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Kamal Pallan Managing Director, J.P. Morgan Investor Services |
The 2008 financial markets events have heightened client focus on their service providers, the strength of their providers' balance sheets, and the quality and value of service received. Here, Kamal Pallan, Managing Director and Western Hemisphere Custody Product Executive, J.P. Morgan Investor Services, discusses sovereign wealth funds, transparency, regulatory changes and other issues affecting global custodians. |
Sovereign wealth funds have become a major investor class. How do their needs differ from those of other investors and how does this impact services they demand from custodians?
Kamal Pallan: Sovereign wealth funds have been around for a long time, but what is new is the sheer size of them, driven in part by record prices in commodities and trade surpluses in many Asian economies. Various research shows total assets under management as of May of this year to be as high as $3.7 trillion. Some of the most experienced sovereign wealth funds tell us that they think of themselves not as a distinct investor class, per se, but simply as highly sophisticated, multiple-asset-class investment managers. In our experience, they are leading change agents and continue to push us forward collectively because of the breadth of their investments and the services they need.
As clients try to improve their understanding of the possible impact of hard-to-value derivatives, custodians are receiving more requests concerning transparency and risk. What is being done to help in this context?
Kamal Pallan: As a custodian, we're not just processing or settling trades. We're providing our clients with insight into their portfolios, how their portfolios are performing and the risk embedded in their portfolios. In terms of derivatives, the biggest challenge is around OTC derivative contracts. There are three main 'pain points' which custodians are tackling. First point-on valuation and pricing, we provide clients with a choice of independent valuations; they can be calculated internally using market data and models, or sourced from third-party pricing services. Transparency as to source and methodology of pricing is critical. Another pain point is managing all of the events across the life cycle of a derivative from trade capture onward. As an industry, we've made considerable progress working collectively to address regulatory and other concerns about processing efficiency. Finally, custodians provide risk analytics, which have been extended to derivatives, among other asset classes.
How is the severe strain on the U.S. financial system affecting clients' views of custodians?
Kamal Pallan:Simply put, our clients want to wake up tomorrow morning and know that their custodian is still in business. Given recent events, that is a valid concern, so there's a flight to quality. We expect that to continue-if anything, it will be an ongoing process. Clients are looking less at just the cost of custody, and more at the quality of their custodian. They want to see a fortress balance sheet, with strength and stability. Also, when markets are changing hour by hour, they want constant information. They want insights on developments in a way that they may not have needed before. Finally, quite apart from the balance sheet, the transparency, the information, it's the service that our clients need to get through really tough times like this.
Pension clients have been moving from defined benefit to defined contribution plans. How will the current market turmoil a their actions?
Kamal Pallan: The pension industry is going to continue to grow, and we're going to continue to see a shift from defined benefit to defined contribution schemes. What we as custodians have to do is make sure that we can accommodate this shift and provide the services, expertise and insight that our clients need, whether it be performance analytics, compliance, consulting or services designed specifically for defined contribution schemes.
How are recent regulatory announcements changing the role of custodians?
Kamal Pallan: I'd like to address two areas where custodians are actively involved. The first is around understanding regulations that are imposed upon our clients and what we as custodians need to do to help them respond to those regulations. The second is around self-governance, where we as an industry come together to address issues and concerns in a coordinated way for the benefit of the markets and our clients. Both of these elements are increasingly important aspects of the custodian's role.
The convergence of investment styles between traditionally long-only managers and alternative investment managers continues. Can you list some key developments and how they affect these managers' service providers?
Kamal Pallan:Traditional funds are behaving more like hedge funds, at the same time as hedge funds are becoming more institutionalized by asking for things that our traditional clients have always wanted, like accounting services. This means, for example, that custodians need to support both long and short positions, and consolidated reporting across both. At the same time, custodians are increasing their derivatives processing capabilities and looking to integrate a wider range of services supporting a broad spectrum of investment strategies. As custodians, we have to be able to handle leveraged portfolios, and bring the entire bank-whether it's prime services, financing or synthetics-to our clients.
How has the growing internationalization and maturing of many emerging markets affected investors and service providers?
Kamal Pallan:What five years ago was a frontier market, today is likely to be more mainstream. At the same time that the markets are maturing, we're seeing our largest clients truly globalize their investments and operations. Where they may have been in just one time zone, they are now aligning operations globally. As custodians, we need to be with our clients as they move globally. Developing countries and their citizens are becoming more affluent and exporting capital. Our clients are setting up local operations to tap that new affluence, and as they do, we have to follow them-or, in many cases, anticipate their movement.
Are the deals between investment managers and custodians for middle-office outsourcing picking up speed in the current market? How do custodians propose to help investment managers focus on their core businesses?
Kamal Pallan: We see the trend accelerating. There's a tremendous amount of complexity that investment managers have to deal with, such as derivative processing and valuations, and many of them don't have the capability or desire to manage these functions directly any more. The first few outsourcing deals several years ago were highly customized 'lift-outs' which turned out to be a challenging model for both clients and service providers. As an industry, we're moving to a model that is much more component-driven and on the service provider's standard platform. Thus, we can package the services that each client wants with components that are not totally customized for each deal. This allows us to provide enhanced functionality coupled with economies of scale and efficiency. It's not 'one size fits all,' but it's moving toward a more standardized model.
Technological innovation has been a recurring theme in the custody business. What can we expect in the future?
Kamal Pallan: What you will see change is how technology investments are spent each year. Systems are becoming increasingly component-based. We're trying to build things that are 'plug and play' as much as possible. Our clients have tremendously complex needs and not everybody wants the same things. So we're looking at how to build a system that's scalable where you get the cost benefit but at the same time the clients get what they want. The other thing that's happening with the current technology is this idea of bringing the best of the bank to the client. It's much easier now, because of technological advances, to knit together things that were not possible a few years ago. For example, we can now talk about things like integrated execution, clearing and custody. Finally, we're in an age of real-time data and extensive data mining; this plays a real role in how we think about delivering information to our clients.
Is the custody competitive model changing as a result of the recent turmoil?
Kamal Pallan: I think it is going to change how we talk about the value that we provide to our clients, and some of that value will be things that our clients may not have thought as much about a year ago. We believe the focus will be on institutional quality, reporting, risk management and service.
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