The major capital markets custodian firms recently reported Q3 2015 financials. The custodians provide critical operations support to global capital markets, and their performance provides an early warning measure of the state of the capital markets industry in general. Here we look at the performance indicators for BNY Mellon, State Street, and Northern Trust, reflect on the implications for the industry, and on the measures being taken to address increasing cost pressures.

The key performance indicators for three of the largest global custodians, below, show percentage changes from Q3 2014 to Q3 2015:

• BNY Mellon:
  • Revenues (18%)
  • Servicing Fees +2%
  • Assets in Custody +1%
  • Non-Interest Expenses (10%)
• State Street:      
  • Revenues (1%)
  • Servicing Fees (1%)
  • Assets in Custody (4%)
  • Non-Interest Expenses +4%
• Northern Trust: 
  • Revenues +7%
  • Servicing Fees +7%
  • Assets in Custody +1%
  • Non-Interest Expenses +5%

Key findings from these results include:

• Overall revenues and servicing fees are flat to declining, revenues growing only in specific markets (e.g. global family offices for Northern Trust, and foreign exchange trading revenues from increased volatility for both State Street and BNY Mellon)
• Assets under custody are flat to declining, custodians with greater foreign market exposure face greater asset value headwinds, and therefore greater revenue pressure
• Non-interest expenses want to grow, but are being aggressively managed downward by successful custodians. Inability to manage non-interest expense is the key financial indicator of operational failure for custodians, since revenue growth cannot be materially increased in the short run.

The current trends will continue until there is a large change in market conditions, probably triggered by a general rise in interest rates as QE is withdrawn. In the meantime, custodians have to drive forward their business based on flat to declining revenues, and that means the successful ones are restructuring their operations. Large financial institutions are notoriously close-mouthed about operational delivery, so where are global custodians looking to adapt operations beyond headcount reduction?

Three key trends in operations outsourcing include:

• Sale of captive operations, including platforms, with agreement that the third party vendor will enhance the platform, share overheads by bringing additional financial institutions onto the platform, and run operations for the client bank as part of the engagement. An example of this is the UBS/HCL Technologies engagement
• Outsourcing of (many) compliance activities. This has been well documented in the press, and due to the 10X increase in operational costs of compliance, will continue to be a prime driver of BPS activity in financial services
• Improvement of data management and analytics.

Improvement of data management and analytics has been an unheralded area of financial services BPS, but custodians are now turning to outsourcing this area of their business. For example, one custodian has entered an outsourcing engagement across the areas of market data and sourced analytics, risk operations, and trade cost analysis, achieving benefits including 20% lower cost compared to internal captive delivery.

In another example, a custodian has outsourced data management and analytics for funds under management, achieving a 67% reduction in processing times by automating manual activities, and consistently meeting 100% accuracy and timeliness.

In summary, custodians are facing stricter operational delivery requirements under conditions of stagnant resources, and are looking to third-party vendors to support them in meeting those challenges. By utilizing BPS vendors, custodians are able to drive improvements in data quality and timeliness at reduced cost. These engagements do not show up in growing profits, but do show up in the industry, with custodians being able to move forward without financial impairment. Custodians who are slow to identify appropriate processes and move them to third-party vendors are experiencing both profit and revenue shrinkage which is faster than the industry. These conditions will not change in the short term. Indeed, rising interest rates, which are likely to bring a change in market conditions, are likely to accelerate cost pressures.