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Custodians on API quest for Holy Grail of scale

Banks on quest to boost profits by digitizing clients’ access to data, but are investors ready?

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Custodian banks think they’ve found their Holy Grail: technology that would let them scale. Like the fabled Knights of the Round Table, they are riding out from Camelot to find the greatest prize.

Of course, custodian banks are already huge, but they must still bow to the needs of the asset managers and asset owners they serve. This clientele is a diverse lot, with their own systems, processes, and – especially in diverse Asia – regulations and reporting requirements. Custody is a reliable but low-fee business that relies on volumes (core custody and fund accounting are often loss leaders). Therefore banks need to make sure their biggest clients’ needs are met, which means expensive customization of reporting and other services.

But what if a new technology came along that could enable banks to magically turn this liability into an asset? What if, instead of having to put up with lots of pesky client requests, they could sit back and tell their client: here’s all the information in the world, now go service yourself?

Not only would this let them save a bundle on client-relationship costs, but it would also, ideally, make for better service: customers could get real-time access to diverse sets of data to let them quickly and effectively manage tasks such as risk management, regulatory reporting and performance measurement.

Gathering for the quest
It’s a win-win – and it’s happening, through the building of banks’ data lakes that institutional investors can connect to via APIs.

“We’re closer to finding something clients and custodians alike have been searching for: one scalable operating model,” said Shaun Parkes, managing director and head of investor service sales for Asia Pacific at J.P. Morgan.

Indeed, being able to create such an infrastructure is now the cutting edge of competition among custodians.

“Over the next three to five years, this is where we’re going to add value,” said C.P. Yap, Hong Kong-based head of custody and fund services for Asia Pacific at Citi.

But it’s happening a lot more slowly than banks like. In fact, some of their clients say uptake is going to be slow and difficult.

“The theory is nice but the practicalities are difficult,” said Dean Chisholm, Asia-Pacific COO at Invesco. “There’s no real standardization in the asset-management industry, so there will still have to be customization.”

Custodians have always served as the source of “truth” in a complex industry of many, many players, each with their own I.T. systems, processes and regulations. Banks spend vast resources on automating processing to eliminate errors and help clients reduce risks.

As technology evolves, so do the means by which banks continue to strive toward this oracle-like status. Today they are harnessing digital tools to overcome decades-old heritage systems, in order to try to cut through traditional silos.

“We’re digitizing the process to develop tools to be that one source of truth,” says Ian Martin, Asia-Pacific head of State Street Global Exchange, a “data as a service” unit of State Street.

The challenges mount
But truth is slippery, because banks remain large, unwieldy organizations with client data stuck in different departments.

The same transaction, involving the same client in the same market, requires information be passed among asset managers, brokers, custodians, administrators, fund registrars, stock exchanges, central counterparties and clearing houses.

“It’s all vertical: they all have their own data models, their own standards, their own reference data,” said John Van Verre, managing director at HSBC Securities Services in Hong Kong and global head of its custody business. “The same piece of data can be interpreted differently.”

This lack of consistency is what custodian banks’ digital development teams are trying to address.

Banks are starting to claim some initial successes with clients in Asia. But APIs – application programming interfaces, bits of code that enable to software apps to communicate – require integration. A client has to invest to connect via an API.

Whether enough clients are willing to do so is an open question.

“Data lakes are certainly a hot topic,” said Mark Konyn, group chief investment officer at AIA in Hong Kong. “I would say take-up is unproven. Institutions are more generally using investment books of record and data-management tools to create dynamic polling and report generation.”

Into the field of battle
Custodians acknowledge it’s early days for this new business model. Philippe Rualt, Paris-based head of digital transformation at BNP Paribas Securities Services, says it will take about three years for APIs to extend throughout the custody business, even for the most basic information, such as NAVs and fund accounts. “Everything needs to be re-documented, and put under a governance framework,” he said.

In some ways, this shift is nothing new: for decades, custodians have been searching for profitable services and more attention from buy sides’ front offices as the business commoditized.

But digitization could realize the “custody Holy Grail” in a more fundamental way, because technology, if allowed, can change client relationships profoundly. It would shift competition among banks further up the value chain, letting them find new sources of revenue derived from providing data insights.

Some players are targeting niches where they think they can add value. For example, RBC is focusing on the registrar function.

“Transfer agency is rich in data,” says Paul, London-based managing director and global head of client experience at RBC Investor and Treasury Services.

Another example: BNY Mellon is developing APIs to help investors get a better picture of their derivatives exposures. Over-the-counter derivatives are a data challenge, as they are “unstructured”. At the same time, however, investors are using them more, as tools for tactical asset allocation as well as to build alpha-seeking portfolios.

By simply sending regular reports, BNY Mellon had only a vague idea of how the information was being used. “We had no insight as to what the client would do with the information,” said Rohan Singh, Singapore-based managing director and head of Asia Pacific for asset servicing. “Now, connecting with them through an API, we can understand how they consume it.”

Quest unfulfilled
Bankers recognize that they have to prove they can create the intelligence to help customers make better decisions, in risk, in product design, and in investing.

But such services don’t come cheap. Building a data lake is an enormous investment, not least because it requires people with data skills (and data scientists are expensive).

The bigger hurdle is on the client side. Only the very biggest asset managers and most sophisticated sovereign wealth funds can afford to employ the small team required to make sense of data.

Invesco’s Chisholm notes that data lakes aren’t the end of the story, either. To really derive value, investment firms need to blend their own information about a given security with third-party sources of data such as indices or market feeds. “A data lake needs meta data, to put it all into context,” he said, adding that this leads to a level of cost and complexity that few institutions can handle.

This suggests custodians aren’t about to grasp the Holy Grail just yet. Digitization will enhance transparency and foster simplicity, which implies more efficient processing but far lower fees. It’s unclear whether the new API-led services will command prices high enough to compensate – or if there will be enough clients ready to pay the price. As King Arthur’s knights found out, the quest is what counts, but Holy Grails are not meant to be possessed.

Asset & Wealth Management

Lu Global reverses the Lufax story

Lufax began as a P2P and became a wealth manager – in Singapore, it’s adding secondary trading.

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Kit Wong, Lu

Lu Global, a wealth-management fintech in Singapore, has just launched a marketplace to enable its customers to trade the same products they bought on the company’s website.

Kit Wong, CEO at Lu Global, says the company has developed its consumer-facing business and is now selling both funds and structured products.

But it believes some clients want to get out of these positions, particularly structured notes. Instead of having to hold them to maturity, they can now see if other users in the Lu system are willing to buy them (at a discount).

Wong says the firm, which has a capital markets services (CMS) license in Singapore, serves about 300,000 customers. Some are resident in Singapore (where the business can only market to accredited investors), others are from outside, who can be either professional investors or retail.

The biggest segment of investors are mainland Chinese, who already know the Lufax brand, but there are also a lot of Taiwanese and Hongkongers, and a growing number of Southeast Asian users, Wong says.

The electronic marketplace has just gone live, so it has no volumes to speak of. Lu Global does not take positions in this secondary trading environment – it merely matches its existing customer base in case users want to make trades among themselves.

Lu Global declined to state its assets under management. Wong says the largest number of products are mutual funds, issued by the likes of BlackRock and Pimco – but the biggest volumes are in structured products.

He believes this may have to do with economic and political uncertainty in the region, which is spurring demand for products with known outcomes and terms.

But such products only pay out upon maturity – and the same destabilizing factors may be leading more investors to want to cash out early, even if they do so at a loss. But providing a marketplace not only gives them access to liquidity (assuming there’s a buyer on the other side) but also lets them sell at a better rate.

The launch of this product is a strange parallel to parent Lufax’s journey. Shanghai-based Lufax began in 2011 as a peer-to-peer marketplace for transactions, financing, and investment management. It exited the transactions and financing aspects to focus just on wealth management.

Lu Global built itself first as a marketplace for wealth products – but now it’s expanding into secondary trading, creating a marketplace for customers to exchange financial products before they reach maturity among themselves – a different kind of P2P than lending, which mainland authorities are clamping down on.

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Asset & Wealth Management

Half of Invesco’s China sales now via digital

But as the PRC joint venture learns how to distribute digitally, Invesco remains unsure of robo’s role in Asia.

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Andrew Lo, Invesco

This week DigFin is highlighting three asset-management firms’ approach to digital distribution, particularly in China. See also strategies from AllianceBernstein and BEA Union Investments. Go here for more insights into digital asset and wealth management.

Invesco is using its joint venture in mainland China, Invesco Great Wall, to figure out digital distribution.

The business now manages about $50 billion of assets, of which about 80% is retail, making it the fourth-largest Sino-foreign fund house in China. Over the past two years, half of retail inflows have come from new digital channels, as opposed to the traditional reliance upon banks, says Andrew Lo, senior managing director and Asia-Pacific CEO of Invesco in Hong Kong.

This is in keeping with a broader trend in the global mutual funds industry, which is shifting from one based on products to one focused more on investment solutions. “There’s an emphasis on designing outcomes for clients, such as through asset allocation or structuring,” to combine types of risk and asset classes.

That’s driven both by client demand as well as market volatility and challenges to active fund houses to deliver alpha (outperformance) on a net-free basis, compared to ultra-affordable passive investments tracking a benchmark.

Reaching retail

That’s been an emerging story for the funds industry over the past decade. But on top of that is a new wrinkle: the ability to use technology to speed up operations and to reach more people.

“Technology is now changing the distribution landscape,” Lo said. “In China, it’s having quite an impact on reaching retail investors.”

For now this has been a story unique to mainland China, where existing bank channels (which dominate funds distribution in most Asian markets) are not well developed, and where regulation favors digital disrupters like Ant Financial.

The power of digital was evident in Ant’s success with money-market funds (under an affiliated fund house, Tianhong Asset Management), but it has now extended to equity and quant products onshore – products that Invesco’s J.V. now sells through fintech channels, including Ant, East Money Information, JD.com (Jingdong) and Snowball Finance (Xueqiu).

This has not been straightforward, however. Fund management companies are designed to cater to bank distributors, and are built on old-fashioned tech.

Still learning

“We learned how to do digital marketing,” Lo said. “It’s very different to traditional distribution. It’s iterative, it changes fast, and you have to listen to customer feedback.” Partnering with digital channels has also required a different sense of product design, and to rebuild the company’s operational process to support round-the-clock digital sales and support.

Lo says the experience will be increasingly relevant as other markets digitalize, although they may need to be tweaked, depending on local regulation, client behavior and distributor demands. “Some things we can learn and apply elsewhere as the world goes digital,” Lo said.

The onshore funds market manages about Rmb14 trillion (almost $2 trillion) in total assets among 135 asset managers authorized to sell to retail clients, of which are 44 Sino-foreign JVs.

But most of these JVs are run by the local partner, with foreign shareholders having less influence. They are limited to stakes no greater than 49%, and local partners are often banks or other powerful institutions. One analyst told DigFin that local fund houses are not particularly bold when it comes to digital channels; and even if they are, the lessons don’t flow to the foreign partner.

But Invesco Great Wall’s case is different. Both Invesco and Great Wall Securities own 49%, with two other shareholders holding another 1% each. Given that Great Wall Securities has its own in-house funds business, it has been willing to let Invesco drive the business. (Beijing has recently permitted J.P. Morgan Asset Management to take a 51% stake in its funds J.V.) Invesco Great Wall is also among the oldest funds JVs in China. It is today led by Shenzhen-based CEO Ken Kang Le.

Robo reservations

In China, Invesco is leading the way in digital opportunities. Elsewhere it seems to be running with the rest of the herd. In the U.S. and the U.K., it has made digital acquisitions: Jemstep, a B2B robo-advisor that services U.S. bank distributors, and Inteliflo, a British platform to support financial advisors.

“We haven’t found the right use case in Asia,” Lo said. Onboarding a digital B2B (of B2B2C) platform needs scale, but Asia is fragmented, with each market requiring its own business and compliance needs.

“Digital transformation is still evolving,” Lo said. “My guess is it can be like it is in China, where it’s a real thing that has become a major part of the industry.” But what that looks like elsewhere remains hard to know – or at least hard for justifying a business case.

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Asset & Wealth Management

New China distribution not just for money-market funds

Investors on digital platforms are beginning to look to other products, says BEA Union’s Rex Lo.

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Rex Lo, BEA Union Investment

This week DigFin is highlighting three asset-management firms’ approach to digital distribution, particularly in China. We will also provide strategies from Invesco and AllianceBernstein. Go here for more insights into digital asset and wealth management.

Retail investors in China accessing funds via digital platforms are beginning to diversify away from money-market funds. That is creating opportunities to push ETFs and active funds, says Rex Lo, managing director for business development at BEA Union Investments.

China’s retail funds industry is mainly about money-market funds (MMFs). The total industry size is Rmb13.2 trillion, or $1.9 trillion, of which MMFs account for 57%, or Rmb7.7 trillion.

Among MMFs, by far the biggest player is Tianhong Asset Management, whose product, Alibaba’s Yuebao fund, is Rmb1.2 trillion in size, or $162 billion – the largest money-market fund in the world.

It’s no surprise then that digital distribution platforms in China mainly cater to MMFs. Lo says until recently, MMFs accounted for about 80% of all funds sold on digital platforms. This is propelled businesses such as Tianhong (which of course is sold via Ant Financial) and a few bank-affiliated fund houses with big MMF products, such as CCB Principal and ICBC Credit Suisse.

But it has made digital distribution of limited interest for fund houses looking to sell equity funds or other actively managed products; for them, traditional distribution via banks has remained the only viable channel.

MMFs: less big

Lo thinks this is changing, however.

The popularity of MMFs lies mainly in the fact that they offered high returns combined with guarantees, real or assumed by investors – assumptions the government has been reluctant to upset.

Yuebao and other MMFs usually invest in non-standardized wealth-management products (themselves supposedly “guaranteed”, with investors assuming a government backstop), that returned 5% to 8% to those managers. They in turn offered investors 5%, an equity-like return on what’s meant to be an ultra-safe and liquid asset class.

Over the past few years, however, Chinese banking and securities regulators have been trying to shift the funds industry onto a footing that respects risk and return, and clamping down on the supply of shadow-banking instruments available to portfolio managers.

“Today MMFs return only a little over 2%, while A shares are doing well,” Lo said. “As demand for money market funds declines, turnover has fallen, so these distributors are now promoting index or active funds.”

In recent months, Lo says, MMFs account for only 70% of sales on digital channels, with ETFs now gaining ground.

Accessing the mainland market

BEA Union is able to sell its Hong Kong-domiciled Asia fixed-income fund to Chinese retail investors through a scheme called MRF, Mutual Recognition of Funds.

This program, which began in 2015, allows fund managers on either side of the border to sell eligible products through a master-agent arrangement. Regulators in mainland China have been slow to approve such funds, however, and there are only seven Hong Kong products available via MRF, including BEA Union’s (and 48 mainland funds available for sale in Hong Kong).

Lo is hoping to take advantage of the shifting fortunes among asset classes to use digital channels to push BEA Union’s bond fund.

Platforms such as Ant Financial are requesting the fund house for more material around equities and active funds management. It’s a big, long-term commitment to investor education – especially for foreign fund managers whose ranking is low on Ant Financial and other digital platforms.

“Domestic investors want familiarity,” Lo acknowledged. “But we continue marketing because we want to be on the platform. Today it’s more for exposure than real [inflows], and ticket sizes are as small as Rmb100 ($14). But if you have 100,000 investors, that becomes a lot of money.”

The intention of this ongoing marketing is to become sufficiently well known among Ant’s users to take advantage when retail investors want to invest overseas.

New ways of doing business

Adding platforms such as Ant to traditional distribution methods has been an eye-opener, Lo says. “They don’t think like a traditional finance company. They’re a fintech, so they’re very responsive and open to new ideas. And they’re independent – they’re not a bank with its own funds J.V. – so there aren’t conflicts of interest.”

Marketing was not the only part of business that had to adjust.

“I was amazed when we began to work with these firms,” Lo said. “Enhancements that would take months to get done in Hong Kong take them a few days. We can learn a lot from working with fintechs.” It’s knowledge that will come in handy as more banks in Hong Kong and Asia add mutual funds to their mobile trading apps, as Standard Chartered did earlier this year.

There are limits, however, to how far a fund house can go selling products on mainland China’s digital platforms.

GBA play?

Those channels are limited to funds from either local licensed retail-facing houses, or offshore products eligible via MRF. The retail funds market in China, at $1.9 trillion, is only a fraction of the total investments industry, which is about $9.7 trillion – but that includes separate licensed businesses for asset managers linked to insurance companies, or to trusts, or to banks. Those businesses for now can’t market to retail or use sell via e-commerce players.

BEA Union is a joint venture formed in 2007 between Bank of East Asia and Germany’s Union Investments. Its initial business model was to service local pension and insurance customers, so its investment expertise has been mainly in Asian fixed income. It has since developed funds in Hong Kong and Asia equities, and its total AUM is now $11.2 billion.

It is the only foreign fund house to establish a wholly owned foreign enterprise (Woofie) in Qianhai (part of Shenzhen), as opposed to Shanghai. This was partly because the authorities in Qianhai were very welcoming, and because Bank of East Asia has a presence in southern China, and the fund house hopes to take advantage of this should cross-border opportunities emerge (under the concept of a “Greater Bay Area”).

This medium-term ambition is another driver of BEA Union’s strategy to build an online brand on Ant Financial and other digital platforms.

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Custodians on API quest for Holy Grail of scale