Upping the pace of consolidation
Bankers in more glamorous businesses may not think much about custody, but they should. The business sits underneath most of what they do, and the custody chiefs at their banks are at the forefront of the most radical re-engineering of global capital markets yet seen.
The driving force behind this change will be the move to settling securities transactions on the day following the trade, or T+1. It is an abbreviation that is likely to become as familiar to capital markets participants as those already notorious triplets Emu and Y2K. Indeed, John Owen, the former global head of derivatives operations at Bankers Trust and now a partner of consultancy the Capital Markets Company (CapCo), is in no doubt as to the potential significance of T+1. "In terms of the changes to systems that are needed to get his done, this is bigger than the year 2000 and the euro put together and multiplied by five."
Normally such an observation might be written off as simple consultant-speak, intended to garner a few fat fees. But the move to T+1 settlement is well on the way to becoming the hottest topic in capital markets once the minor hurdle of the new millennium is out of the way. And, according to Albert Petersen, executive vice-president at State Street: "If you're talking about how difficult [T+1] is to do, then [Owen's assessment] is correct."
Going straight through
For the custodians of today it represents an opportunity to transform the nature of the service they provide. The function they perform will need to be integrated into a system for processing securities trades that can meet the demands of next-day settlement. What many in the market are aiming for is global straight-through processing, or GSTP, where transaction information flows seamlessly through an automated system from trade execution to settlement reporting, regardless of the counterparties and custodians involved.
Global custodians are at the forefront of initiatives to develop GSTP. If they manage it – and that remains a very big if – then the settlement function as a source of revenues will be dead. One custodian expects that by 2005 transactions will be processed in a tenth of the time it takes today. The fees custodians earn for their part in that process will also be just a tenth of what they now receive.
According to Mark Tennant, senior vice-president of global funds services at Chase in London: "Those who say global custody will still be an industry as we know it in five years time have got their heads in the sand."
What is clear is that at some point early in the next millennium, global custodians are going to have to deal with T+1 settlement. A deadline has already been suggested by the Securities and Exchanges Commission in the US, which wants to see T+1 installed as the US market norm no later than June 2002. As Joseph Anastasio, CEO of CapCo's North American operations and a member of the Securities Industry Association sub-committee on T+1 points out, such a deadline would at least provide another use for all those millennium countdown clocks set to become redundant at the end of this year. Simply pull off the Y2K label and stick on one saying T+1, and reset your clock to 913 – the number of days after the new millennium when the SEC expects to see trades routinely being settled the day after execution.
Nor is the change likely to be limited to US markets. "After the advent of the euro – which many people in the industry see as the Americanization of Europe – there's more acceptance that a global standard like this can come into place," suggests Bob Gallagher, director of network management at Investors Bank & Trust Company. "T+1, when it arrives, will be global."
Although a further shortening of the settlement cycle has been likely ever since T+3 became the international market standard in 1995, only in the past 12 months has it started to receive much attention from those within the industry. "The discussion on how we might move to T+1 is one of the most exciting developments in the market," says Lucille Knapp, who is responsible for European business development at Northern Trust. "But until we get Y2K off the public agenda I don't think it's going to move to the forefront of people's minds."
When it does penetrate the popular consciousness, the scale of the task at hand will be daunting. The SIA sub-committee has identified seven major building blocks that it feels will be necessary if the market is to achieve a reduction in the settlement cycle:
- Real-time trade matching for institutional delivery-versus-payment transactions
- Real-time broker-to-broker trade comparisons
- Dematerialization of physically issued securities
- Closing the remaining gaps on achieving finality of payment
- Cross border GSTP
- Electronic links to foreign depositaries
- Electronic dissemination and storage of investor information
Given the sweeping changes that would be required across capital markets to realize these building blocks an understandable response would be to seek a delay in the move to T+1. Yet the rapid growth in securities trading around the world makes a reduction in the settlement cycle and the accompanying overhaul of market technology an imperative. "We've doubled the volume of trades since 1994 in almost every market," says Anastasio. "We're not going to be able to do that again with the current technology."
Yet all the indications are that the burgeoning growth in securities trading will continue. The 1.5 billion shares traded daily on the Nasdaq, Amex and NYSE exchanges in the US will likely have grown to between 3 billion and 4 billion by 2002 according to SIA forecasts. Such a volume would threaten to overload the existing means of processing transactions. There would be a very real risk of a backlog in settlements bringing trading to a standstill.
According to Anastasio: "GSTP is the biggest stumbling block. If we can get that done it will be a big catalyst." And it is the move to GSTP which is at the forefront of custodians minds.