By David Turmaine, Executive Director at Capco

The majority of custody banks are today sitting on ageing, and heavily customised technology. Their systems are 20-30 years old, and over the years have evolved in disparate fashion into a collection of related but distinct platforms across multiple locations to meet the needs of diverse client bases and different local markets.

While custodians may have lowered their core fees due to competitive pressures, reducing their cost of operations remains a challenge due to unwieldy and expensive legacy applications. Custodians are understandably inclined to say ‘yes’ to their clients and accordingly have bolted on capabilities ad hoc to meet their needs, such as more insightful client reporting creating highly complex and ever more outdated infrastructures.

Custodians now recognize it is time for a rethink. Their mindset is shifting towards a more disciplined and standardised model, and fact they must recognize the need to build new systems around best practices and consistent processes globally. Amongst their clients there is also a reduced tolerance to the inefficiencies that flow from disparate bespoke processes. The days of being everything to everyone are likely drawing to a close.

Understanding cost drivers is key, and many custodians have already invested in data metrics and advanced analytics to understand more clearly where those drivers are hidden within post-trade processes. However, this remains still a continual – and hence sub-optimal – process of evaluation for firms.

Quick wins

Custodians should be looking to co-create solutions with their client base as the buy-side is also under pressure from its own clients to reduce costs. Firms should have a clear strategy to remove legacy applications and adopt new ways of working. Custodians also need to determine how best to minimise the drain on top line revenues through the adoption of more fit-for-purpose fintech solutions and through driving standardisation across their clients.

It can take years for a custodian to remove multiple legacy platforms within its core infrastructure and transition to a new technology solution, typically at a cost of many tens of millions or more. Through partnerships with technology firms they can though implement solutions more quickly to drive innovation and solve the challenges and costs associated with operating and maintaining multiple platforms.

The emergence of technology wrapper solutions now offers a strategic stepping stone towards harmonisation. These technologies ‘wrap around’ multiple (often legacy) systems, bringing them together within a single-user interface and workflow, providing immediate standardisation. Those processes that do not generate a competitive advantage can be aligned around a standard solution. A move from ‘walled garden’ to open architecture will in time deliver clear cost benefits.

Certainly, this is a progressive shift. Custodians will need to live with both the old and the new for some time. Legacy technology cannot simply be eliminated overnight, and it must be assessed on a component-by-component basis, which inevitably takes time. However, custodians can focus on targeted high priority use cases and begin to incorporate new technologies that solves specific challenges they are experiencing.

Fintech partnerships

As mentioned, a fintech partnership is the most impactful way to adopt a tech wrapper solution across multiple legacy platforms to enable single UI capabilities and standardisation of process. Fintechs can offer workflow solutions to wrap around legacy tech, using data from underlying systems, normalising that data and the processes and procedures it informs.

The days of custodians building entire unique technology estates for themselves are likely to be at an end for all but the largest players with the deepest pockets. Identifying white label solutions and integrating them is far faster than embarking  on a large platform (re)build that is likely not to deliver even after a  couple of years down the line. With self-builds, custodians often face much higher costs and in many cases, a significant risk of failure. Even when things do go right, banks may find they’ve overbought and overbuilt, and find themselves in possession of a platform with capabilities they never use to their fullest extent.

With a fintech-sourced off-the-shelf package banks can be more confident they have a proven solution already road-tested by other firms (or at least one or two). Custodians typically build their technology in an accretive fashion – adding to existing solutions, taking a retrospective view and looking to replicate what worked before. Conversely, fintechs approach each challenge afresh and build technology that is future-proofed to accommodate evolving industry dynamics. This flexibility and targeted ‘best case scenario’ strategy will be key to helping custodians retain (or restore) their competitive edge and thrive in the future.

Self-service capability

Banks have already explored putting portals within their customers’ systems to enable a certain level of self-service, for example around regulatory reporting. The industry is now overwhelmed with portals to the frustration of buy-side clients, who in very many cases will not use them to their fullest extent.

The utility concept emerged in recent years as more comprehensive outsourcing solution built around self-service capabilities, but it too failed to take off fully due to lack of mass adoption and slow progress on the data sharing between custodians that would have made it most viable. Custodians are now looking at how they might build such capability internally using the new, agile technologies now available to them. We expect to see firms looking first to create an internal utility before turning their gaze outwards to lobby others to adopt this approach.

Moving forward, custodians will utilise open-source technology and in particular low code/no code solutions to facilitate more agile outsourcing. This could enable them to commercialise their own technology more easily and deliver it to other outsourcing providers, though progress on this front remains at an early stage. Many custodians have built something close to an internal utility for one specific business line, but there are still greater untapped efficiencies to be extracted by pooling resources across multiple operations divisions, such as wealth, investment banking and securities services.

Ultimately, custodians are overdue an upgrade. The adoption of technologies such as cloud and DLT will continue to accelerate as banks move to embrace a digital future and use the power of advanced data tools and analytics to provide more informed decision-making. Agile, modern technology, quickly deployed, will be key.