What is The Security Services Sector?

Securities services denote to all processes in the post-trade domain, including clearing & settlement of securities, protection of assets, securities lending, and fund services.

Firms delivering securities services and processing activities within capital markets play a crucial role for institutional/retail clients across various asset classes/ geographies.

The sector is a scalable business and firms generate revenues from clearing and settlement of securities, asset servicing, securities lending & foreign exchange, and safe-keeping of assets.

Historically, the segment has been a transactional business where size is significant and revenues similar to an annuity from normal revenue streams kept the business functioning. Firms have transformed their business models after the financial crisis.

The sector witnessed its best period before the financial crisis. The equity markets were performing well globally, which resulted in year-on-year growth for pension funds, asset management firms, and brokerage houses. This improved the profitability and revenues of firms.

However, the financial crisis significantly impacted the sector and wiped out a huge amount in stock market capitalization. The decrease in investor confidence impacted the performance of securities services firms.

The sector is witnessing several stress points - reduced margins, greater cost- income ratio, and strict regulations.

Reduced Margins

The assets under custody (AuC) of prominent players have grown after the crisis, but the gross margins have fallen.

The security lending revenues were impacted by lesser interest rates and restrained mergers & acquisitions activity (decreased arbitrage options). FX revenues were lower because of lesser volatility in the currency markets, decreasing fees, and lower transaction volumes.

Margins were also impacted by investors choice for safer asset classes and reduction in a number of equity trades because of uncertain market environments.

Greater Cost-Income Ratio

The total cost-income ratio of the key players increased after the financial meltdown. The top-line growth was impacted by a reduction in margin, uneasiness in the markets, and other macroeconomic reasons.

Competing with Central Securities Depositories

Central Securities Depositories looking for other revenue sources would make an entry into the normal revenue-generating streams of sub-custodians. There would be intense competition among the market players.

Decrease in Securities Lending Function

Revenues from securities lending functions have been reducing because of lower interest rates globally.

FX revenues dropped mainly because of the lower volatility (narrow spreads) in foreign exchange markets and greater inspection in pricing.

Clearing and settlement costs are more in certain markets like Europe because of lesser volumes, market structure, legal, regulatory, and technical obstacles.

Strict Regulations

In the recent past, the sector has witnessed several strict regulations aimed at decreasing systemic risk and improving consumer protection.

The regulations are placing a tremendous burden on firms with regard to additional capital, modified reporting needs, improvement of existing technology systems, and the establishment of new platforms.

The regulations mainly impacting the securities service sector include:

• Basel III.
• Dodd-Frank and European Market Infrastructure Regulation.
• Target2Securities (T2S).
• Alternative Investment Fund Managers Directive (AIFMD).
• Markets in Financial Instruments Directive (MIFID) II.

At present, the sector is affected by tough economic scenarios, lower margins because of commoditized services, and higher costs.

It is a very niche business that needs frequent investments to be in line with the changing regulations and advanced products entering the market. Though regulations present several challenges, they also provide opportunities.

The various financial stakeholders are also re-evaluating their operating models. Firms are seeking new methods to optimally use the existing capital. The financial decision makers are considering outsourcing as an option.

Consolidation Activity

The sector is expected to witness more consolidation due to thin margins and higher cost-income ratio.

Consolidation is mainly steered by bigger firms with the capability to make investments in the latest technology.

The key trends that are forcing asset managers to look for outsourcing options are:

• Pressure on Fees.
• Diversified portfolio.
• Higher operational costs.

Since the revenue generation has been impacted, asset managers are focusing on the critical function of managing assets and creating returns for investors. This has resulted in a greater demand for outsourced solutions.

This provides a substantial opportunity for securities services firms to manage the non-investments functions of asset managers.

Securities services firms with the adequate scale and human resources are starting to reposition themselves and increasing their expertise to cater to the precise requirements of asset managers.

The firms are presenting a distinct platform that would ensure asset managers can select the necessary services compatible to any asset class.

Firms must offer innovative services to be relevant in the highly competitive market. They must take over the securities processing functions of investment banks. This would ensure they can generate more revenue.

Firms could implement a technology transformation to decrease costs while consolidating their operating platforms. Regulations covering OTC derivatives are expected to result in a shortage of collateral and would make it costly. Firms must execute real-time collateral management systems that would enable them to monitor collateral globally expeditiously.

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