Reflections of the ISLA AGM & 12th Annual Post Trade Conference

On 1 November 2022, our community gathered in London for our 12th Annual Post Trade Conference. The day was a mix of keynote addresses, economic updates, and interactive panel discussions all built around the theme of the life cycle of a trade from inception, through trade execution, the management of collateral, and on to life cycle events. The day concluded with a glimpse into the future with a discussion on the operational impacts of managing crypto and digital assets, but more of that later.

After the formalities of the ISLA AGM were completed the main part of the day’s agenda started with a fascinating economic update from James Pomeroy (Global Economist, HSBC). Inevitably, in any economic update there were positives and negatives. Inflationary pressures are evident around the world driven in part by the spike in energy costs following the war in Ukraine. However, some of those pressures appear to be easing with wholesale energy prices falling ahead of winter in Europe, suggesting that the peak of the energy crisis could well be behind us, at least in the short term. Having said that, some economies are displaying persistent underlying inflation which appears to be driven by very robust levels of consumer spending. As we have come out of the pandemic, consumers have come back to restaurants and other social settings and, for now, they appear to be immune to price rises that are being fuelled by the increasing costs of raw materials, including food. One of the most important factors that will define where economies and markets go next, will be the sentiment of consumers and their spending patterns over the coming months.

Following James, we were joined by Emiliano Tornese (Deputy Head of Unit, European Commission (EC)). Emiliano provided the group with some insights to the EC’s current agenda and where this resonates across our industry. Inevitably, he touched upon CSDR and mandatory buy-ins, and whilst he did not comment on this area in detail, I felt that it was clear that mandatory buy-ins are still very much on the table, notwithstanding the pause in their implementation. It is important that we as an industry recognise this, and quite simply we cannot be complacent in this matter.

In a slight change to our regular opening panel session, where we would normally reflect on the key economic fundamentals and other factors that are driving performance and profitability, this year we wanted to anchor that debate firmly in the post trade world. In opening the discussion, the panel considered how the long equity bull run is over, with shorts back at pre-pandemic levels. Not surprisingly, revenues are being driven by specials, although the record levels of GC balances out in the market were also noted. In an audience poll, it was suggested that circa 50% of today’s balances support financing trades, rather than the traditional lending of specific stocks, whilst still important, is now only a component of a multi-dimensional financing and liquidity management business.

The panellists also emphasised how important the link between operations and front office is for the success and viability of any business. However, it is clear that for some firms that integration is going further, with at times, no clear line between the two. When I was at the RMA conference in Florida last month, I heard the phrase ‘Ops Alpha’ used several times, which I feel encapsulates much of what this session, and the overall day was all about. Thinking about operations in this way, will potentially add significantly to the bottom line, and allow firms to be better positioned to deal with regimes such as CSDR and Basel IV. In terms of overall priorities, in a second audience poll, CSDR dominated people’s responses with Basel something of a distant second. Although this was not unexpected, and CSDR is something of a ‘here and now’ issue, the rolling impact of the Basel regime could offer significant headwinds for certain elements of our community as we look at past 2023.

When the group talked about structural issues such as matching SSI’s, trade pre-matching, and better collateral mobilisation, I was struck by how intractable some of these issues appear to be. I am sure I am not alone in thinking that we have been discussing how to deal with challenges associated with SSI, and wider on-boarding issues, for most of the twelve or so years of this event. There is no doubt that there is much to be positive about as the industry increasingly redefines itself as a liquidity pump for the capital markets more broadly, but I do feel we need to put some of these issues that act as a drag on progress to bed once and for all.

Following closely on from that first panel discussion, the next two sessions looked at KYC (Know Your Customer), together with onboarding and documentation, followed by trade initiation and settlement finality. The concept of KYC, onboarding, and the provision of documentation is at the heart of our business. Getting it right can be the difference between a successful and profitable relationship, or one that is plagued by fails and potentially penal regulatory capital treatments. In that context the panel felt that ‘compliance is everything’ and the need to check things like authority and capacity was more important than ever. The panel notably expressed some disappointment, or even exasperation, that we were still talking about these issues some fifteen years after the introduction of the European Agent Lender Disclosure (ALD). Although it was felt things had improved somewhat, the onboarding process was plagued by incorrect information, and lack of consistency of approach, particularly where borrowers have not been able to agree on a standard set of KYC requirements.

The panel also touched upon the provision of third party or vendor led solutions as part of a move towards standardisation, but here again and notwithstanding the improvements that have been noted, the lack of any real adoption of these services within our markets seems out of step with other markets where similar challenges exist. As this session closed, I was struck by how little progress appears to have been made on this issue and what we can do to move this forward. ISLA has a KYC & ALD Working Group that is trying to take the discussion forward, but we do need to see member firms coming to the table here with new and novel ways of thinking, otherwise we might simply be talking about the same issues again this time next year.

Many of the issues associated with KYC and onboarding found their way into the next panel, where the focus was on trade initiation, settlement, and the vexed issue of settlement rates. Inevitably, the discussion centred on CSDR and the reasons why trades are falling. I was frankly saddened to see unmatched SSI’s as one of the main reasons for trades failing. Despite all our collective efforts, not much seems to have advanced over the years on this issue, and whilst we have been discussing this issue, I worry that if the industry cannot solve this the regulators will eventually do it for us. As we look at CSDR, I have no doubt that if we collectively fail to deliver real solutions to these problems that are now attracting fines, we will see others, not just the regulatory community, delivering real solutions to these issues. That could undermine our markets and raise questions about our role in the capital markets eco system.

The second half of the day started with a more detailed look at collateral. At a time of both increased volatility and liquidity shortages in certain asset classes, having the right collateral in the right place, at the right time, is ever more important. We have known for some time that the collateral leg of any loan is important but with a reported 50% of the market being characterised as financing business, the role of collateral in making the business function efficiently is clear.

Although there was wide support for the current business model around collateral, that is typified by the offerings from the various tri-party agents, the group still felt that more could be done across the industry. Set against the backdrop of optimisation, it was noted that there are a number of tools and products available to the market that are not currently being used. However, it was also felt that to drive the efficiencies that we are all looking for, there needs to be a fundamental rethink in the way we look at this side of the business. The logical place to look for those efficiencies is in and around Distributed Ledger Technology (DLT), with tokenised collateral being a strong interim step along that path. It was felt that full DLT in our markets could still be several years away, but it was suggested that it is vitally important that firms start investing now in these technologies to capture these future benefits. Before concluding, the session briefly talked about ESG and its impact on how we think about collateral. ISLA has already published a piece of thought leadership in this area, and the discussion talked through many of the issues highlighted in the ‘Applicability of ESG to Collateral in the Securities Lending Context’ paper. The proliferation of ESG collateral schedules was highlighted, and how lack of clarity from the regulatory community is driving very diverse outcomes. All felt that better guidance from the regulatory community is needed, to deliver a more scalable and economically viable business model to support clients’ ESG objectives.

The final plenary session of the day rounded off our discussions with a look at the operational implications of managing crypto and digital assets. This was a fascinating discussion that covered a lot of ground. The group considered the nature of legal property, and how to create a security interest over a token or crypto asset. Whilst this may appear something of an intellectual exercise, it was recognised how important it is to create legal certainty around anything that we do. As part of the next steps, ISLA will soon publish a joint whitepaper on digital assets with Ashurst LLP that considers these issues in more detail.

Following closely behind legal certainty is the need to create regulatory certainty. The group discussed how we have seen both convergence and divergence from a regulatory perspective, and how the current Basel framework essentially adds incremental layers of RWA charges for crypto or digital assets. Whilst not wanting to underestimate the task at hand, it was noted by several speakers that crypto and digital assets are in many ways simply another asset class and should be treated accordingly. This provides comfort as the developing crypto and digital world progressively merges with our existing physical settlement and custodial frameworks.

Before concluding this brief overview of our 2022 Annual Post Trade event, I wanted to take a moment to highlight one further session which was the ‘In Conversation with…’ discussion on Diversity, Equity and Inclusion (DE&I) in this regard I would like to personally thank both Jane Karczewski (UK Head of Markets Sales for Asset Managers and Hedge Funds, Société Générale) and Sunil Daswani (Global Head of Securities Lending, Standard Chartered Bank) together with our moderator Caroline Dawson (Partner, Clifford Chance LLP) for a most compelling and thought-provoking discussion. In the past, many discussions around this vitally important topic have tended to centre around what organizations may or may not do to improve their own DE&I footprint or credentials. In contrast, this session was simply a conversation between individuals sharing their personal experiences and challenges in the context of their own particular experiences.

As I close this short review, I wanted to pause for a moment to consider the key messages from last week.

Events like our annual post trade conference are always an ideal opportunity to assess where our market is on some fundamental issues.

The importance of post trade to the overall trading environment was clear, and the idea of ‘Ops Alpha’ sums up much of the mood during the day.

We have always been an industry that is able to adapt and change to the circumstances before us, and the growth of so-called financing trades, which now dominate many securities lending programs, is a prime example of how our market is able to evolve and change to continually serve its participants.

Having said that some of the challenges and headwinds that we all face are, regrettably, all too familiar. Whilst I take a positive view into 2023 and would feel very strongly that through groups such as those offered by ISLA, we can address and solve for many of these issues, we do also have to accept some of matters have been with us for far too long.

Andrew Dyson

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