Jim Aramanda, TCH: During the past 30 years, you’ve held executive and senior positions in many parts of State Street. How would you say the role of the bank executive has changed during your career, and what is required to run a multinational bank today as opposed to 20 years ago?
Jay Hooley, State Street: I would start by saying that what has changed is right out of Tom Friedman’s book, which is that the world has become flat. The globalization of financial assets has absolutely exploded. What 20 years ago looked like discrete, domestic markets has now become one global marketplace. In the management and distribution of financial assets, it’s now a unified global world.
Yet while the world is flat from a standpoint of investing, the world is very domestic from a standpoint of financial regulation. That introduces tremendous complexity in a multinational financial services setting. You have a global strategy, but you’re very much local from a standpoint of the products you deliver to the individual markets and the regulatory guardrails you have to operate within. It creates significant complexity.
Another factor adding to the complexity of our business is that the range of financial products has exploded. It used to be people would just invest in stocks and bonds. But now investment products range from index funds often opened through ETFs to mutual funds to a widening range of alternative products such as hedge, private equity and real estate funds.
The globalization of financial assets has absolutely exploded. What 20 years ago looked like discrete, domestic markets has now become one global marketplace.
The investment world, which is the world that we focus on, has meaningfully expanded from the standpoint of the range of products and complexity. And in a global organization in a highly regulated industry, the management of risk has become extremely important and very hard to do well.
Aramanda: The custody business is an interesting one, and it’s often not understood by a lot of people in the financial services industry. How has the custody business changed?
Hooley: I’ve seen a steady evolution of the custody business. Twenty years ago, the value prescribed in custodians was largely around one’s ability to settle trades effectively. You’ll remember 20 years ago, it was pretty exciting to get a trade settled in Italy, for instance. The value was more in the local operations, the coordination across different countries, and different regulatory and securities regimens.
Today, it has evolved from settlement and basic accounting to what I would call a backward integration into the middle and front offices. I think the most dramatic change is that it’s moved from a technology-enabled operations business to a data management business.
Today, the value that our clients see in a custodian is largely around information and the ability to assemble and create insights for things like risk management, investment performance, and compliance. All the things that were once viewed to be valuable 20 years ago are still being done, but they are much more highly automated, much more reliable, and at a much lower cost. The value has moved from the back office, to the middle office, to the front office, and that value is largely around data and information, or what is commonly referred to today as data and analytics.
Aramanda: I was surprised to see that State Street goes back to 1792. You’re actually 60 years older than TCH. State Street is obviously doing a lot of things well to have that kind of longevity. You have been vocal about the need for innovation and how technology is disrupting financial services. Can you discuss some of the advances State Street has made with newer technologies? More specifically, how do you see State Street becoming a financial services disruptor?
Hooley: Our 225-year anniversary is this year, which is pretty remarkable. We will pause to celebrate this occasion but also use it as a reminder of how important it is to continually adapt to emerging trends. Let me give you a short analogy to frame the risk and opportunity that we all face when it comes to technology and innovation. In the U.S., the financial services industry has developed sophisticated systems and infrastructure. However, because it’s been built over time, in many ways, it doesn’t fully employ some of the newer technologies and capabilities that exist today.
Let me tell you a story that was instrumental in some of my thinking around where the world is going. We have a subsidiary in Hangzhou, China, with a couple of thousand people. Hangzhou is also where Alibaba, China’s biggest e-commerce company, is headquartered. A few years ago, I visited Alibaba’s financial services subsidiary, called Ant, and I saw some of the things that they’re doing. On the back of Alibaba’s e-commerce business, they developed a payments business. On the back of the payments business, they were able to figure out an algorithm that would assess one’s credit worthiness. They started a bank, opened up a money market fund, and they want to get into wealth management. That’s not a strikingly remarkable strategy, but what was striking is that this was being done for hundreds of millions of investors in real time, with the credit dynamics in real time as well. Somebody could go in and, using a cellphone, purchase a TV based on a dynamic, real-time assessment of their credit. The whole infrastructure was run on a public cloud. When you think about that example, and you consider that here in the U.S. the infrastructure is burdened with practices such as T+1, you realize how far we have to go.
Sometimes the strategy is not the issue. The execution is the issue. The question is how do you internally disrupt the organization so that you break the mindset that incremental change is acceptable.
For me, that was a moment where it became very clear that State Street, and I would say the entire financial services industry, needs to rapidly digitize all of the infrastructure that we’ve created over many decades, so that we’re able to deliver real-time information and real-time processing to the investment industry. The leapfrog capability of emerging markets not having to work through old infrastructure is the challenge, and the opportunity, that sits in front of all of us. I like to view it as our greatest opportunity, which is to digitize all the things that we do and interactions that we have with other people in the financial marketplace. Ultimately, it gets at this point about data – information and analytics – on a real-time basis.
Aramanda: What’s fascinating with Alibaba is that they’re fully integrated. Not just digitized, but integrated.
Hooley: Alibaba had two things going for them. One, they didn’t have to change an existing, embedded infrastructure. They created a new one. Two, they probably got some favorable regulatory treatment in order to enable banking to the unbanked. But it really does point to one of our greatest challenges, which is to transform – radically transform – the infrastructure that’s been built up over decades.
It really creates opportunity. Enabling real-time data is going to help our clients. Digitizing our operations is going to give us better controls. It’s going to lower costs. All good things happen from it.
Aramanda: While we’re on the topic of innovation, can you talk a bit about the work State Street is doing with distributed ledger technology (DLT)?
Hooley: I think we were fairly early adopters of not so much blockchain but distributed ledger. In our world, there were several obvious places that we could begin to pilot DLT. For instance, in collateral management, in securities lending where you have a borrower and a lender, and in loan processing where you have multiple parties converging on an accounting activity in order to reconcile participation in a loan. We have for several years been piloting distributed ledgers in different places, and we think some of the applications will be ready for active use.
But, to me, distributed ledger is a tool which will bring counterparties together on a real-time basis for greater efficiency, greater data movement, and greater accuracy and controls. It’s just one tool. I don’t think distributed ledger will redefine our world, but if different firms start to agree on standards for interoperating, that’s where something like blockchain can be very impactful. As a custodian, we can control and digitize all the things within our four walls, but the industry is so interdependent that standards need to be established in order to really optimize the financial system.
Aramanda: Are you seeing take-up with counterparties? Because, you’re right – you can’t do it in a vacuum.
Hooley: It started slow but it’s accelerating. I think it’s one of these things that the more you experiment with it, the more your imagination opens up and the more possibilities you see. They say it might not just be blockchain, but the whole opportunity to digitize and to interoperate.
In addition to participating with external providers, we’re building up our own internal expertise through research centers around different technology concepts, such as artificial intelligence and machine learning. There are a number of very advanced technologies that traditionally have not been found in financial services, but we’re seeing them in other industries. Sometimes, you have to go outside of your industry in order to be enlightened about how technologies are creating new products or enabling new capabilities. Several years ago, I set up three different teams within State Street. I sent them off on a six-month mission to go out and try to figure out, if you’re on the outside, how you would disrupt State Street – our custodian business, our trading business, and our asset management business.
That journey took us out to, naturally, the digital platform providers, but we also looked at what’s happening in other industries – technology, manufacturing, and sciences. That also helped to broaden our lens with regard to the different technologies that are available that can create meaningful change in a business. That’s what led us to artificial intelligence and machine learning, which we’re now working with internally to try to bridge the traditional operationally oriented activities to fully digitized activities.
Aramanda: That’s a terrific story. When the teams came back, were they charged with taking the ideas and making some practical applications?
Hooley: Absolutely. And, it comes back to the challenge that we all have. Often the strategy is not the issue. The execution is the issue. The question is, how do you internally disrupt the organization so that you break the mindset that incremental change is acceptable.
Aramanda: Let’s switch gears a little bit and talk about exchange-traded funds. They’re very popular and they’ve been a source of significant growth for you, but it’s become a crowded market. What do you see happening in the years ahead and how do you see State Street fitting in?
Hooley: I talk about ETFs as disruptive technology, just to steal a phrase we were just using. Remarkably, State Street launched the first ETF 24 years ago. It took 10 to 15 years before things really started to get going with ETFs. I think it was probably a process innovation before its time. But as investing started to move into beta and more into asset allocation modeling, ETFs took on a new purpose. An ETF is a very efficient way to access exposure to a market, and it has some advances over traditional funds, like the fact that it’s exchange traded, and it has some tax advantages. But, at 24 years old, it’s now a $3 trillion segment of the asset management world. I think you’ll continue to see rapid growth, because a growing part of the asset management industry is favoring asset allocation solutions, as they’re called frequently. It brings back the old question, where does alpha come from? Is it more from the selection of stocks and bonds, or is it more about the asset allocation? We’re now able to offer asset allocation at a very reasonable cost to smaller retail investors, as well as institutions. I think you’ll continue to see growth for that reason – the phenomenon of asset allocation-based solutions populated by lower-cost beta delivered through ETFs. I’m not sure what the ETF of five years from now is going to look like, but if you apply science and technology, you can create customized experiences around an individual in lower-cost ways. Just think about robo-advisers today. There is likely to be a different innovation from a product standpoint five years out, and even more so 10 years out. In my opinion, we’ll see an acceleration of product proliferation enabled by technology.
Through a robo-adviser, you can provide a tailored, risk-based experience to an individual and then, on the back end, enable that requirement through a low-cost, but highly sophisticated investment product. That is something that we wouldn’t have even dreamed about 10 years ago. We’re on the early edge of that technology evolution.
Aramanda: Yes, it will be fascinating to see where technology takes us. Moving on to another topic, in the last eight years the financial services industry has undergone probably more sweeping regulatory change then at any time in our history. Do you think the regulatory changes achieved their mission, and, if you had a magic wand, what would be the changes you’d make to the regulatory environment?
Hooley: I would frame these comments in a bank setting. I think the architecture of the regulatory change that focuses on capital, liquidity, and resolvability is completely appropriate. It’s hard to argue with that. Within those different sleeves, I think there’s been good work to make sure that everybody is viewing things the same way.
I think the place where it’s been overdone is the calibration. How much capital is enough capital to prevent bad things from happening, but not to be so risk averse that you’ve put undue burdens on banks and constrain credit to markets? The same applies to liquidity. The first thing we need to really think about is the calibration. How much capital? How much liquidity? How sophisticated of a resolution recovery plan is appropriate? And, should it be tiered by different sizes of institutions? That’s my first point.
My second point is that we have had so much change in the financial industry over the past eight years, it’s dizzying. Perhaps it’s time to step back, hit the pause button, and start to measure the cumulative effect of regulation on different parts of the economy and the banking system. I would also say the one area that gets a lot of attention, and should get a lot of attention, is the effect of all these regulations on liquidity and the fixed income markets. I believe, and I think others believe, that the change has dramatically shrunk the natural liquidity in those markets, and the has it gone too far? Are we setting up the next issue, because we haven’t fully appreciated the cumulative effect of all these rules on the financial markets?
Those would be two regulatory areas. Have we got the calibration right? And we really need to step back and assess the cumulative effect. Certainly, this needs to be done before we do anything else. That might lead us to scaling back or changes that would refine this tsunami of regulation, most of which has already been implemented.
Aramanda: I think most would agree that it is time to assess the impact, both good and bad, of all the regulatory changes and identify the unintended consequences, etc.
Hooley: I think that the U.S. reacted most proactively to the financial crisis through regulatory change. In some respects, the U.S. has led the world in regulatory reform. This is an important point that goes back to my previous answer about the globalization of assets and investing. But it’s important that regulations across the world, at least the critical ones, are synchronized. Because if they’re out of balance, then you’re going to have regulatory arbitrage, and you’re going to create the next set of issues.
Aramanda: What’s your take on Brexit and how is it impacting State Street?
Hooley: I was traveling through Europe during that fateful vote. I was surprised as I talked to people. The prevailing view was that Great Britain would agree to stay in the EU. When the news broke, I was in Switzerland meeting with some CEOs, and I was hoping that they would provide some calming words to me. Instead they were more panicked than I was. I think it’s hard for me to know whether long term it’s the best thing for the U.K. Independent from the debate around controlling borders, is independence a good thing for the U.K. long term? I can’t help but think that, short term, it’s going to be very disruptive when you look at the percentage of GDP that gets created through that EU connection.
Brexit will happen. As I’ve thought all along, it won’t be a soft Brexit. The U.K. and the EU both have a lot at stake here – more so the EU so as to not set a precedent with the U.K. because you have Italy, the Netherlands, and Spain all watching closely. So, I think it will be a hard Brexit. I think it will be disruptive. If you consider financial markets, the U.K. is the predominant jurisdiction of choice for trading activities and for several other financial services activities.
For State Street, our interests are in pools of assets to service, manage, and trade. Some years ago, we set up an international bank in Germany, which is systemically important in the EU. So, we have significant banking operations both in the U.K. and in Germany. We operate in 12 different markets across Europe. So, we actually feel pretty balanced. We don’t think that much of our infrastructure will have to shift around. But we do think that folks who manage assets for a living and who have chosen structures that are domiciled in the U.K., will likely have to adopt different structures. They will likely migrate to places like Dublin and Luxembourg to reposition their funds so that they can distribute them across the natural boundaries of Europe. Those are two places where we have market leadership.
Aramanda: State Street is well-positioned in either case.
Hooley: Yes. I think we’re in pretty good shape. Again, we set up an EU bank. Thirty percent of our revenues are in Europe, so it’s a big deal for us. We needed the bank for other reasons, but it happens to serve this purpose quite well.
Aramanda: For the last question, I’ll ask you to look into your crystal ball. What significant changes do you see in the banking industry over the next decade?
Hooley: I think about three things that help me imagine what the future’s going to look like. The first is economic growth. I think that the developed market slowdown is going to be with us for a long time, and the emerging markets aren’t going to make up the difference, so the world is in a 3% slow growth market for a long time.
The second thing is regulation, which as we’ve already discussed, I think we need to step back and assess. The third is technology. In a slower-growing world and with regulation hopefully normalizing, we have just seen the tip of the iceberg as far as how technology is going to transform all businesses. You can look at retail. It’s evident to most people what’s happened to traditional retail and how online is redefining the future and how value chains are going to be the envy of the folks that ultimately succeed. I think financial services are a little bit behind the curve.
The good news is that there is a lot of room to use technology to enable digitization, new product capability, cross-border activity, efficiency, and better controls. I land on technology being the lever with the most transformative implications. You either transform or die. There’s a bit of a regulatory moat around financial services, so the disrupters will have to go a little slower than in other industries. But that protection won’t last forever, and a useful role for regulators would be in helping to promulgate standards to smooth the transition. What we have seen in other industries is a call to action to our industry to move more dramatically, not only firm by firm, but across the system to make sure that we can streamline, automate, digitize, take costs out, and use data to enhance the customer experience. We’ve got to disrupt this infrastructure that has served us so well but is growing old – and leverage the many transformational technologies that exist today.
So, I would end with, it’s an exciting time. It is a time for change, and it’s going to run for a while.
