Trends in Supply Chain and Network Management AlfaSec Advisors Pte Ltd

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1 Trends in Supply Chain and Network Management AlfaSec Advisors Pte Ltd SINGAPORE HONG KONG - TOKYO sec.com 1

2 Introduc;on Agent and Supply Chain Network Management is a growing focus by Financial Ins;tu;ons and other Firms that leverage extensive 3 rd party agent networks either directly or via their Service Providers. In 2013 and 2014 we have seen a greater shi\ in focus on this func;on that at any other point in the past 15 years. Interna;onal Financial Services provision today requires use of complex Supply Chain models frequently with extensive use of in- house subsidiaries and 3 rd party en;;es, where the selec;on of ongoing management of these en;;es can have a material risk impact to the financial service provider and their clients. This pack provides a summary of AlfaSec Advisors view on this func;on is evolving in response to a growing level of focus by business managers in response to growing regulatory pressure on importance increasingly important func;on and how sophis;cated players in the market are developing their models. We provide a range of Consul;ng Services in this area. Our exper;se includes direct career experience in running sophis;cated Agent Network Management func;ons with major Financial Ins;tu;ons, as well as extensive management experience in running banking businesses in the Agent Supply Chain. We would be delighted to discuss your model and agenda in more detail. 2

3 The Growing Focus on Agent Network Management Banks, Brokers, Corpora;ons and Investment Firms are increasing their cross- border ac;vi;es exponen;ally as client demands, regional business expansion and the easing of restric;ons encourage greater interna;onal focus by firms. Tradi;onal approaches to Agent Network Management are falling under greater scru;ny as Regulators and Risk Managers deepen their focus on this area, recognising that weak models can compromise AML controls, Liquidity Management and Client Money Protec;on. It is es;mated that only 25% of Financial Ins;tu;ons have a formal approach to Agent Network Management, and where these are present they frequently only cover cash correspondent arrangements and core custodian arrangements. There a few drivers for the growing level of focus by firms on this area. 1. Regulatory Compliance. The suite of new regula;ons on Client Money Protec;on and the recogni;on that significant client assets are o\en held via 3 rd party agent arrangements is driving a new set of Compliance obliga;ons for Firms. Regulators are seeking a stronger set of procedures and enhanced control mechanisms. 2. Risk Management. The reputa;onal and financial damage of poor Account Management can be a significant management distrac;on. For firms with complex en;ty opera;ng models, the need for consistent standards and integrated control systems is become core. 3. Efficiency. As the volumes of cross- border ac;vity grow the aggregate fees that are paid to Agent rela;onships are becoming a significant expenditure. Benchmarking rates against the market remains challenging and firms need strong approaches to op;mising their use of Agents globally. 4. Product Alignment. For many firms, Agent ac;vi;es are not only covering cash management, but also securi;es services, equi;es and bond trading, deriva;ves, collateral management and other rela;onships. Tradi;onal models of retaining ownership for products under independent business teams is falling into focus as firms seek to apply consistent standards and to leverage their buying power in a more aligned manner. 5. Supply Chain Focus. The use of 3 rd party en;;es in the Supply Chain model is expanding the realm of Network Management beyond the historical focus on Banks covering Cash and Securi;es Custody, and into a broader view of a Firm s use of Banks, Clearing Houses, ICSDs, Exchanges, Central Depositories and Payment Systems. 3

4 Regulatory Compliance Regulators are deepening their focus on Agent Network Ac;vi;es within firms. We are seeing a growing need for firms to ac;vely demonstrate the strength of their Controls and Compliance Framework. Examples of the areas falling into focus include: 1. AML and KYC Controls. Significant fines in recent years for breaches of AML and KYC control frameworks that are driving a need for strong account ac;va;on controls and procedures to ensure that key steps are not by- passed, and that the framework of ongoing oversight remains ;ghtly managed. 2. Client Money RegulaHons. A range of global client money regula;ons are requiring Financial Ins;tu;ons to report and prove compliance with the ra\ of legisla;on that followed the 2008 financial crisis. This not only looks at the manner that client money is held, but the associated control frameworks over in- house and 3 rd party management of client monies. Investment and Brokerage firms are under new levels of scru;ny on clear segrega;on of client assets, o\en requiring a change to booking models and ac;va;on of a broader set of client designated accounts. 3. Client Asset ProtecHon Measures. The growing levels of investment fund and direct poreolio investment is driving new levels of focus on enhancing Investor Protec;on against any failure by any of the intermediaries used to safekeep such investment posi;ons. New levels of liability are being introduced for Investment Managers and Custodians to ensure that contractual ambiguity within the supply chain does not weaken the levels of investor protec;on. An example of this is the new AIFMD regula;ons in Europe that are expected to become a standard in many parts of the globe. 4. BASEL III. The BASEL regula;ons on bank capital adequacy, stress tes;ng and market liquidity risk include a growing set of requirements for stronger oversight of bank capital and liquidity management. The growing use of 3 rd party agents to hold bank liquidity is under focus, and driving the focus on ensuring ;ght control frameworks for use of 3 rd party en;;es. 5. Tax RegulaHons. A growing focus on the need to validate that taxes are being paid and need for agent networks to confirm compliance under regula;ons such as FATCA. If the FTT taxes are also introduced this will add a further layer of complexity to this picture for firms. 4

5 Risk Management While Regulatory Compliance is o\en the first focus for many firms, a clear agenda to enhance Risk Management is also bringing the Agent Network func;ons into Focus. This is driven by a few themes: 1. Account Controls. Firms require a ;ght set of controls over their universe of opera;ng accounts and control procedures that encompass the opening, amendment and closing of such accounts. Central registers are now the norm and strong workflow controls accompany these to protect against devia;ons. 2. Agent ConcentraHon Risk Management. The expanded use of 3 rd par;es across sophis;cated firms is driving a desire for stronger views on aggregate assessment of counterparts and agents and controls to ensure that breaches in concentra;on risk policy do not exist. 3. Credit and Financial Strength Oversight. While many firms have concentrated on the monitoring of credit lines, the requirements to ac;vely track the risk ra;ngs of Agents and ensure formal ac;ons when changes occur remains paramount. 4. Legal Risk Management. As the network of agents increase and complexi;es of mul;- product rela;onships prevail, the importance of an integrated approach to Legal nego;a;on policies and strong storage of exis;ng agreements becomes more cri;cal. Dated agreements need to be reviewed frequently to ensure that market frameworks have not changed in a manner that makes exis;ng clauses ineffec;ve. 5. Due Diligence Standards. It is common in the financial services industry for service providers to place the risk of 3 rd Party Agents against their client, and barring negligence in the appointment and ongoing management of the Agent this risk is o\en passed to the Client. Very strong standards and documenta;on of Due Diligence standards are required in such instances to protect against poten;al li;ga;on in the event of an Agent failure, and some regulators are introducing formal requirements for tracking in this area. 6. Asset SegregaHon. The segrega;on of client assets from the books and balance sheet or Agent Banks remains a contractual and significant risk management priority. Historical use of omnibus account structures with intermediaries are under scru;ny. 5

6 Efficiency Management In an industry where financial margins con;nue to contract, the importance of running Efficient Agent Network Management opera;ons remains a driver for focus on integrated models: 1. Fee NegoHaHon. While this has o\en been the primary tangible manner that Network Managers have been assessed on performance, the industry is increasingly looking to evolve from the labour- intensive RFP exercises that drive fee schedule enhancement to more sophis;cated means of benchmarking fees to ensure alignment with industry rates. 2. Fee Invoice Management. As the use of 3 rd par;es expands, the logis;cal challenges of managing the forecas;ng, reconcilia;on and payment of agent invoices is becoming a significant opera;onal burden. Firms are examining ways to improve control and automa;on of these processes to ensure that the costs of broader agent networks does not result in significant headcount increases. 3. Reciprocity Management. The industry has o\en looked at this category with dis- taste, but it remains important that firms understand and monitor the balance of servicing arrangements that they have in place, with an ability to calculate and gauge the value of their business to 3 rd party Agents and how this is leveraged to ensure that the Firm s own growth interests are protected. 4. Network OperaHons Efficiency. Managing large networks of agents across the firm requires significant resources and hence there is a growing focus on automa;on of processes and other methods to reduce headcount and retain efficient Network Func;ons. A new set of tools and systems are increasingly being selected to enhance management of this area. 6

7 Product Alignment It is rare for firms to consider Agent Management an enterprise- wide func;on, and yet the growing demands for global access and broad products sets is increasing the number of Agent Rela;onships that firms have in place. This is bringing a growing level or poten;al risk, inefficiency and product mis- alignment where a lack of integra;on and coordina;on exists in the management of Product- based Agent Rela;onships. The Products in focus o\en include: Cash and Liquidity Management Securi;es Services and Custody Deriva;ves Execu;on and Clearing Securi;es Lending and Collateral Management Cash Equi;es and Bonds Trading; Commodi;es Trading There are a few drivers for focus in this area to drive a roadmap for Expanding Agent Network Management func;ons: 1. Control and Consistent Policies. There is a need for consistent standards and policies applica;on across firms in the appointment and ongoing management of Agent Rela;onships. The approach to Agent Management is complex and requires specialist focus. 2. Product IntegraHon. Many Banks and Brokers are focused on aligning and integra;ng their products for clients as a means to differen;a;ng their proposi;ons with Clients. This is driving the focus on ensuring that agent arrangements are aligned with this product strategy, shi\ing firms from seeking a segregated product focused Best Agent Provider approach to one that balances the benefits of a collec;vely Strong Agent that supports the Integrated Product agenda. 3. Efficiency. There are significant buying power and agent rela;onship efficiencies to be gained from more integrated approaches to Agent Management across the firm s product suite. 7

8 Supply Chain Focus There is a growing use of the term Supply Chain Management in the Financial Services industry as service providers recognise the significant reliance that they have on a complex network of service providers throughout their delivery models. The tradi;onal Agent Network Management func;on is rapidly being asked to transi;on into a broader Supply Chain Management func;on in many as it is recognised as being closest to the target model and func;on. Supply Chain Management in several firms morphed into Vendor Management u;li;es in companies as the focus on consistent standards in contractual arrangements with IT companies and general suppliers required more consistent standards. But there is growing recogni;on that the Market and Agent Supply Chain Management needs to be dis;nguished from the infrastructure capabili;es due to its significantly different regulatory and risk management features. Supply Chain components in scope include: Cash Correspondent Banks, Custodians and Sub- Custodians, Central Depositories, ICSDs, Exchanges, Payment Systems, FX Se'lement Systems, Equi;es Brokers, Bond Dealers, Deriva;ves Brokers, Clearing and Collateral Management Agents, and Securi;es Lending Agents. A few key drivers for this change include: 1. Control. A desire for common standards and group policies across the Supply Chain model. A recogni;on that it is hard to jus;fy why higher control standards would only be applied to Cash and Custody agent networks. 2. Risk. A recogni;on that the need for ;ght risk management oversight needs to go far further than purely Cash and Custody agent banks, and that firms have a significant poten;al risks of reputa;onal and financial damage where voluntary decisions are made on Supply Chain en;;es. 3. Market EvoluHon. There are significant changes happening across the financial services industry that impact different parts of the supply chain. Firms are recognising the benefits of developing func;ons that can look across the supply chain model and recognise the impact of a change in one area on another part of the supply chain. 8

9 Enhancing Best Prac;ce Agent Network Management covers a complex set of func;ons, where clearly defined policies and procedures are cri;cal. NETWORK MANAGEMENT Asset & Product Scope Market Ac;va;on & Approval Market Informa;on & Advocacy Agent Selec;on & Rela;onship Mgmt Fee Management ü Asset Coverage Review (Cash, Securi;es, Collateral, Deriva;ves, Commodi;es) ü Product Coverage (Custody, Equi;es Clearing, Deriva;ves Clearing, SBL, Collateral Mgmt) ü Country Risk Reviews ü Legal Risk Reviews ü Internal Approval Frameworks ü Market Informa;on Solu;ons ü Bank & Client Market Advocacy Agenda ü Industry Body Alignment ü Agent Selec;on Criteria ü RFPs ü Agent Review Process ü Reciprocity Management ü Fee Nego;a;on ü Fee and SLA Benchmarking ü Performance Fees ü Out of Pockets CORE ACTIVITY STREAMS Service Performance Management Legal & Compliance Risk Management Investor Market Access Opera;ons Management ü Defining Service Level Agreements ü Due Diligence Frameworks ü KPI Frameworks & Tracking ü Agent Review Management ü Legal Agreements ü Annual A'esta;on Processes ü Investor Domicile Compliance ü Regulatory Compliance Oversight ü Enhancing Asset Segrega;on ü Credit and Infrastructure Risk Assessment ü Ongoing KRI Frameworks ü Investor Approvals ü Investor Documenta;on ü Tax Considera;ons ü Market & Agent Procedures ü SLAs ü STP and Processing Op;misa;on ü Coverage Models CURRENT INDUSTRY DRIVERS: ² Changing Product and Asset Scope of Agent Network ² Increasing Regulatory focus on Agent Liability in Supply Chain ² Leveraging Buying Power through common alignment and Decision Making ² Growing demands from clients for Interna;onal Access solu;ons ² Changing Compe;;ve Assessment of Supply Chain 9

10 2014 Summary Trends In 2014, In summary a few core trends are emerging: 1. OrganisaHonal PosiHoning. The shi\ of Network Management from an Opera;ons aligned support func;on to an Enterprise- wide Department with strong ;es into Risk, Compliance, Opera;ons and Product Management, and with a broader Supply Chain focused agenda. 2. Enterprise Agent Appointments. Firms are looking more broadly at Agent selec;on in their supply chains, seeking efficiencies and product value proposi;ons beyond the historical single product focus. 3. Risk and Control in Focus. A significant shi\ in focus towards processes, systems and policies that enhance control and risk management of the Agent Network. 4. AIFMD. The o\en controversial regula;on that makes Investment Managers and their primary Custodians ( Depositories ) liable for the safekeeping of a fund s assets is driving analysis of the supply chain model, and whether the Custodians should broaden their in- house custodian networks or develop lower risk 3 rd party solu;ons than exist today. 5. Asset SegregaHon. Growing focus by Investors for an evolu;on of historical models for asset segrega;on, and seeking to reduce poten;al exposure or delays in asset access in the event of intermediary bankruptcy or failures. 6. Collateral and Clearing. On the back of the Dodd Frank and EMIR regula;ons, and globally aligned regula;ons, a new set of agents have been added to the exis;ng complex global model by many first with addi;onal agreements, accounts and rela;onships to manage. A dilemma for firms whether this should be the trigger for a more integrated Supply Chain model. 10

11 Execu;ve Profiles Roger Harrold, Managing Director Giles Ellio', Managing Director Over 30 years in the Securi;es Services industry with Deutsche Bank and JPMorgan Chase, and 18 years in Asia Pacific. Over 20 years in the Securi;es Services industry with JPMorgan, HSBC and Standard Chartered Bank, and 15 years in Asia Pacific. Prior Experience and Roles Include: Prior Experience and Roles Include: Asia Pacific Regional Head of Custody and Fund Services at JP Morgan ( ). Created a comprehensive APAC Product strategy focused on key clients, product segments geography and profitability level. Recruited a regional team to drive the growth of a sub- custody franchise. Group Head of Securi;es and Investor Services at Deutsche Bank ( ) with global responsibility covering 30 markets, 1000 staff and 1500 client rela;onships. Established Domes;c Custody Services as a key growth area within the Global Transac;on Bank. Established Domes;c Custody Services as a key growth business within the Global Transac;on bank. Expanded the Global franchise footprint into 15 new emerging markets (Eastern Europe, middle east and La;n America), adding Fund Services, TA and Uni;sed Pricing. Director, Product Management Investor Services at Deutsche Bank ( ). Created a global processing center in Singapore and Indi, integrated the Morgan Grenfell and Bankers Trust business and managed Y2K transi;on. Various posi;ons in IT and Opera;ons for DB, Morgan Grenfell and Bankers Trust ( ). Global Product Head at Standard Chartered Bank in Singapore and grew a $500 million business ( ). Expanded network from markets, changed regional custody and funds IT plaeorms and acquired Barclays Africa business. Built regional product func;on and developed Investor Segment focused model covering securi;es, cash and liquidity products. Expanded business across the Middle East. Head of Product Development at HSBC for Asia Securi;es Services (2004-7), expanding footprint in La;n America, Strategic agenda and M&A ac;vity in Australia, developed new Business Support and Network Management model. Head of Regional Opera;ons at JP Morgan Asia based in Sydney ( ), with focus on efficiency improvement, opera;ons workflow design, offshoring of opera;ons and integra;on of BTFM opera;ons teams. Head of Network Management Asia at JP Morgan in HK ( ) and Europe, Middle East and Africa ( ) in London. Outsourcing heritage Chase sub- custodial network, and built risk assessment model on markets, se'lement systems and depositories. Heavy focus on nego;a;ng service and fee contracts. 11

12 Execu;ve Profiles Philippe Metoudi, Managing Director Over 30 years in financial services and 25 years in Asia with key leadership posi;ons in Clearstream Banking in Asia Pacific and the Middle East and previously American Express Bank. Prior Experience and Roles Include: A seasoned senior transac;on banker with execu;ve experience at board level and in depth knowledge of Greater China. Member of the Execu;ve Board and Head of Rela;onship Management Asia Pacific and Middle East at Clearstream Banking. Key responsibility for Strategy, marke;ng and Client Sales/Management in the region. Developed key rela;onships with Supra Na;onal Banks, Central Banks, Universal Banks, CSDs, Broker Dealers with a strong focus on Greater China. Member of Clearstream Client Advisory Board, driving strategic discussion and planning with some of the worlds largest financial ins;tu;ons. Key Market advocacy ac;vi;es to develop cross border holding structures for interna;onal clients and par;cipa;on in Industry debate and forums. Close working rela;onship with key regulators and Asian Central Banks to improve efficiency of regional clearing systems. 12

13 Disclaimer This presenta;on has been created in good faith by AlfaSec Advisors Pte Ltd ( AlfaSec ) and does not purport to be comprehensive and has not been independently verified. No responsibility or liability is or will be accepted by AlfaSec or by any of its respec;ve directors, officers, partners, employees or agents as to the accuracy or completeness of the presenta;on or wri'en informa;on made in connec;on with it and any liability is hereby expressly disclaimed. Whilst AlfaSec uses its best endeavours to obtain informa;on from sources that it considers to be reliable, AlfaSec makes no representa;on, or warranty, express or implied, that the informa;on or opinions contained cons;tute, or is deemed to cons;tute, legal, tax, financial, investment or other advice nor is it to be used for, or relied upon, for making investment or other decisions. 13