The challenge of duplication
Thomas Zeeb, CEO, SIX Securities Services, was the recipient of Global Custodian’s Lifetime Achievement award earlier this year. Here he speaks with Richard Schwartz about whether the post-trade world can move beyond the search for scale.
This industry is discussing, among other things, a wide range of newer technologies with varying degrees of promise for the securities industry. What in your view should be top of the agenda to address?
I think there are two elements to that question and technology is the lesser of the two, to be honest. Let’s take technology first: we’ve got to move from talking to doing. We’ve got a lot of experimental work going on, blockchain being just one example. When I look at FinTechs and our own incubator, there’s a lot of spaghetti being thrown against the wall and it’s not at all clear what’s going to stick. We need to get to the point where there’s a little more starch in the spaghetti, so it sticks. What that means is that we need to begin to see concrete applications that bring demonstrable value to us and to our clients.
If, for example, you were equally enthusiastic about blockchain, big data, AI and APIs, would you have a coherent direction?
I do think we’re entering a phase where AI and robotics are a viable alternative to near-shoring and that will change the dynamics of how and where our work is done quite substantially. It gives us the opportunity to move beyond the search for scale in the post-trade environment, if we can implement it properly and the potential is realised.
Can you give me an example?
For 30 or 40 years, the primary dynamic that has been shaping the post-trade world is high fixed costs. You therefore have to bring volume onto these platforms, because that’s the only way to get your unit costs down. The high fixed costs are partially IT-related, since these are not uncomplicated platforms, but also include regulatory and compliance overheads. There is a certain amount of non-productive investment we need to make just to be in the business. As a result, there has been a 40-year quest to generate volume. With an AI or robotics revolution that goes beyond automating one or two processes, we could turn some of these fixed costs into variable costs and break the dependency on scale. It’s a substantial shift in how we all do business. But it’s not going to be easy.
Scale has been an issue in another sense with any wholesale or industrial level adoption of new technologies. Things start out that look exciting, but can they cope with the kind of throughput that the securities services industry needs?
I think we need, as an industry, to look more broadly at not just what potential exists through IT or other enablers, but also at what already exists in some markets. In this regard, I refer to the segregation of accounts at CSD-level down to the final beneficial owner as is done, for instance, in Scandinavia, India, or Turkey. This provides the potential, in a second step, to eliminate duplication, and therefore cost, in the overall value chain. Now that’s a long way down the road, because it implies that both banks and CSDs can move beyond the omnibus environment into a fully segregated environment. Doing that in a five- to-10-year timeframe would, for example, be cost-prohibitive for the industry. We should start looking at these things as end-of-life replacement activities that bring substantial cost saving. It will also take a long time for all the various stakeholders in the value chain to redefine what their role will be in this changed environment.
That brings us directly to the second thing that I’m seeing and that will start to happen more. We have to redefine the relationship between the various stakeholders in the market, including infrastructure, banks, asset managers and the investors behind them. I think these relationships will have to become much more collaborative in future. Partially, that will be driven by regulation, because regulators are increasingly – at least passively – encouraging investors to have accounts directly at the CSD and the CSD Regulation (CSDR) will allow for that.
That creates a few potential tensions between traditional CSD clients, the banks, and the CSDs themselves. Frankly, most CSDs are not in a position to provide the kind of reporting that institutional investors need and whether it’s worthwhile developing that is somewhat questionable, but the possibility will be there. It will change how our business flows work. Behind that is the question of what value each participant in the chain adds. Banks at a retail level are already experiencing this change. Nobody under the age of 60 regularly goes into a branch anymore. You set up your account, get paid into it and pay your bills and you do all that online. And do you really care if your bills get paid via a mobile phone provider? Probably not, as long as there’s a reasonable amount of safety around the account, which would be regulated. Redefinition of the role of bank branches and the employees that work in them is therefore already changing. Similarly, if you look at how FX is done today, you can go up to any number of FX platforms and get your money. You don’t need to go to a bank branch. That is unlikely to be the model of the future.
When you mention things will be more collaborative, how do you see that collaboration happening? There are examples of industry collaboration that have not been too successful.
I think the attempts to collaborate horizontally – in other words CSDs with CSDs, banks with banks, is slowing down, because the value is hard to present and realise. Some of the challenges are regulatory and some are simply the reality of different platforms and strategies. What I do think we will see more of is a much closer working relationship between banks and infrastructure to reduce core duplication and costs along the value chain.
For example: if I create a CSD platform that is fully segregated down to the end-client that allows our clients, the banks, over time to seriously consider linking individual accounts to individual accounts, instead of having a vostro based on individual accounts and a nostro that is omnibus. That makes the whole compliance, tax disclosure and AML monitoring process much easier. If you do that, you can start taking significant duplication and cost out of the value chain.
If I take the Swiss market as an example, the back-office costs are CHF 800 million-1 billion per annum. My core custody platform at the CSD costs me about CHF 23 million in running costs per annum. If I flog my IT department to within an inch of its life, I might get CHF 5-10 million out of that cost. That’s a stretch that would come with a reduction in service, but let’s say I could do it. Taking CHF 10 million out of a CHF 23 million cost hardly shows up on a dial that goes up to 800 million. Bashing down on individual elements of the value chain and saying, you have to be cheaper, is not the solution. We have to eliminate the duplication we all do. I think it’s part of the role of the infrastructure to put a few lines in the sand where we say, “Look, here are some opportunities. We are going to create the technology that helps you, the bank, and other stakeholders to redefine how your business works.” It’s going take time, but if we could get CHF 800 million to CHF 1 billion down to, say, CHF 400 million by taking out duplication, that’s substantial.
How advanced is this groundswell that can lead to collaboration?
Obviously, we talk to stakeholders. We have an advisory board and we talk to the financial technology community. And when we talk to IT firms that know the business, they too have a view on what technology can do to enable the development of our business over the next 15 years.
Are we seeing concrete moves in this direction yet? Not really, but I think it is inevitable. There’s only so much water you can get out of the stone. Most banks are working reasonably efficiently, most CSDs are working reasonably efficiently. We can trim around the edges, but it doesn’t resolve the issue of duplication. Getting rid of those duplications will be the next frontier for the industry to move forward. That will inevitably require vertical collaboration and trust, rather than just horizontally between similar stakeholders.
One of the big challenges in redefining the role of infrastructure is looking at where we can augment our clients’ business model rather than competing with it. As I mentioned, banks already face significant challenges to their business models. If we can help them compete with new providers, that’s a decent role for the infrastructure to have. There’s still time to have those dialogues, if we’re open and honest about where the threats and opportunities lie.