth Asian market, but potentially in Europe and the United States as well. Smaller and midsize players might be integrated by ambitious large firms, as economies of scale remain important and necessary investments in technology require spending power, granting the largest firms a structural advantage.
— From a global perspective, the industry continues to be concentrated in a handful of large firms—in 2017, four global firms held 60 percent of global assets under custody. Moreover, only a few new companies have ventured in, a partial indication of the strength of incumbent firms. While concentration is strongest in the United States and select European countries, other European and most Asian markets are more fragmented, owing to remaining differences in tax policy and regulation from country to country in Europe, and a market infrastructure in Asia that is still under development.
— Utilities in the maturing securities services industry will be formed, as the value chain blurs and firms increase their outsourcing of less-critical functions. Moreover, some large firms will position themselves even more effectively as “insourcers” of services where they have superior capabilities and scale.
— Regulation has been challenging for the securities services firms in the last couple of years. In Europe, many in the industry believe that regulation has reached a plateau with the implementation of the Central Securities Depositories Regulation (CSDR). And while not technically a regulation, the introduction of the TARGET2-Securities (T2S) system has affected all market participants. In conjunction, these two initiatives will create opportunities for global custodians but pose challenges for smaller, more local custodians and CSDs—unless they manage to adjust their go-to-market models and strategic positioning and partner with larger firms. For US firms, uncertainty over upcoming regulatory requirements calls for close monitoring.
— Automation and robotics have the potential to raise the industry’s efficiency to the next bend on the cost curve. If applied at scale by securities services firms, these tools could reduce the industry’s costs by an estimated $20 billion or more. Bold firms that invest in these technologies and reap the benefits at scale can achieve steep profitability increases, with corresponding boosts to their valuations.
— While technology as a whole is a game changer, DLT alone will not disrupt the core operations of the securities services industry—at least not at a global scale in the near term. Full disruption would require coordination and broad acceptance among firms that are traditionally competitors, as well as among other key players such as broker-dealers, investors, and regulators. In the medium to long term, however, DLT has disruptive potential, and firms are well advised to develop a DLT strategy and consider the potential impact on their IT operating model.
— Securities services firms can play an important role as custodians for cryptoassets. The total market capitalization of cryptocurrencies—admittedly a volatile figure—stood at $355 billion early March 2018, while capital raised via initial coin offerings (ICOs) exceeded $2 billion in 2017. Risk-taking securities services firms have an opportunity to tap these new revenue pools by expanding the classic custodian value proposition to include a new asset class.
— The monetization of large volumes of data held by securities services firms is another potential revenue stream, particularly when enhanced with externally sourced data. Leading firms are already investing in the technology and data sources required to capture this opportunity; however, the sporadic application of analytics in the hopes that a multitude of commercially significant use cases will emerge is a shaky strategy.
— Securities services incumbents should view fintechs as partners rather than competitors. More than 70 percent of securities services–oriented fintechs are developing products and services for incumbents, rather than targeting the industry’s end customers and striving to disintermediate incumbents. However, incumbents must pay careful attention to the progress fintechs are making and should leverage fintechs in their own operations and in interactions with customers (Exhibit 4).
Based on these developments, we can paint a clear picture of how the industry structure will evolve. We believe there will be four viable strategic archetypes in the securities services sector. These archetypes exist to some degree today; however, firms that are currently stuck in a gray area between these distinct archetypes will need to make definitive choices about how they will compete going forward:
— Global full-service providers, covering all key geographies and offering comprehensive securities services to customers in the major markets.
— Regional leaders with broad offerings, capitalizing on their deep expertise in country markets and their close ties to local customers and regulators.
— Core securities services providers at scale that focus on crucial, but nondifferentiated, core services in custody and asset servicing as well as fund administration. Their scale and minimal costs will compensate for low margins on commoditized services.
— Focused boutiques offering tailored, bespoke services, as well as services in specialized asset classes. They excel at managing complexity and often boast very high margins.
In addition, two new value propositions are developing. Ideally, these are combined with one of the established winning strategic archetypes, as successful incumbents reposition themselves for technological change and the continued integration of value chains:
— Ecosystem orchestrators, leveraging new technologies and partnering with fintechs in an open platform approach. These firms will develop and expand into adjacent areas and offer completely new services at attractive margins, as they continue to own the customer relationship and interface.
— Data and analytics powerhouses possessing sophisticated data resources and analytics capabilities. These firms will generate significant revenue streams from their insights on markets, investor behavior, risk analytics, and regulation. However, only a few firms possess data that are truly unique, and have the capabilities for truly differentiating analytics. This value proposition requires the willingness to make data an absolute strategic priority, and to invest accordingly.
Senior securities services leaders should not be lulled into complacency by the slow but steady performance of their industry. Now is the moment for firms to make decisive choices about how they fit into an evolving securities services landscape and how to position themselves as one of the pioneers in a new era for the industry.