In the FCA’s 2013/2014 Business Plan, it said: “The custody bank business model… is facing strain”, which could “lead to harm” to consumers, as custodians are forced to “exploit areas of profitability”.Custody banks make money by offering services to pension schemes, hedge funds and other institutional investors, as well as to brokers and banks.
However, over the years, the high-volume, low-margin safekeeping and custody services for which these trust banks are known have attracted fewer and fewer column inches – largely because they are making less money.
Instead, there has been a rise in value-added ancillary services – such as securities lending, foreign exchange trading and collateral management – that reap millions of dollars for custodians every year.
With low interest rates and regulatory costs putting “strain” on the custody models, the FCA
Custody banks, however, said the industry had already made the move to self-govern, stamping out potentially dishonest or detrimental activity long ago. Speaking to Financial News, one custody banker said: “This should have been done in 2008. The industry has already policed itself.”
Nevertheless, the FCA investigation is likely to have raised doubts in the minds of custody banks’ clients. The industry waited eight months for the regulator to announce its findings – which it did, in a speech by FCA director of supervision Clive Adamson at the regulator’s Asset Management Conference in October.
He said: “[The FCA] concluded that standards and transparency across the industry have improved over the past few years… custody banks have responded by improving their service levels.”
He added that clients had an important role to play themselves, saying: “You need to continue to hold the custody banks to account to ensure you are getting the services expected at the correct price, just as you would do for any third-party provider.”
This investigation into ancillary services was not the first undertaken by the watchdog. In December 2012 the FCA’s predecessor, the Financial Services Authority, sent out a “Dear CEO” letter to 125 asset managers, asking that they consider their outsourcing arrangements with external providers – such as custody banks. The regulator encouraged the industry to look at its reliance on and arrangements with outsourcing providers and to think about what would happen in the event that one of these entities should fail.
In response, a group of custody banks and asset managers, along with the Investment Management Association, clubbed together to square up to the regulator’s challenge, forming the Outsourcing Working Group.
Despite the attention, there has been little for the industry to worry about as its ability to self-police appears to have been largely successful.
The FCA said in a paper released earlier this month that it had been “encouraged to see that asset managers in conjunction with their service providers are able to make improvements in the absence of regulatory intervention”.
And to that point, at the FCA conference, IMA chief executive Daniel Godfrey said the industry’s vision is to “reach a point where [it regards] the regulators as almost irrelevant”.
But with regulatory scrutiny as intense as it has ever been, industry practitioners are aware that this is unlikely to be the end of the road.
The FCA declined to comment beyond referring Financial News to Adamson’s speech.
--This article originally appeared in the print edition of Financial News dated November 18, 2013