As their customers needs become ever more complex, custodians are finding themselves providing services that are far beyond their traditional realm.
The custody business has undergone dramatic change in the past five to 10 years. With profitability levels becoming increasingly difficult to maintain and the ongoing need to invest in technology, a number of players exited the business, selling their assets to one of the large global players, which manage assets in excess of $30 trillion.
Consolidation, and the need to sustain profit margins, means it has become more important than ever to differentiate on service levels. At the same time, the customer landscape has also changed dramatically, forcing custodians to move beyond core custody provision into more sophisticated areas.
As Jeremy Hester, senior vice president, Global Funds Services, Northern Trust, explains, As little as five years ago there was still a lot of pure custody in the UK and Europe, which he attributes to the fact that throughout the 1990s the industry was less mature, and Northern Trust was focused primarily on servicing the pension fund sector. The provision of core custody was limited to a set of services involving the movement, settlement and safekeeping of securities, as well as services such as income collection and corporate actions processing. Anything above and beyond that was considered value-added. Reporting was basic, with each custodian developing an individual system, and clients were left to do their own fund and portfolio accounting, says Ramy Bourgi, a business executive at JPMorgan Investor Services.
But the 1990s heralded a number of changes, not least of which was the impact of regulation on institutional investors, forcing them to re-assess what was core to their business and what they could outsource to third-party providers. Once we started servicing the investment management sector, they started asking questions about our capabilities in Dublin, fund accounting and administration, says Hester, areas in which custodians were historically not involved.
It wasnt long before custodians found themselves moving beyond core custody and the investment managers back office into the front and middle office, where more emphasis was placed on value-added capabilities. We have re-invented ourselves as an asset servicing company, says Hester, adding that few firms today are still focused primarily on core custodyalthough safekeeping and settlement is still an integral part of custodians asset servicing menu. Alan Greene, executive vice president, State Street, says there is still broad interest in products and services that are linked to custody. But when the bank competes for large mandates, custody alone is never enough. For us the definition of custody and everything it includes has become fairly broad and includes specialized functionality that we dont believe others have, he says. It is not just clearing and settlement, but income projections, market analysis, market research and information supporting reconciliation.
While some claim core custody has become commoditized, Hester says custodians still differentiate on service delivery, operating models, reporting, technology capabilities and their flexibility to adapt to different customer needs. In the area of reporting, for example, a number of custodians are looking to differentiate based on their level of technological sophistication. The Bank of New York recently gained a UK patent for an electronic messaging interface that facilitates communication between investment managers and the banks BNY SmartSource platform, which it uses to manage investment managers middle- and back-office functions.
Access to data, the kind of data the customer wants, how, when and where they want it, is very important, and we have focused a lot on these areas, says Greene. Providing this data demands constant investment in technology, though. State Street invests 20% to 25% of its operating budget in technology, for example.
Evolving To Meet New Demands
The emergence of fast-growing emerging economies such as China was certainly a factor in SAPs decision to offer software financing. The offering of financing in emerging markets is new and of biggest importance for the growth of SAP, says Hans Juergen Uhink, SAPs senior vice president of new business development. The company was also eager to make the costs of implementing its ERP application software less prohibitive for SMEs and believed the only way it could do that was by providing some form of financial assistance to help these companies get on the first rung of the ladder.
We wanted to accelerate growth in the mid-tier market segment and overcome the obstacle of financing, says Uhink. We are convinced that there is the need for financing ERP projects especially among mid-tier companies. Although SAP Financing is largely targeted at new customers, Uhink says existing customers or larger corporates could also use it to fund ongoing SAP software upgrades and IT projects. Within two months of launching, SAP Financing had already attracted significant deals from companies in both mature and emerging markets, with deals ranging in size from 15,000 at the lower end of the scale to tens of millions at the higher end, which is expected to increase significantly within the first year.
Uhink says pay-as-you-use software financing provides companies with predictable monthly payments, covering all project-related costs, including software and hardware costs, external service costs (software customization, implementation, training) and internal service costs (costs incurred by the company in implementing and maintaining the software). There are no hidden surcharges or unexpected surprises, he says, adding that this allows companies to more accurately predict and budget for IT costs over a period of several years.
Unlike purchasing software upfront, Uhink says payments under its financing program only commence once the installation has been deemed productive. SAP Financing also includes an online investment calculator so that mid-market companies can measure the total costs of ownership, including monthly repayments, before implementing an SAP solution. PwC estimates that the cumulated annual net cost savings are higher for pay-as-you-use than for traditional software purchasing solutions up to the fifth year. One of the drawbacks, however, of the pay-per-use model is that the company does not own the software outright.
SAP initially thought about providing the software financing itself but was advised by PwC that, if it did so, US GAAP accounting regulations would not allow software sales to be accounted for immediately until payments were due. The business model developed by SAP with advice from PwC assigns the financial risk to an independent third party [SFS] and the performance risk to SAP, Trattnig of PwC explains. This solution enables SAP to recognize revenues immediately.
But why not just leave software financing to the banks? Traditionally, companies may have sought bank financing to fund major IT and software projects. However, the credit cycle is contracting, and banks are less inclined to extend credit to non-investment-grade SMEs. Offering unsecured loans for periods of up to seven years in countries, including emerging markets, without additional collateral is unlikely to appeal to the banks, especially those having to comply with Basel II regulations. So SAP turned to SFS. SFS has 10 billion in assets under management and a financial network spanning 30 countries.
As Diers of SFS explains, using a global credit risk portfolio approach, it is able to spread the credit risk it assumes on behalf of SAP across its global portfolio of customers, which means that a strong credit profile among UK customers allows it to meet the needs of companies in more challenging economies such as Russia, for example. Thanks to our activities in the Project and Export Finance [PEF] division, we have good contacts to local sales financiers in a multitude of countries, Diers explains. This is why we were able to offer SAP financings even in markets such as Russia, India, Australia, Mexico and Brazil, countries where we do not have a balance sheet that would allow us to handle our own financing transactions.