MiFID stumbling block to change

Private banks need to rethink their core competencies says, Tom Isaac, managing director for global transaction services at Citigroup. This may necessitate more outsourcing via a re-evaluation of core activities and relationships with services providers. But first there is MiFID to tackle. That the needs of private banks are changing when it comes to middle and back office functions is not in question. But Mr Isaac thinks the problem of definition and operational scope must first be tackled in order to better define what needs to change. But with MiFID, the Markets in Financial Services Directive, fast approaching, much of the budget and human resource has already been grabbed. And Mr Isaac insists that once MiFID has been effectively taken on board, wealth managers will really need to knuckle down and have a good think about which areas they can continue to operate profitably in. “This is an interesting situation where the wealth managers really have to start thinking about what it is that they do,” says Mr Isaac. “They need to ask themselves the question: ‘Are we advisory, distribution or operational?’” According to Mr Isaac, Citigroup’s current capabilities are largely aimed at institutional clients but he says that over the next three to five years, the firm will see a big change as the wealth managers rethink their positions. “At the front end, our current transactional banking relationship with private banks is providing omnibus custody,” he says. “This is where the private bank’s clients buy ‘x’ asset and we then hold that asset for the bank and do the reporting. The private banks themselves then split the report into their individual client portfolios, get the pricing information and do the aggregation as regards charges and trail fees,” he explains. He says that the second area of activity is execution. Here the firm’s own platform, CitiConnect, was originally designed with retail clients in mind and has been adapted to fit in with the needs of private wealth managers such as Banca Monte dei Paschi di Siena. The system allows private banks to get straight through processing (STP) when executing a single stock, he explains. “This gives a high settlement rate, execution efficiency and timeliness, a key area for private bank clients. We have recently added an alternative asset capability too,” he says. But Citigroup is also looking to grow its business with wealth managers, and securities lending is just one area where Mr Isaac reckons there lies potential. “With the take-off in alternative investments, many alternatives managers are looking to borrow assets and the issue for private banks is whether their existing contracts with clients allow for asset lending,” he explains. Compliance and regulatory issues also come into play. Obviously, each jurisdiction has different rules and Citigroup looks to deal with this somewhat complex area on behalf of private banks. In addition, it acts as an agent, choosing brokers on behalf of the private bank and playing a key role in defining and setting acceptable collateral to be placed against the loan. Mr Isaac explains that although take-up of this particular service is not yet huge, that it is expected to grow as the business case to outsource becomes irresistible, partly due to the demand for this sort of service from hedge funds. “For this to really grow private banks would also need to renegotiate initial contracts which takes time and resources,” he points out. But an area important in wealth management and already seeing more in the way of business growth for Citigroup is self-managed accounts. Essentially this is where fund managers offer private banks and other similar retail players, access to funds that have previously been available at institutional level only. Mr Isaac explains that the concept of self-managed accounts, already popular in the US, will soon cross the Atlantic. “Private banks will then be looking for funds that can add individual accounting, valuations, tax service and trailer fees via their fund services provider, and at the moment there is no player in the market that can do this,” he says. But Mr Isaac thinks that before any of the areas he has outlined can see real growth, that the real issue lies in defining the various functions of a private bank to include which are best kept in house and which would be better outsourced. “All retail distributors occupy a similar space in the marketplace but there is no clear definition of what their problems are, therefore no universal solutions,” he comments. Obviously, service providers like Citigroup are eyeing this space and looking to provide solutions to these as yet, undefined problems. One of the main issues seems to be the juxtaposition of offering a single IT solution for an industry that thrives on the provision of customised offerings. “Within the private market there are various segments and when you get towards high-net-worth and ultra high-net-worth clients then much of the offering is based on it being a bespoke service. How can you successfully have an off-the-shelf outsourced offering in such a bespoke industry?” he asks. “It’s a very interesting space to watch and in the United States we are making progress by targeting asset managers’ retail separately managed accounts (SMA) business. The foundation of Citigroup’s SMA capabilities is Citigroup Asset Manager Solutions, an integrated end-to-end operations platform. It provides asset managers with a modular solution that promotes efficiencies and reduces operating costs,” he says. He notes that, as ever in Europe, having a patchwork of national regulations and compliance requirements does not help when it comes to providing a single platform. He thinks that perhaps from the private client perspective it is intead best to try and solve problems that exist in areas where common ground has already been identified. One such area is in real time information and transparency and, according to Isaac, “for those trading larger volumes the ability to move assets quickly and react to say a corporate event is also important.” Sooner not later He says that this is one area that clearly needs tackling sooner not later. “Private banks generally tend to have different execution methods for different instruments,” he explains. For example, a single equity might be traded on an in-house platform for example, but for another foreign equity there might be an external counterparty on a different platform. “Once bonds and funds are added on, each with their own execution pathway, then the whole issue is further complicated by adding on more products through open architecture and it’s easy to see why such seemingly simple issues such as execution have yet to be tackled in anything other than ad hoc fashion,” he says. “These legacy systems are slow compared to the internet age where people expect immediate access to information and the real time challenge is a very important one,” he continues, “and front end payment systems for tax, trail fees and end allocation to clients are another area which comes into play.” “In three to five years we will certainly see the white labelling of platforms offered by custodians. There is enough interest and strategic advantage to justify it in time,” he says. But Citigroup is also keeping one eye on the regulatory horizon and aims to capture some of the inevitable trade that comes up as a result of MiFID. Indeed, one of the key components of the directive is that firms must now offer best execution; key elements of which are real time pricing and pre-and post-trading transparency. Mr Isaac comments that much has been said about the challenges of best execution. “What is more interesting for me is how firms will decide to allocate resources between MiFID, front and back end with limited technology spend,” he states. Indeed like other players, Citigroup has yet to announce its strategy as regards MiFID. “So far, it has been mostly about best execution and clearly it’s an opportunity for custodians to embed best execution processes into their space,” he says. Indeed private banks must be able to demonstrate that they are offering best execution and many will choose to use a third-party provider for that. This will give an independent slant in front of the regulator and let the private banks focus on their core competency. Services providers also need to think about how they can help private banks to work with brokers. “There is needed whole set of platforms to help and we don’t yet think that custodians have embedded the best execution process into their space, clearly it’s an opportunity,” he says. Of equal concern yet not as much talked about is the client classification aspect of MiFID. “Up until now, clients have been classified on a marketing basis not on the basis of how frequently they trade. It will inevitably become more of an issue once the execution conundrum has been solved,” he says. Indeed Mr Isaac reckons that the private client industry will outsource various functions like execution and client to its custodians bit by bit until eventually a patchwork covering 60 or 70 per cent of activity will be created. “At that point there’s a good business case for private banks to outsource the remaining function as well,” he says.