Solving the Supply/Demand Issue for Non-U.S. Investors (by Roger Shaffer, INTL FCStone)
In recent years, there has been a sharp increase in demand from non-U.S. investors for custody of their investment portfolios at U.S. institutions. While the U.S. has always been a popular destination for non-U.S. investors given its stability, strong regulatory regime and relatively low cost structure, the recent and drastic demand increase appears to be driven by other factors. One major factor is the change in disclosure policies by certain European banking jurisdictions. Historically, investors utilizing custody in these jurisdictions paid dearly for “secrecy” in the form of custody fees and higher transaction costs. Now that these jurisdictions have adopted policies of full disclosure, investors are questioning the value of these institutions—creating more demand for custody in the U.S. Ironically, the number of U.S. institutions accepting non-U.S. customers is effectively shrinking.
Large U.S. financial institutions have become more selective when accepting or retaining non-U.S. investors, specifically with respect to the client’s jurisdiction, as well as account size and product offerings. I recently spoke with Javier Rivero, Senior Vice President of the International Division at Dynasty Financial, about this issue. He noted that in the last seven years, many large U.S. financial institutions have closed offices or sold their businesses in international markets. As U.S. regulatory demands increase and the perceived risk profile of clients comes into question, large U.S. firms are cutting down on the number of jurisdictions they allow their advisors to serve, according to Javier. Additionally, these organizations are increasing the minimum account balances required to open new relationships and maintain existing ones.
Both Javier and I believe that a solution lies in the “Independent Adviser” model, which allows for true open architecture and access to best-in-class products. When advice, custody and products are separated, an advisor can match a client’s needs to the right custodian and the right products without being restricted to just one institution. Although the independent adviser model is part of the solution, restrictions imposed by large U.S. institutions on non-U.S. investors still must be addressed.
Enter the middle-market firm, which largely still views non-U.S. investors as an important part of a diversified client base. Non-U.S. investors are often motivated to make investment decisions by different factors than their U.S. counterparts. Additionally, they often utilize different products than do U.S. investors, including a greater emphasis on fixed income securities, offshore mutual funds, UCITS and structured products. The varied investment motivations and products, which are inherent when maintaining an international client base, can help even out revenues for middle-market firms. Finally, in addition to benefiting middle-market firms, providing custody to non-U.S. investors facilitates their investment in U.S. securities, stimulates the economy and ultimately creates jobs.
Now for the reality check – middle-market firms are in fact subject to the same regulations as are larger institutions. So, why would it make sense for a middle-market firm to accept the non-U.S. accounts that a larger institution would reject? In many cases, due to their smaller size, middle-market firms can achieve account level profitability with smaller account balances than their larger counterparties. Without the overhead of a larger firm, middle-market players can apply more resources to risk management, surveillance and compliance.
I recently spoke with Luis Mariño, CEO of Union Capital Group (USA) and former Director of International Private Banking at Merrill Lynch, who has witnessed firsthand the increased demand by non-U.S. investors for custody in the U.S., with larger U.S. firms simultaneously becoming more restrictive. Luis believes that middle-market firms whose management teams are experienced and comfortable working with international clients can offer unique solutions for many of these issues, as they are often more nimble and willing to add new products specific to non-U.S. customers.
As non-U.S. investors increasingly turn away from European financial institutions and seek custody in the U.S., those middle-market firms willing to be open and accommodating, while not afraid to put in the work, will likely find themselves a premier destination and ultimately a solution to the current supply/demand conundrum.
A&O, IHS Markit and SmartDX partner on derivatives regulation.
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