Post-trade services in financial markets: Moving from backstage to center stage
As the capital markets landscape changes, the market for post-trade services has come of age and represents a real opportunity for firms to generate stable and sustainable returns. Moreover, there is a significant first-mover advantage for those that can quickly develop the right capabilities and distinguish themselves through focus and strategic coherence.
Post-trade services in financial markets Moving from backstage to center stage
London Gagan Bhatnagar Partner +44-20-7393-3747 gagan.bhatnagar @strategyand.pwc.com Crispian Lord Partner +44-20-780-48148 crispian.lord @uk.pwc.com James Nodder Partner +44-20-7393-3567 james.nodder @strategyand.pwc.com Jason Moorhead Director +44-20-721-34928 jason.j.moorhead @uk.pwc.com Timothy Power Principal +44-20-7393-3725 timothy.power @strategyand.pwc.com Joerg Ruetschi Senior Associate +44-20-7393-3597 joerg.rutschi @strategyand.pwc.com
Munich Johannes Bussmann Partner +49-89-54525-535 johannes.bussmann @strategyand.pwc.com Thorsten Gommel Partner +49-69-9585-2050 thorsten.gommel @de.pwc.com
Zurich Andreas Lenzhofer Partner +41-43-268-2156 andreas.lenzhofer @strategyand.pwc.com
About the authors
Gagan Bhatnagar is a partner with Strategy& based in London, where he specializes in strategy and transformation for investment banks, securities firms, asset managers, and other wholesale and capital markets firms. He has more than 21 years’ experience in the capital markets sector and has worked in Europe, the United States, and AsiaPacific with some of the world’s largest and most successful banks. Crispian Lord is a partner with PwC based in London, specializing in the definition and delivery of new operating models as a result of business and regulatory change. He has more than 18 years of experience in financial services, managing program delivery of senior-level and complex engagements across banks, brokers, funds, and infrastructure companies. Timothy Power is a principal with Strategy& based in London, where he specializes in operational transformation and technology strategy. He has more than 14 years of experience working with financialservices clients, with a particular focus on securities servicing firms and asset managers across Europe, the U.S., and Asia-Pacific. Joerg Ruetschi is a senior associate with Strategy& based in London, focusing on strategy development and business transformation of financial institutions with large capital markets and securities servicing businesses. He has a dedicated background in risk and capital with more than 12 years of experience in investment banking and asset management. He holds a Ph.D. in finance as well as the chartered financial analyst and financial risk manager designations.
The capital markets landscape is fundamentally changing, driven by a combination of three powerful forces. First, the continually increasing regulatory burden is placing renewed focus on market transparency and risk mitigation, among many other things. Second, alternative asset growth will continue to outpace the rest of the market; total volume is projected to double in size by 2020, forcing firms to meet more complex operational, regulatory, and risk mitigation obligations.1 Combined with this is the effect of derivatives standardization, with the proportion of centrally cleared derivatives projected to increase from 25 percent today to more than 60 percent by 2020.2 Third, pressure on capital markets profits continues unabated, with margins squeezed in a number of areas, driving firms to seek out new and diversified revenue streams. These realities are forcing many firms to enter or expand their presence in the market for post-trade services. The competitive dynamics will be very different from anything previously seen in the services industry, characterized by multiple diverse players, including investment banks, custodians, and infrastructure providers, competing to provide similar services and all bringing different capabilities. Many of these players already have some of the capabilities required to win in this market. Few, however, have the full complement, and there is a significant first-mover advantage for those that are able to build and integrate the right service capabilities quickly. Not all players entering the market will succeed. However, the winners will distinguish themselves through focus and strategic coherence — the ability to align products, services, and capabilities with one clear “way to play,” and the discipline to disinvest in nonaligned capabilities. For the winners, this principle will pervade everything they do: driving acquisitions and strategic alliances; determining the personnel they employ; informing their legal entity strategies; underpinning their operational footprint; and defining the technology platforms they choose.
The market for post-trade services is no longer boring — it has come of age and represents a real opportunity for firms with the right capabilities to position themselves strategically at the heart of the new market, while delivering the stable and sustainable returns that could elude their core banking businesses for some time to come.
A new market is born
As the upheaval continues in Western capital markets infrastructure, participants are increasingly turning their attention to the previously unfashionable world of post-trade services, which we define as all functions that are performed after a trade is made, including supporting market infrastructure such as centralized clearing platforms (CCPs) and central securities depositories (CSDs). Previously deemed “boring,” “low margin,” and “not strategic,” the market for post-trade services has come of age and is now viewed as an opportunity for service providers to position themselves strategically at the heart of the new market. A combination of three powerful forces is driving the renewed focus on post-trade services. First, regulation has made the use of post-trade service providers a necessity for many market participants that would never have considered using them in the past. Second, the continued growth of alternative assets is making processing more complex and spurring greater demand for related services, such as external funding and collateral management. Related to this, the standardization of some derivatives and the growth of passive funds continue, creating an opportunity for firms to reduce the cost per transaction. Third, the unabated squeeze on trading margins is driving firms to pursue innovations in their service offerings as they seek opportunities to generate greater returns on equity. Regulation creates new revenue opportunities New G20 regulations that address weaknesses in global market infrastructure and counterparty risk mitigation have led to new client requirements and are bolstering demand for post-trade services (see Exhibit 1, next page). In Europe, these regulations are primarily manifested in the Markets in Financial Instruments Directive II and Regulation (MiFID II/MiFIR) and the European Market Infrastructure Regulation (EMIR), which will demand far greater market transparency through reporting requirements and standardization rules on regulated trading venues. EMIR includes strong risk mitigation requirements through bilateral collateral exchange and central clearing.
Exhibit 1 Changes in the financial services industry
Global regulatory themes
– Governance – Capital / liquidity / leverage
– Recovery and resolution – Ring fencing
– Transparency – Market structure / integrity – OTC derivatives reform – Investor protection and choice
The regulatory landscape
Transaction reporting Risk mitigation, including bilateral collateral management and clearing U.S. derivative regulation Reporting and risk mitigation via bilateral collateral management and clearing
Higher capital requirements More stringent rules for capital quality Increased cost of ratios
Capital Requirements Directive IV
Trading venues Electronic trading
Criminal sanctions for market abuse Tighter trade disclosure requirements
Market abuse regulation
Recent regulatory changes
U.S. regulation Restrictions on property trading Limits to ownership of covered funds
CSD regulation and T2S
Recovery and resolution Separation of retail and commercial Constraints on property trading
Securities to be harmonized Common rules for depositories
Market structure changes
– Clearing – Venues – Structural changes (recovery and resolution plans, separation) – T2S
Risk mitigation costs
– Collateral – Capital (product level and total)
– Exiting businesses – Outsourcing of noncore activities
– Trade and transaction reporting – Governance requirements – Alternative Investment Fund Managers Directive
Source: PwC and Strategy& analysis
One of the major effects of the new regulation will be the standardization of over-the-counter (OTC) derivatives; we anticipate that the proportion of centrally cleared trades is likely to at least double from its current level of approximately 25 percent once the regulations are in full force. In addition, a new European security settlement engine, Target2 Securities (T2S), will centralize delivery-versus-payment settlements across European securities markets. Market participants will have to ensure compliance with these new regulations, and for many small and midsized players, compliance will prove extremely difficult. As a result, these players are actively seeking outsourcing providers that can meet their needs across multiple geographies and asset classes. The market evolves, powered by growth in alternatives Despite the difficulties facing today’s capital markets participants, asset growth is continuing. We anticipate that total global assets under management (AUM) will increase by more than 50 percent from current levels to exceed US$100 trillion by 2020.3 Within this growth we will see some interesting dynamics that have implications for post-trade service providers as the asset mix and product characteristics evolve. By 2020, alternative investments and passive products such as exchangetraded funds will represent 35 percent of all assets managed by the financial-services industry.4 Alternative asset growth will continue to outpace the rest of the market, almost doubling in size to $13 trillion between now and 2020 (see Exhibit 2, next page),5 as various managers seek out enhanced yields and institutional investors match longer-dated liabilities with assets that offer an illiquidity premium. As investment banks struggle to deal with changing capital rules, restrictions on proprietary trading, and other forms of ring-fencing, asset managers are likely to assume a greater role in risk taking and capital facilitation through alternative investment mandates. Another dynamic is the increasing shift to standardized products as a result of regulation and changing investor demands. Passively managed products, particularly exchange-traded funds, are increasingly in demand as investors seek lower-cost ways to adopt various investment strategies. We expect passively managed products to continue growing and make up 13 percent of AUM by 2020. On the derivative side, we are seeing the move to standardize OTC products and a shift to clearing. Although these changes will affect different parts of the industry value chain, the evolution toward highly standardized products creates an opportunity to drive straight-through processing and efficiency within the industry. The result of all these changes is that asset managers will have both opportunities and challenges in their middle- and back-office functions. There will be opportunities to improve the standardization of some
For many small and midsized players, compliance will prove extremely difficult.
Exhibit 2 Projected growth in assets under management (all investments and alternative investments)
63.9 5.3 2.5
Global AUM growth
(US$ in trillions)
Global alternative investments
(US$ in trillions)
Source: PwC and Strategy& analysis
processes, but in other areas processes will become more complex as a result of moves to alternative investments and new regulator obligations. These demands will prompt many asset managers — particularly in small and mid-size firms — to seek outsourced solutions as they grapple with these challenges. Margin pressure drives buyers and sellers of services Pressure on capital markets profits continues unabated. Macroeconomic factors, combined with increasing capital and transparency requirements, are squeezing margins in a number of areas, with fixed income, currencies, and commodities (FICC) most affected. Annual FICC revenues at major global banks in 2015 will be approximately 80 percent of their 2012 levels.7 Return on equity at the major investment banks has fallen substantially since the financial crisis, and the recovery from singledigit levels remains very slow. Margin pressures are having a twofold effect. Large market participants are increasingly leveraging and integrating their existing capabilities to enter the more lucrative services market, for example, through the provision of collateral services. At the same time, other players are trying to externalize more components of the value chain to reduce operational cost and risk and help them manage their regulatory obligations in an affordable way while they focus on niche trading and risk-taking strategies.
Changing competitor dynamics
Staking the right claim in the changing landscape is no easy matter. With a time horizon of only three to five years before the services market begins to mature, those that want to join the group of leading global service providers will need to start soon, move fast, and stay focused. To make the right bets, players will need to understand evolving competitor dynamics. They will also need to home in on a focused market position. This will require them to invest in the right organizational, operational, and technical capabilities, while proactively disinvesting in non-relevant ones. The large variety of heterogeneous competitors that are beginning to offer post-trade services is a distinctive element of this market shift. Investment banks, custodian banks, and infrastructure players such as international central securities depositories (ICSDs) will likely compete to provide similar services in the short to medium term. Many of these players already have some of the required capabilities, but few have the full complement. Therefore, there is a significant opportunity for first movers that have the focus and discipline to build and integrate the right service capabilities quickly. As Exhibit 3 (next page) illustrates, we anticipate the following mediumterm competitive moves: Investment banks, including broker/dealers: Profit pressures from new instrument standardization, as well as trading venue and capital requirements, will drive these organizations into new and diversified revenue streams. They will leverage their risk management capabilities and access to inventory to provide collateral, client clearing, and liquidity services in particular. Asset servicing firms: Asset servicing firms will offer a broader set of more closely integrated services. The global custodians in particular will strengthen their global footprint by acting as gateways for transaction, collateral, and reporting services, with success hinging on the ability to combine post-trade capabilities with core custody services. These moves will put pressure on sub-custodians as global custodians increasingly bypass them to achieve greater control of the process and better service levels.
There is a significant opportunity for first movers that build the right service capabilities quickly.
Exhibit 3 Competitive dynamics across the value chain
Risk-taking Post-trade Collateral management
– Bilateral risk mitigation through collateral – Reconciliation, compression
– Trade origination – Idea generation – Structuring – Promotion
– Trade execution – Market making – Proprietary trading – Booking
– Central clearing through member mechanism (clearing brokerage)
– Trade reporting – Financial, investment, and risk reporting
Settlement and custody
– Settlement, payment of transactions
– Middle ofﬁce/ back ofﬁce – Fund administration – Management services – Transfer agency – Fiduciary
Impact on revenue Market participants
Global custodians Sub-custodians
Asset servicers Asset managers
Trading venues Platform providors
Market data providors
1. Universal banks and investment banks move to post-trade services 2. Asset managers take on greater risk 3. Global custodians bypass domestic custodians, enter clearing platforms (CCPs), and challenge CSDs 4. CSDs and ICSDs move from infrastructure to post-trade service provision 5. New competitors enter funds service provision 6. Market participants establish industry utilities and center activities on technology platforms
Players facing minimal impact Players facing signiﬁcant impact
Source: PwC and Strategy& analysis
Universal banks: These institutions will increasingly integrate trading and post-trade functions. The combined offering will provide them with the unique ability to leverage balance sheet, inventory, and risk management capabilities to integrate execution, reporting, clearing, financing, and other risk-taking activities into the service suite. ICSDs: These depositories are in a good position to take advantage of the opportunity afforded them by the current European market reforms to expand their role in the value chain and compete directly with global and local custodians. In particular, collateral services represents a golden opportunity, given the requirement for firms to post collateral at a depository. Successful firms will extend their traditional role by optimizing and transforming collateral directly or in tri-party arrangements. ICSDs have a built-in advantage in that their internal technology platforms are designed to support large-scale, highthroughput, and relatively broad asset class coverage. However, they do not have all the required capabilities and will need, for example, to develop more sophisticated asset servicing capabilities or collaborate with other players that already have them. Technology providers: Market uncertainty and tight investment budgets put a new emphasis on technology providers that can offer industry-wide platforms, utilities, and software solutions. We anticipate disruptors in this space evolving from existing but unexpected providers. These providers may take on incumbents in parts of the value chain, or capital markets firms may create syndicates with them to achieve the greatest possible efficiencies as they struggle to improve their return on equity.
Service providers that focus will win
We have found that winning companies achieve success through strategic coherence, which we define as the alignment of products, services, and capabilities with one focused “way to play”: a clear articulation of how the company will create value better than its competitors can. For service providers, there are likely to be five fundamental ways to play, as shown in Exhibit 4 (next page). Three of these — the infrastructure provider, the global scale player, and the multi-market specialist — are well established and mature. The remaining two — the end-to-end post-trade service provider and prime services plus — are evolving rapidly and therefore present the greatest firstmover opportunity. Post-trade, end-to-end servicers: These firms will offer the full range of post-trade services across the value chain. A new and critical service that these players will provide is regulatory, transaction, and client reporting — a significant burden for smaller investment firms today that will only grow. Post-trade, end-to-end servicers should be able to offer a degree of financing, collateral management, and liquidity services, but will not necessarily have access to balance sheet or risk management capabilities to provide the financing facilities of a prime service provider. However, they will be able to integrate their services seamlessly, handle very high volumes of transactions at high STP rates, and cover a broad number of markets and asset classes. Prime services plus: These providers will combine the post-trade services described above with front-office trade execution, risk-taking, and financing capabilities. However, they are likely to be more limited in their market and asset class coverage because of their risk appetite. Traditional prime service models rely heavily on balance sheet and funding commitment mainly for leveraged accounts such as hedge funds. New capital requirements and constraints on leverage ratios challenge the profitability of these businesses. The new post-trade infrastructure requirements of collateral management and central clearing offer new opportunities for investment banks to extend their
prime service offering to other institutional clients such as pension funds and insurance companies. Clients will increasingly need a holistic offering that combines these services with custodian and treasury services. Although the demand for an integrated service offering could be significant, very few institutions (if any) currently have the capability to deliver it.
Exhibit 4 Ways to play for service providers
Way to play
Emphasis on compliance and risk mitigation as a complement to traditional ﬁnancing services Full banking services (including leveraged bank balance sheet) Will increasingly compete on quality of risk analytics and client service Prime services plus Full service plus balance sheet Post-trade, end-to-end servicer Full range of services across the value chain Will compete by covering as much of the post-trade value chain as possible Likely to exclude risk-taking and ﬁnancing activity with the exception of clearing Emphasis on seamless integration Focused market or product specialist Multi-market specialist High-touch service in select markets Global scale player Control through local custody to CSDs, at scale Will prioritize client service over cost Will compete on depth of local market relationships, product knowledge, and client service Will compete through market and product ubiquity, seeking to maximize footprint and product coverage Will be continually engaged in a “transaction cost arms race” Infrastructure provider Example: CSDs Local Example: utilities Global Provide specialized operations and technology platforms for the market Increasingly mutualized Increasing levels of functional sophistication
Securities servicing focus
Technology and operations
Source: PwC and Strategy& analysis
What capabilities will service providers need?
The post-trade, end-to-end servicer and the prime services plus areas involve somewhat different sets of capabilities (see Exhibit 5, next page). To win as a post-trade, end-to-end servicer requires the ability to integrate custody and settlement offerings with clearing, trade reporting, and collateral management services, while ensuring regulatory compliance for clients. The servicer must also furnish broad market and asset class coverage. Winners in the prime services plus segment must provide an end-to-end product including financing, borrowing, and lending services. These players will also have to master a broad range of risk methodologies, provide leading-edge proprietary risk models, and develop a deep understanding of complex asset classes and access to financing sources. The key for both types of players will be back-office service integration instead of selling bundles of disparate products. It should be noted that a key and common challenge to capability delivery is underlying data, both in structure and content. The siloed, multi-geography technology that underpins many of today’s organizations often entails disparate data structures, from the front office through the back office to enterprise data stores. The data itself often requires enrichment to populate key elements increasingly required by regulators (such as the purpose of the trade). The result is difficulty harmonizing this data to enable the consolidated reporting, client access, and ondemand analysis that regulators and clients increasingly require. Some of the data integration challenge can potentially be resolved through service providers or by replacing technology, at a cost that needs to be weighted carefully against provision of some end-user services. However, the “judgment-based” data enrichment required by regulators will inevitably remain with the firm. Combinations of service offerings and capabilities systems In response to deep industry consolidation, market participants may combine their service offerings and capabilities systems to realize the
Winners in the prime services plus segment must provide an end-to-end product.
Exhibit 5 Sample capabilities systems
Required capabilities Client service Risk and regulation Implement full risk methodology across asset classes (including reporting and other regulatory requirements) Market and asset expertise Specialization in derivatives processing and funding operations Provision of proprietary research Technical innovation Focus on technical and operational integration Data management, including cleansing and integration of fragmented trade data
Way to play 1: Prime services plus
Very high-touch service, with emphasis on advisory skills
Way to play 2: Post-trade, endto-end servicer
High-touch service but greater emphasis on operational integration, fails management, turnaround times
Provision of regulatory compliance and risk mitigation services (e.g., collateral and clearing services)
Provide expertise in derivatives and funding across all markets and asset classes
Focus on technical and operational integration Data management, including cleansing and integration of fragmented trade data
Way to play 3: Multi-market specialist
Focus on customer service over cost, with emphasis on local skills, product knowledge, and client knowledge
Focus on operational risk (especially vendor management)
Focus on asset class depth and quality of local relationships
Focus on connectivity and client service
Way to play 4: Global scale player
Highly structured, globally standardized relationship management and service model with tight linkage to operations and IT
Focus on operational risk and technology resilience
Own extensive global custody and sub-custody networks Own peripheral revenue capabilities (e.g., FX payments)
Focus on technical and operational integration — effective system integration, large-scale processing, and STP are critical
Way to play 5: Infrastructure provider
Standardized relationship management and service model with tight linkage to operations and IT
Leverage internal capabilities into offerings Focus on technology resilience, data security, and cybersecurity Provide deep expertise focused on platform / utility function Data management, including provision of “gold copy” external data
Importance as differentiating capability: Low
Source: PwC and Strategy& analysis
vision of an integrated trade and post-trading offering. We expect a series of mergers, acquisitions, joint ventures, and/or collaborations between industry platform and utilities players and investment banks, asset servicers, and infrastructure providers. Investment banks offer balance sheet capacities, risk management capabilities, market access, and trade execution. Asset servicers, with their custodian and treasury services, provide the hub for collateral services, deposits, and backoffice functions. Specialized suppliers across operational platforms, IT, and software solutions will create the infrastructure. In conclusion, new regulations, technology developments, and market evolution are fundamentally changing the capital market and securities servicing business. To succeed in this environment, every market participant will need to identify a clear way to play and invest in differentiating capabilities. Scale in local markets, or global scale across service functions, will be a crucial element that further accelerates the industry consolidation and leads to new combinations of businesses and strategic alliances among market participants.
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“Asset Management 2020: A Brave New World,” PwC, 2014. “Asset Management 2020: A Brave New World,” PwC, 2014. “Asset Management 2020: A Brave New World,” PwC, 2014. “Asset Management 2020: A Brave New World,” PwC, 2014. “Asset Management 2020: A Brave New World,” PwC, 2014. PwC and Strategy& analysis. Tricumen and Strategy& analysis.
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