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The rise of financial utilities

In a highly competitive business like banking, cost and performance efficiency is a major determinant of success. As a result, banks are always looking out for opportunities to derive a little more value from their already optimized operations, a search, which has only intensified in these tough economic conditions.

One opportunity that has their attention is the area of regulatory compliance, where costs have gone up substantially thanks to ever multiplying mandates, often involving the same processes and documentation. Sensing an opportunity to optimize, entities such as client data and documentation utility Clarient – a joint initiative by Wall Street banks and DTCC (Depository Trust & Clearing Corporation) – have sprung up to act as a centralized hub for internal onboarding services and to also help banks manage KYC, FATCA, EMIR and Dodd-Frank requirements. Thomson Reuters and SWIFT have also launched KYC registries.

The utilities proposition, to aggregate and abstract common, undifferentiated activities into a packaged service, is both simple and attractive. It can help financial institutions improve savings, transparency and control by merely centralizing important but non-core and standardized functions, as well as make them more responsive to changing regulatory dynamics.

We are seeing a rising interest in financial industry utilities, especially among mid-tier institutions with relatively higher costs per trade, who are keen to co-create similar entities for centralizing post-trade process servicing, KYC/onboarding, reconciliation, and so on. Over the next three to five years, we expect utilities to evolve into a central role within the industry. There is definitive value in the utilities’ promise of relieving banks from the burden of non-core activities and a savings potential of as much as 60 percent on the cost per trade. But given time, they might even do more.

For instance, by freeing financial institutions of routine tasks, utilities can help them focus on core, business-generating activities. Banks can concentrate on building competitive advantage by accelerating time to market, improving service delivery and enhancing quality of output.

As utilities evolve, the way they are conceptualized, built and implemented will also change significantly. The collaborative model (such as Clarient’s) is fairly well established.  Going forward, individual institutions could take up the task of developing such an entity and then offering it to their ecosystem. Other possibilities include third-party technology vendors offering the technical backbone directly to a market heavyweight such as DTCC, or a collaboration between technology service providers and leading product vendors.

But the success of a utility will depend on how well it facilitates productive collaboration between all stakeholders including banks, product vendors, market infrastructure players, leading technology companies and perhaps even regulators. The last is of particular interest given that most regulators are quite circumspect about the scope that should be allowed to utilities, especially in critical areas like risk management and compliance.

Right now, regulators are divided on the value of utilities, and especially on the wisdom of handing off functions like compliance and risk management, which they still view as the core responsibility of banks. There is also some concern about where to pin liability and accountability in this new disintermediated model.

Clearly, the future growth of utilities will depend on how well banks and financial institutions engage with the regulatory community on this issue. Meanwhile, utility companies should bolster their core proposition with structures and strategies that allay prevailing concerns.  They should show that they can balance risk and value by governing their organizations well, leveraging solid collaborative partnerships, clearly defining roles and responsibilities, and complying with all security and privacy norms. 

This will require a clear roadmap to start with, followed by vision, strategy, governance, and risk management, to name a few. Utilities also need to define their scope of service, product and service strategies and structural frameworks for ensuring privacy and security. A coherent technology strategy that takes into account utilities’ likely evolution from say, an enterprise platform to intermediate stages on private cloud to full-fledged status, is a must. There also needs to be continuous innovation.

Last but not least, it is important to see the utilities as long-term benefits rather than cost savings in the short-term.



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