External Asset Management & Private Banking

External Asset Management & Private Banking Redefining the business model in response to emerging trends, industry pressure and client demands

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This past year has been a turbulent one for External Asset Managers (EAMs) and private . Brexit, increasing regulations, fee pressure, sluggish growth in (AUM), and declining net new assets (NNA) and revenue margins – are all very serious threats to continued survival. Many banks are reacting in a conservative way and are playing the wait-and-watch game. They are focusing on cost-cutting until the conditions are clear. On the other side, some banks have decided to use this period strategically for growth and revenue increase with bold decisions and investment for when the market picks up.

Traditional private banks are being disrupted as an increasing number of their relationship managers leave and set up as EAMs to fill gaps in the marketplace by offering bespoke, transparent and non-transaction led services. Although this is a challenge for private banks, it is also an opportunity, as they can take advantage of this trend and position themselves as specialist EAM service providers. The coverage of the EAM segment is a sustainable revenue source and a natural extension to the development of the private banking business. Leading Swiss, American and European private banks have embraced the rise of an independent advisory segment by providing EAM desk coverage with dedicated relationship managers and cutting edge EAM IT platforms. However, regional banks are trailing in providing an equivalent EAM service and business model.

It is highly unlikely that all EAMs or the private banks serving them will be successful going forward as their operating models will need to significantly evolve and change to keep pace with multiple and challenging industry trends. To help management teams of EAMs, we identify the top 10 trends that will impact and reshape their operating models. For private banks that want to provide specialised services to EAMs, we present our view of the changes and transformation needed in the current offering to meet new industry requirements.

2 www.orbium.com 10 KEY TRENDS FOR 2017

01 02 Growing AUM Consolidation and number of of private banks EAMs

04 03 Custody, Re-focus on reporting and lending books brokerage set-up

05 06 Digital driving Increasing innovation regulations

07 Partner with 08 Increasing the right price pressure custodian banks

10 09 Evolving business Fragmented model and client platforms segmentation External Asset Management & Private Banking

01 Growing AUM and number of EAMs

A report from Julius Baer¹ forecast that the average AUM by 60% for Singapore and 43% combined AUM run by EAMs in Singapore and for Hong Kong. These figures have caught the Hong Kong will grow by more than 100% to attention of EAMs and custodian banks. around US$55bn by 2020. Similarly, the number of EAMs is projected to increase by 25% for 1 Independent Report: Asia Singapore and 50% for Hong Kong, and the

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EAM, IAM, FM Relationship Manager Family Offices Investment Advisor

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Target Acquirer

Société Générale DBS

ANZ DBS 02 ABN AMRO LGT Consolidation UBP of private banks BSI EFG *SG branch was shut down in 2016 by MAS for money Since 2014, seven foreign private banks have laundering exited Singapore. ABN AMRO is the latest to withdraw with the disposal of its Asian books. Exited Asia with Over the next three years, the combination DZ Privatbank exclusive referral of legal and administrative burdens and agreements with challenging market conditions will lead to significantly lower margins and therefore a in place heightened risk of mergers and takeover.

Experienced and successful relationship Barclays Bank of Singapore managers are opting to become EAMs, viewing independence and entrepreneurship as an end game with less politics and better There will likely also be an exit of EAMs income potential. In addition, EAMs are in (wind-down or merge) to attain the critical prime position to capture clients who have size which has been rising to approximately become disenchanted and are becoming US$200m AUM therefore only larger EAMs victims of the fall out from consolidation. will continue to thrive.

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External asset managers are increasingly looking for sophisticated lending solutions for end clients to improve liquidity or take advantage of an investment opportunity. Lending solutions help establish EAMs as complete service providers and provide additional value through collateral and liquidity. EAMs are partnering with banks 03 to build customised solutions to offer Re-focus on Lombard lending and mortgage demands. lending books Strategy and partnership with the right custodian will play a key role in the way EAMs develop their lending capabilities. As banks face new regulatory requirements for minimum capital, it will be crucial to partner with banks still able and willing to offer margin lending books.

To stay true to the unbiased and independent nature of the business, EAMs often build a wide broker network and multiple-custodian partnerships. As a value-add service, leading EAMs offer consolidated and customised reporting across asset classes (including 04 both bankable and non-bankable assets, e.g. Custody, private equity, real estate, arts etc), with details for custodians, countries and currencies. They reporting provide a holistic view of total assets, liabilities and exposure of a single beneficial owner or & brokerage family using white labelled and personalised set-up reports. This also allows the relationship manager to offer high-quality strategic advice and transmit the message through channels in line with the corporate identity.

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There are varying reasons to maintain broad care of best execution themselves. To custody and broker networks. achieve a better execution price, they run their own trading desk and build up The custody network a large broker network for bonds (we have seen clients with over 40 brokers). This segment will continue to grow as EAMs They slice the size they intend to onboard more clients and RM teams poached trade and allocate the clips to various from competing banks bring in more end brokers who will deliver the positions clients. Industry trends show that EAMs are to the custodian banks. The trading trying to reduce the number of custodian desk might also spread the order over banks to under 10 but experience has shown several days to ensure that the order that this is not always easy. can be absorbed without creating negative market impact. The broker network Sophisticated EAMs are developing in-house Classic EAMs: in most cases the custodian enhancements to their Portfolio Management also serves as broker i.e. if the EAM has 20 Systems (PMS). This is not often the case for custodian banks, they usually also have 20 private banks as they tend to use standard brokers (there is minimal DVP business). core banking solutions and invest regularly to ensure they have the latest features and Fund managers regulatory enhancements. - Equity: the number of brokers depends on the need for research, EAMs would, however, do well to move events, distribution, etc. This means away from in-house solutions and evaluate that the EAM may need three sources standard third-party solutions. While some big of research (e.g. for , pension funds rely on global custody set-ups , Morgan Stanley) and to consolidate assets across several custodian therefore equally allocates the flow banks, others (given the high price tag of to those brokers who – in return – will such set-ups) are taking care of consolidated ensure the EAM gets all the benefits. reporting, and coordination of corporate actions themselves. The latter - Bonds: since there is less liquidity in approach requires partnering with fintech firms bond markets, EAMs generally take to get a head start in consolidation services.

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05 Digital driving innovation

Digital Clients are increasingly interested in accessing research and investment advice on their EAMs could consider collaborating with an mobile devices and want to be updated independent software provider for a PMS that about their portfolio and trades on a real-time also includes a view-only version for the end basis. Accordingly, leading private banks have client. For example, a that allocates already deployed – or will soon deploy – digital the wealth of their family members across banking for end clients and advisors. In terms of various custody banks (for risk diversification) maturity, most banks are offering basic digital will want to provide their beneficial owners capabilities including portfolio viewing and with a single login to view their consolidated often provide more advanced functionalities assets and exposures instead of expecting such as securities trading, dedicated EAM them to log into various stand-alone online portals and peer-to-peer advice platforms. The banking systems. EAM industry is lagging behind private banks and there is a need to recalibrate business To meet growing client needs EAMs must models to avoid threats from the proliferating work with custodian banks that have state of fintech firms that promise to provide a richer and the art digital PMS solutions that can help to more dynamic experience via mobile and tablets. differentiate in a crowded market place.

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Automated brokerage and settlement are launching robo-advisory for end clients. Without automation, operational processes Meanwhile, Crossbridge Capital recently are prone to errors. A broker/dealer may launched a robo-advisory for high-end give incorrect trade details in the notice accredited investors². of execution; the EAM may fail to spot a mismatch between the actual trade order and In our view, integrating robo-advice should be what is reported. End to end automation from considered if it is in line with business models trading to settlement is critical for EAMs, as and long-term strategies. Generally, EAMs and this will achieve the necessary efficiency and private banks go to great lengths to offer high economies of scale while helping to reduce degrees of product and service differentiation. operational risk. This bespoke service is critical to their differentiation. Consequently, some clients may Blockchain not view robo-advice as adding value. Blockchain has been actively discussed Despite the challenges (such as bespoke in private banking since 2012 and is service, product differentiation, content, currently being piloted. However to infrastructure), we expect more EAMs to tap date this technology has not yet realised into flexible auto-generated models that could its full potential. The first concrete be customised to client preferences. It seems roll-out of blockchain use cases is expected in inevitable that EAMs and private banks will late 2017. This will enable delivery of cutting- incorporate automated investment advice as edge solutions for today’s sub-efficient, part of their own business models in the very post-trade space and for stronger audit trails near future. conforming to regulatory requirements. Big Data & analytics Robo-advisors EAMs and banks should continue to invest Although robo-advisory was pioneered in Big Data analysis to provide predictions of by independent American and European end client needs. This includes improving the fintech firms (such as Robinhood, Wealthfront, customer experience (for example upsell and Betterment, Mint etc), external asset managers cross-selling, event-based pricing etc) and and private banks in Asia have since also operating model (new products and services). adopted this approach to serving clients. In Asia, Singapore-based Smartly & Bambu and ²http://fintechnews.sg/8958/roboadvisor/ Hong Kong-based 8 Securities & Quantifieed firstdigital-onboarding-in-singapore-robo-advisor/

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Further developments to existing regulations and new regulatory shifts are expected in the short term including: • Investment suitability3 • MiFID II • FINLEG • EMIR 06 • Cross borders • Regulatory reporting Increasing regulation • Automatic exchange of information (under CRS) • Indonesian tax amnesty and outsourcing

Regulators are increasing pressure on private To keep regulators at bay and avoid possible banks and EAMs because of the breadth of wrist-slaps, fines or other reputational damage, their product offerings (from investments EAMs and private banks need to invest in IT to capital markets and lending) as well as and in tax and compliance expertise to ensure the sensitive nature and high profile of their they meet their obligations to address these client base. Any regulatory change is likely to regulations effectively. be more abrupt for EAMs — especially if they become subject to banking regulation laws in ³Further reading: Orbium Article - Why Asia’s their markets. Private Banks Must Transform Investment Suitability Frameworks

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- Portfolio Management System (Swift/ CSV) connectivity for reconciliation between EAM and custodian 07 - Agreed service levels and comprehensive operating Partner with the right memorandum - Modern IT platforms developed custodian banks specifically for EAMs with real-time data and digital capabilities

- Timely trade executions Not long ago, EAMs were unregulated small shops. In rare cases, one person with a phone - Direct market access (APAC, EU & US line, a Bloomberg terminal and an Excel hours) spreadsheet was considered an EAM. Times have changed. EAMs have grown and are now - Best executions principle, Straight- regulated. In a world of complex investment Through-Processing and Algo-trading markets and an evolving onshore-offshore landscape, EAMs are continually evaluating - Wide product range (all asset classes their partnership with custodian banks to and world-wide markets) deliver the sophisticated services High Net Worth Individuals (HNWI) increasingly expect. - Value-add services: ◦◦ Credit and lending books ◦ In a evaluation and selection ◦ Regulatory consulting (cross- process, EAMs should consider in order of border, MiFID II, FATCA, Investment priority: Suitability) ◦◦ Training services for EAMs on - A reputable bank with an experienced products and system and dedicated EAM desk with ◦◦ Traditional banking – payments and dedicated RMs and Investment credit cards Advisors/Consellors ◦◦ Corporate Banking ◦◦ Access to private banking and - A multi-custodian framework: this is research and a requirement for EAMs in certain investment ideas jurisdictions, otherwise they could ◦◦ Wealth structuring and planning, be seen as an agent of the bank. On the flip-side, more banks mean more ◦◦ Specialized tax consulting overhead for EAMs ◦◦ Private label funds

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Regulatory requirements for price transparency include:

1. Fee disclosure: indicate the fee to clients, including the details, amount and bps

2. Breakdown of the fee: often EAMs and 08 custodian banks charge a combined fee to clients instead of providing a clear Increasing price breakdown and itemisation. For example, pressure settlement fee and transaction fee are not listed separately and are combined as a third-party fee.

3. Justification of the fee: the absence of a fee schedule by service makes it impossible External asset managers and private banks are for banks to justify the value each service under price pressure. Clients are demanding brings to the client. a transparent advisory fee instead of a commission-based model. Banks will need Most EAMs do not yet have the capability to to look deeper into client segmentation and distinguish between various elements of fees flexible pricing models (annual, transaction- and pricing. They will need to review pricing based, performance-based or hybrid). Models schedules and ensure their IT platforms of remuneration (retrocession payments) have the capability to include these fees and between custodian banks and EAMs are breakdowns in the advices and statements (as also under keen scrutiny by end clients and required by MiFID and other regulations). regulators.

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09 Fragmented platforms

EAMs’ perspective

IT platforms are integral to many aspects - Non-functional: scalability, user of the EAM investment process, including experience, audit trails trading, risk management, operations and client service. EAM technology needs are beginning to mirror those of private banks, although on a smaller scale. EAMs are learning EAM TECHNOLOGY VENDORS through trial and error about the classic buy vs LANDSCAPE build dilemma for their portfolio management system to connect to private banks. When The market for EAM technology making such a decision, they also need to is highly competitive, with many consider whether the technology can support vendors. changing local regulatory and compliance Examples of EAM technology frameworks, in particular for client onboarding. vendors and systems: However, most EAMs tend to ‘buy’ as there are a growing number of vendors for standard Portfolio Management Systems solutions in the market. 2S Technology, Advent, Allocare, Expersoft, Privé Managers, Assetmax, Iress, Crealogix, Advent Banks’ perspective Geneva, Broadridge, Tradar, OPUS Private banks servicing the EAMs are growing and must constantly reinvent their platforms and service offerings to gain a competitive In addition, EAMs and private banks are also edge. They can continue to invest and enhance investing in technology for the distribution of their dedicated EAM platforms in the following FX derivatives and structured products, and areas: in multi-dealer technology platforms such as Leonteq, FinIQ and AG Delta. Typically, a - Functional: portfolio management, risk distributor provides its product capabilities management, benchmark performance, and distribution channel to the bank, which trading, fee calculations, standard and will issue the products under the platform in customisable reporting co-operation with the distributor.

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We advise client segmentation according to needs. For example, a private-label fund with US$100m will have very similar needs to the one with US$2bn, but completely different needs from an EAM with 500 end clients. Segmentation can then be translated into 10 tailor-made products and services to derive Evolving business optimal segment-specific strategies and pricing. model and client Some questions to consider:

segmentation 1. How is the execution-only, advisory and discretionary business positioned today, and how does it fit into the current spectrum of service offerings to clients (including revenues, costs, profitability)?

EAMs and private banks should look deeper 2. How can the service offering be re- into client segmentation. The criteria for packaged to be more commercially viable selecting a client should not be based entirely and profitable in today’s competitive on AUM but also on the price the client is landscape? willing to pay for a service. This is not to say that same products should be priced differently in 3. What are the future implementation-model the same market (or even in different markets) options for this re-packaging? How can the as there should be transparency, for example, advisory business be structured to enable in Switzerland and the UK. EAMs to meet their regulatory obligations (MiFID II, cross border, investment suitability and fund distribution)?

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To remain competitive, both EAMs and private banks need to act now

Disruption is rife in private banks and EAMs are on the cusp of experiencing similar competition from new entrants.

EAMs’ perspective As relationship managers continue to leave banks, there is a potential flow of senior RMs into the EAM landscape presenting the EAM segment with impetus for growth. Consolidation in the EAM business is underway, led mainly by rising costs and regulatory pressures. To stay ahead of the curve, EAMs will need to invest in IT platforms as they simply cannot continue to rely solely on the systems provided by the banks. There is a clear trend as EAMs evolve and become more institutional with significant assets under management. This increase in AUM enables EAMs to have strong negotiation power with banks and leads to pressure on the banks’ margins.

Banks’ perspective Meanwhile, banks can position themselves as specialised EAM service providers, creating an evolving ecosystem of traditional and value-add service. To achieve this, banks will need to rapidly transform their current EAM service offer, back office processing, technology platforms, investment in automation of processes (such as brokerage and settlement, client onboarding processes, connectivity of in/outbound data, etc) and pricing structures. On top of that, there are several additional areas where banks can still earn revenues, including lending (balance sheet required, which not all banks can offer any more) or investment solutions/products.

All these changes will require extensive redesigning of current processes. It is clear that both EAMs and banks will need to be careful about costs, particularly since implementing the latest technology platform can often be an expensive proposition. Critical issues of partnering with the right custodian, increasing price pressure and fragmented platforms are shifting the industry. EAMs will need to adjust to the new expectations and adopt new technologies for the benefit of their end clients. On the other side, banks will need to redefine their current operating model and actively engage in reshaping the business to adapt and thrive in the private banking environment. Overall, we expect the EAM business will continue to grow and banks with an efficient offer will be able to benefit and grow their business by serving this segment. External asset managers and private banks that rise to these new challenges, market conditions and technology disruptions with robust evolving business models will thrive while the future will be considerably dimmer for those who remain complacent. Orbium can help banks and EAMs to successfully navigate these market trends. Orbium’s structured approach gained from in-depth experience allows a firm to benefit from an objective assessment of the challenges and opportunities ahead and ultimately achieve improved performance.

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