Rob, it’s been three years since you joined BNY Mellon in New York. How are things going?
Robert Chiuch: Has it really been three years? Clearly, it’s been a very busy time. And with all of the extraordinary changes and external forces shaping the industry, globally, we recognised the opportunity to evolve and remain at the forefront of servicing the industry. As the world’s largest custodian, we have excellent human and financial resources to deploy with a strong commitment to investing in the future. Notwithstanding the various challenges we all experience day-to-day, it’s an exciting time to be at BNY Mellon. In short, things are going well.
Having also taken on further responsibilities on the fixed income trading side, can you tell us about your expanded role?
Chiuch: Yes, I was appointed global head of our fixed income business earlier this year in addition to my role as global head of equities. We’ve observed similar trends in consolidation at other firms. The changing environment requires greater collaboration and coordination between product segments. Understanding those interdependencies is now more important than ever.
How have you restructured the securities lending desks?
Chiuch: We view this as a realignment of our capabilities and global services versus a true restructuring. We looked at opportunities to create value for our clients and the marketplace across our value chain and saw that we had all the ingredients. We have a great team and we’ve amplified our focus on global execution, while also leveraging the specialised expertise and resources of our regional teams on the various continents. Our fixed income and equity teams work closely together. We’ve introduced advanced trading technology as we continue to enhance and streamline day-to-day operations.
Notably, we formally integrated the team from our Canadian joint venture, CIBC Mellon, and that book of business onto our platform, providing us with, we believe, unparalleled knowledge of and presence within Canada—not to mention enhanced presence and capability from our five locations around the world. We have more work to do as we build out the business globally. Our clients have told us that our focus has been successful so far and I’m very proud of our team.
What do you see as some key themes facing the industry?
Chiuch: These three themes immediately come to mind: regulation, taxation, and central counterparties (CCPs). But I’m not going to talk to any of those—at least not in detail! Seriously, those are all important topics but they get a lot of coverage. Regulation is obviously a key theme, so let’s break from the status quo and frame it in the context of market forces at play and the potential impact on earnings quality.
As a lender, I’m going to be preoccupied with borrower demand and capacity. The industry is seeing that various proposed regulations—some of which are not yet finalised—have raised costs and constrained volumes. Leverage ratios, the liquidity coverage ratio, and the net stable funding ratio (NSFR), for instance, are introducing new challenges to balance sheet management and capital cost. Aggregate market demand for high-quality liquid assets (HQLA) over various terms, especially with regard to NSFR (which implies significantly longer term funding) will likely widen spreads.
This is a good/bad news story, meaning, while higher spread business will grow, there will be less of it—at least in the near term. This development is generally unwelcome news for capital-intensive, low-margin, high-turnover businesses.
That said, markets appear to be turning over globally, notwithstanding the apparent economic divergence between the US and the rest of the world. Higher initial public offering and mergers and acquisitions volumes, increases in other corporate action activity, increased demand for HQLA and mounting pressure for tighter monetary policy in the US would likely translate into higher volatility down the road. The markets will respond accordingly, albeit at generally improved spreads.
So, where does that leave earnings quality? There are definitely a lot of moving parts to consider. For starters, the current environment will have a broader impact on earnings that will require better coordination—or balance of trade—across capabilities, products and services, globally, and at the regional level. Internal consolidation of business units is already happening across the industry as capital intensive activities get better coordinated with the goal of achieving stronger results. While ongoing changes in the regulatory space are likely secular in nature, economies and markets are cyclical and they are improving. Notwithstanding the unknowns, earnings are well poised.
John Templeton: For the markets, there’s definitely a lot in play with the regulations, and a lot of work to be done with respect to implementation and compliance. The industry has moved off of the negatives and is looking practically at how the business will evolve. There will be winners coming out of this. The firms that will be best positioned are working now to become even more nimble and effective.
Custodians are having a tough time at the moment. How is this affecting your business?
Templeton: BNY Mellon is sharply focused on our clients’ needs, which are evolving quickly. We continue to be highly rated by our clients for our innovative solutions and the quality of our capabilities. And we’re well positioned to deliver what our clients need because we have resilient business model that we built on a diverse group of fee-based businesses.
Since the financial crisis, beneficial owners have come back to lend but hedge funds seem less keen. What’s happening at the moment with hedge funds?
Chiuch: In general, hedge funds wouldn’t typically lend in the past, per se. Given their business model, they would more likely choose to optimise the use of their own assets for themselves versus lending. Having said that, I’m not sure hedge funds are any more or less keen to lend today, but we do see them repositioning themselves. The changing macro-environment in the prime brokerage space affects their ability to optimise available resources. Like everyone else, hedge funds and their prime brokers are looking carefully across their value chain activities at how best to manage assets.
How have markets been affected?
Chiuch: Collateral markets have obviously been affected. HQLAs once considered less desirable for lending are now in vogue. This is probably a good segue for John, but I’ll just add that collateral flexibility and the ability to mobilise and optimise the desired assets at the right time and the right price will continue to be a priority.
John, how do you see your clients changing their activity as a result of the market changes?
Templeton: Global regulations have certainly had an impact on our clients, both on the buy side and the sell side. On the sell side, they are affected by capital standards such as Basel III, which requires them to hold more capital and for a longer duration to finance trades, and the US Dodd-Frank Act with stricter collateralisation requirements on a much broader range of asset classes.
This has led the sell side to re-examine the return on balance sheet usage and to reduce or exit trading activities that do not generate the desired returns. This has been especially true on matched book repo trading for liquid assets, where the spreads are narrow and balance sheet usage is significant.
On the buy side, our clients are dealing with the complexity of complying with collateral requirements that are new and different, and now directly affect the price of their trades. This has moved collateral management from a back-office role into the front office. Complicating matters for some on the buy side is that the collateral management function for different trading activities is performed in silos with very distinct processes, but the client draws assets from a single pool for each legal entity. Clients are then reaching out to their custodians to assist them in solving their collateral challenges.
At the same time, the buy side has seen the sell side change its approach to financing trades. This has led cash providers in repo to increasingly term out their investment books to match the sell-side’s need for term liquidity and for beneficial owners to re-examine the collateral they will accept for loans—broadening the eligibility requirements to include other assets such as equities. And we expect more changes to come as more clients understand the costs of daylight credit.
Securities lending has always been a relationship business—is this changing?
Templeton: The industry is in transition, so we recognise that relationships and capabilities are more important than ever.
That’s the primary reason we’ve realigned our capabilities at BNY Mellon. For example, two years ago we formed our global collateral services business, bringing together a number of leading capabilities and solution sets including securities finance, global triparty collateral management, term financing, asset segregation, liquidity management, and derivatives middle-office. As clients face ever-evolving regulatory and marketplace pressures, through global collateral services they can engage with us around their financing and collateral needs.
While we’ve always had strong enterprise-level, strategic coverage, we wanted an internal alignment to match the execution of a client’s overall strategy versus dealing in siloed businesses. By aligning our capabilities, we’ve made it easier for our clients to engage with us (and us with them). At the same time, we’ve aligned our relationship management teams by client segment, so we’re redefining the client experience in a new way with added focus on the client and what’s driving their business. As a result, we are continuing to deepen and strengthen our relationships.
We’re hearing about further consolidation at BNY Mellon. What can you tell us?
Templeton: We’ve been successful in the creation of global collateral services, which is a first step in designing our capabilities and services for the future. These new opportunities build on client needs and where we see the industry moving. One of the really interesting developments for us as of late is the creation of BNY Mellon’s markets group. This summer, we started combining all of the bank’s markets-facing businesses: global collateral services, global markets and prime services. We’re still in the early stages of building the markets group, but it’s been well received by our clients who want expertise combined with scale, execution and distribution.
John, how important is BNY Mellon’s markets group for today’s market participants?
Templeton: When you look at the changes facing the industry, we’ll only solve these challenges by working collaboratively. And when you look at BNY Mellon, we’re unique in that as a custodian—the beneficial owners, asset managers, and broker-dealers are all equally important clients to us in terms of our current capabilities as well as how we expect to grow. So when we look at the industry’s challenges, we seek to build solutions that help the industry as whole, and not just particular segments.
To our clients, the markets group is already extremely important, our securities finance business is one of the largest in the world and we are the leading provider of collateral management services, too, but we’re very focused on how we will continue to add even more value for our clients as they respond to market, industry and regulatory changes.
What real benefits is the new markets group going to bring to the street? Are there real changes or is it marketing?
Templeton: I don’t think there are any firms that make significant internal changes for marketing purposes! No, we see real benefits to our clients and that’s the main reason we created the markets group.
Chiuch: If you interpret the word marketing to mean spinning a story, then, I totally agree with John. Good marketing can also mean that we clearly understand our target markets, that we’ve set clear objectives and that we’re determined to deliver for our clients. And, John’s second point is right on the mark.
Investment services fees over the past quarter were down 1 percent year-over-year. Is this a worrying trend or a minor blip?
Chiuch: We don’t consider the year-over-year decrease in the second quarter to be a worrying trend. The decrease was primarily from lower depository receipts revenues driven by fewer corporate actions, lower revenues from our corporate trust business, and higher money market fee waivers. We saw gains in asset servicing and clearing services fees. We continue to see strong demand from our clients for our solutions, and two consecutive quarters of growth in our investment services fees highlights that.
Do you have any predictions for the next 12 months?
Templeton: G-SIFIs may realign their businesses to pass along the increasing balance sheet and capital costs resulting from Basel III. Alternative managers may consolidate business at their strongest prime brokerage relationships. And there will continue to be an increased focus on CCPs in the financing markets.
Chiuch: Prospects for our space in 2015 look good, with some regional differences in performance likely. We’ll likely see more industry consolidation in the interim. And, I’d like to see the Maple Leafs win the Stanley Cup, but that’s me. Go Leafs!
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