Custodian Banking and Know-Your-Customer Compliance
Todd Breeden
Custody Banking Market Overview
Understanding the Custody Banking Landscape to identify opportunities of investment to enhance
XXXX market position
What Is a Custodian Bank?
https://www.ecb.europa.eu/pub/pdf/scpops/ecbocp68.pdf?cd251dd1ed508e2b2a1b569c07609ede
Institution charged with handling safekeeping, servicing and settlement related to customer securities Settlement: When securities are bought and sold,
the custodian takes care of the delivery and receipt of securities against the agreed upon cash
Asset Servicing: Managing benefits, rights and obligations related to holding securities, such as dividends, voting, and other corporate actions
Securities Services OverviewCustody services as it fits into a landscape of
securities services provided by broker-dealers, clearing houses, central securities depositories and others
Role of a Custodian in Securities Settlement System
http://gendal.me/2014/01/05/a-simple-explanation-of-how-shares-move-around-the-securities-settlement-system/
Buyers and sellers of securities have their assets safeguarded and serviced from the operations of the broker.
Central Securities Depositories hold all of electronic securities on behalf of issuers, and facilitate the transfer of securities between custodians when a trade is cleared
Drivers of Custody Sector Growth
http://www.institutionalinvestor.com/article/3481359/asset-management-hedge-funds-and-alternatives/cautious-hedge-funds-spell-big-business-for-custody-banks.html#.Vnr5LcArJD0
2008 Failures
• Lehman Brothers / Madoff drove asset managers to custodian services to safeguard assets against counterparty failures
Increased Regulation
• Dodd-Frank and Europe’s Alternative Investment Fund Managers Directive require hedge funds to use third-party custodian
Institutional Investor
Requirements• More rigorous
transparency requirements and governance around asset allocation at investor level forcing hedge funds to adopt custodian services
Demand for Custodial Services Outpacing Growth of Total Financial Assets
Competitive LandscapeIncreased competition from market infrastructure services for the core custody product has negatively impacted pricing pushed custodians into adjacent fund services to differentiate
Declining Margins Affecting Top-LineDespite AUC increasing at 8% p.a from 2008-2013 for the largest custodians, fee compression has significantly impacted revenues of the custodian market – causing massive consolidation and concentration of assets in search of operational efficiency/synergy
Big 4 Dominate Market
http://www.trefis.com/stock/bk/articles/310610/q2-2015-u-s-banking-review-custody-banking-assets/2015-08-20
$25.1TR AUC
Avg Fee: 0.0142%25% of Overall
Revenue
$22.0TR AUC
Avg. Fee: 0.0182%50% of Overall
Revenue
$20.5TR AUC
Avg. Fee: 0.019%4% of
Overall Revenue
$15.5TR AUC
Average Fee:
0.015%3% of
Overall Revenue
AUC of Big 4 represent ~2/3 of Global Custody Industry
Custody Market: Conclusion
The commoditization of core custody services has increased the demand for
adjacent value added services. Providing these services will allow custodians to
increase AUC and market share v. competitors.
Know Your Customer (KYC) and Foreign Account Tax Compliance Act (FATCA)
Adjacent service to custody banking creating a massive market opportunity
Twin Regulations Driving a New MarketKYC (2003)
• Regulation requiring financial services to verify the identity of its clients
• Mandatory for all US banks as anti-money laundering (AML) compliance, as well as the prevention of financial fraud and terrorist financing
FATCA (2014)• Regulation requiring US
citizens to report non-US financial accounts and requires FFI’s (foreign financial institutions) to report assets and identities of US account holders to the treasury
• FFIs in agreement with IRS to search customer databases to identify suspected US account holders informationEstimated Ongoing Cost of Compliance ~$8bn/year (Forbes)
In 2014 – Financial Institutions paid over $12bn in reported AML related fines
Challenges to Remaining CompliantCustomer Due
Diligence• Each account holder
needs to be reviewed for US indicia , not previously required under KYC/AML rules
• Periodic reviews to accounts must be performed as the holders’ of accounts status is subject to change
Intergovernmental Agreements (IGAs)
• Country-by-country agreements to help financial institutions comply with FATCA, despite legal barriers to do so (i.e data privacy)
• IGAs provide relief to allow more types of documents to be used to classify if an account holder is a US person, increasing the complexity of customer due diligence• PWC’s “Quick” Ref
erence Guide to Global KYC/AML Laws is 583 pages…
Process & Technology Coordination
• All information collected as a part of KYC/AML process must be made available to the IRS, in order to verify authenticity of data, complicating the on-boarding of customers
• Disjointed technology processes and technology silos that store relevant customer data in front, middle, and back office operations often do not rely on the same or harmonious data sources, complicating reporting
Failure to uphold compliance and maintain program governance results in a 30% withholding tax on income from the US
Global Banking Segments Affected
http://www.mindtree.com/solutions/fatca-compliance-solution
Customer Demand is Real Over 80% of surveyed financial institutions
ranked AML & KYC management overhaul a priority in the coming years, while over 90% cited the biggest challenges to management is access to internal data and expertise
http://www.oracle.com/us/corporate/analystreports/chartis-financial-crime-risk-2541655.pdf (Chartis)
Costly / Difficult Implementations Despite high demand for KYC/AML
management, only 12% of 2015 surveyed respondents felt they had a fully integrated system
Incumbent Vendor LandscapeAML and Transaction
Monitoring KYC and Client Onboarding
http://www.oracle.com/us/corporate/analystreports/chartis-financial-crime-risk-2541655.pdf (Chartis)
Most major consultancy practices (PwC, E+Y, IBM, Mindtree, KPMG to name a few) offer implementation services for vendors on the above landscape, or build custom solutions for financial services clients
Investment Thesis
Given the tremendous ongoing cost burdens of maintaining FATCA and KYC compliant, as well as the fines/withheld income for compliance failures, financial institutions and investment groups able to manage compliance efficiently at a low cost will begin to generate alpha for their customers in the form of cost-savings,
providing excess net returns over peer groups invested in similar products
Emerging Technology Vendors
Examples of investible opportunities compiled from Crunchbase, LinkedIn, and other publically
available sources
Company SpotlightSector: RegTechProduct: Automated collection, verification and secure storage of customer due diligence (CDD) data and documentation.Target Market: “SMB” and up
Company Pitch: Viewable Here
Traction: Partnered with Accenture’s FinTech LabThesis: Automated data refreshing and auditing deployed in an API protocol that can be easily integrated (under 1 day) into an existing KYC/AML compliance enviornment reduces sales cycle concerns and lengthy implementations
PassfortHQ: London, UKFounded: 2015Investors: Accenture, Entrepreneur FirstFTE – 15 (LinkedIn)Capital Raised: [undisclosed
Company SpotlightSector: RegTechProduct: Customer On-boarding and due diligence product making KYC processes more efficientTarget Market: Financial Institutions and Regulated EntitiesMajor Customers: KPMG
Traction: Early days
Thesis: Consumer-driven KYC environment frees up resources at FI/RE level to generate operational efficiencies and cost-savings across the KYC/AML stack
TrunomiHQ: San Jose, CAFounded: 2013Investors: KPMG, Visionnovation, Saturn Partners, Persistent Ventures, SenaHill PartnersFTE – ~10 (LinkedIn)Capital Raised: $5.3M
Company SpotlightSector: Fraud ManagementProduct: Risk management and anti-fraud services for enterprise
Target Market: E-commerce ecosystem: Acquiring Banks, Payment Processors and Gateways, Payment Service Providers (PSP/ISO/MSP,IPSP), and Online MerchantsTraction: FinTech Forward Company to Watch 2015 / CIO 20 Most Promising Compliance SolutionsThesis: AML solution helps Money Service Businesses (MSB’s) including Money Transmitters and Bitcoin Exchanges by issuing alerts based on suspicious activity related to the movement of funds
IdentityMind GlobalHQ: Palo Alto, CAFounded: 2013Investors: Benhamou Global, Cybernaut, SBT Venture CapitalFTE – 37(LinkedIn)Capital Raised: $12.6M
Company SpotlightSector: RegTechProduct: Online identity verification services, powering fraud and compliance systems worldwide.Target Market: Enterprises and Financial Services Partners: LexisNexis, Experian, IDology, CallCredit, AvokaMarket Traction: As of Oct. – KYC/AML API covers 4 billion identities worldwideThesis: Next-gen verification designed for cross-border transactions to aid businesses complying with AML and KYC rules
TruliooHQ: Vancouver, BCFounded: 2010Investors: Blumberg, BDC Venture, Amex, TenforeFTE – 34 (Linkedin)Capital Raised: $23.3M
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