Competition among custodians offering middle-office outsourcing is heating up, with HSBC becoming the latest bank to offer these services to broker-dealers in Asia.
Last year, Citi and UBS teamed up to offer middle- and back-office post-trade services to broker-dealers across Asia Pacific, a partnership that surprised a number of participants, given the two banks have equity desks competing in many global markets. Other custodians providing middle- and back-office outsourcing include BNP Paribas and Deutsche Bank.
Many expect the trend will continue as strict capital requirements under Basel III, coupled with sluggish commission growth, have squeezed broker-dealers’ profits recently.
Participants also anticipate that broker-dealers’ internal middle- and back-office functions – which include trade matching, confirmations, securities settlement and exchange clearings – will in 10 years’ time see costs rise by 40% from current levels, as existing infrastructure will need to be upgraded.
At the moment, custodians and service providers argue that broker-dealers should go back to their bread and butter – namely, execution – and leave the middle- and back-office functions to others.
Colin Brooks, global head of sub-custody and clearing for HSBC Securities Services, says broker outsourcing is a natural extension of the bank’s sub-custody business, which today offers clients a choice of agency clearing or third-party clearing.
Custodians will take all of the risks, including security settlement liability and clearing obligations, Brooks adds. (Under an agency model, these responsibilities lie with the broker.)
Yet Clive Triance, head of broker-dealer outsourcing, says HSBC’s middle office post-trade platform differs from others due to its ability to process trade life cycles of asset classes, be it equities or fixed income.
“The fact that our platform is built based on a rule-based architecture means that so long as the clients can define the rules of the life cycle of that trade, the platform is capable of processing activities such as trade matching, confirmation, all the way through to clearing and settlement on all asset classes,” Triance tells AsianInvestor.
HSBC’s middle and back office also allows clients to expand into new markets, saving them from having to make on-the-ground investments. For example, if a broker wants to start trading in a new market in Asia, such as Thailand, HSBC can deliver the necessary middle- and back-office services, allowing the broker to start trading in the market within three months.
HSBC, which will mainly target global and regional brokers, as well as large Asian banks with regional brokerage divisions, claims brokers could save up to 30% of their annual operating costs by using its services.
But not everyone is convinced that outsourcing offers savings. One chief operating officer at a Hong Kong-based mid-sized brokerage says his team have reviewed a variety of custodian services, but decided against it.
“We have done the math, but after our review we do not think there will be as much cost saving as the service providers touted,” the COO says. “Besides, it appears that every time we want to launch a new asset class, we would have to make additional payment so that the middle-office platform can continue to support that.”
Nick Gardiner, a partner at Boston Consulting Group specialising in Asia-Pacific capital markets, argues that smaller brokers will likely benefit more from outsourcing than top-tier brokers.
“Smaller broker-dealers cannot sustain the platform or IT investments required to compete with tier-one brokers,” Gardiner says. As such, he adds, they are not able to capture large flow volumes or trading volumes of less complicated products on behalf of clients.
“It makes more sense for them to invest in front-office capabilities [traders, sales, client coverage]…rather than in trying to build best-in-class execution [infrastructure].”