On the heels of our flagship annual European conference which took place in Lisbon in June, this side of the year saw ISLA continuing at full speed, with events in Frankfurt and Paris, and just recently in London for the ISLA AGM & 13th Annual Post Trade Conference.
Our Post Trade Conference has always been a well-attended event, this year being no exception, with members and delegates gathering at Goldman Sachs on 1 November. The day was a mix of presentations and interactive panel discussions centring on what happens once a securities finance trade is booked, notably against the backdrop of the imminent arrival of a shorter settlement cycle in the U.S. This topic, alternately referred to as Accelerated Settlement or T+1, shared a high priority position throughout the agenda, along with the implementation of regulatory frameworks such as Basel III.
Following the formalities of the AGM and opening remarks, Jamie Rush, Chief Europe Economist at Bloomberg, opened the proceedings by looking at the current macro-economic landscape. The broad topic of a higher interest rate environment very much dominated; the global economy’s apparent resilience and ability to weather the strain attributed firstly to consumers, and their reliance on strong balance sheets and excess savings accrued during the pandemic, but furthermore an identifiable time lag between the tightening of monetary policy in the form of rises and the impact on the real economy. He alluded to the very real possibility of underlying rates gently increasing over the coming decades, mainly as a result of increased debt issuance in the United States, but also the impact of the ageing population in advanced economies – as baby boomers retire, the draw down on savings creating an upward pressure.
The ‘Key Business, Trading & Product Drivers’ panel continued to provide an invaluable contextual backdrop to the rest of the day. Much of the discussion was dominated by the imminent arrival of the Basel regime and how trading flows are likely to be more fragmented as firms look at various trading tools and techniques to mitigate the extremes of the Basel framework. Here the discussion touched upon the use of central clearing, the development of pledge and the pledge-back markets, as well as the greater use of derivatives as a proxy for securities lending, and alternative funds rating models. It was clear from the discussions that the market is unlikely to coalesce around a particular preferred solution, as in reality firms are likely to adopt different business profiles at different times to solve for specific risk-weighted asset (RWA) constraints. In relation to Jamie’s reference to the higher interest rate environment, this has bought real yields back to our markets. 2024 opportunities were highlighted around the Middle Eastern and North African (MENA) markets in particular, although there was something of a cautionary note expressed by the group around the developing tax agenda especially in Europe that is likely to be a prominent in our markets into next year.
Alina Dragomir, Senior Policy Officer at the European Securities and Markets Authority (ESMA), delivered this year’s keynote address, focusing on the core agenda themes of settlement efficiency, accelerated settlement, and the use of new technologies and tools that may bring efficiencies throughout the issuance trading and post-trading chain. She spoke at length about the main objectives of Central Securities Depository Regulation (CSDR) in terms of ensuring stability and settlement efficiency in EU financial markets, whilst protecting investors, but also acknowledged that fail rates continued to remain high across all asset classes, notably exchange-traded funds (ETFs). The importance of best practice and standardisation were highlighted, and it was good for the audience to hear again of ESMA’s continued support for trade associations finding and setting those standards with members. At the same time, ESMA, amongst other priorities in this area, continues to assess the effectiveness and proportionality of the current penalty mechanism, as well as focussing on a reduction in the length of the current EU settlement cycle, including the prospect of a T+0 state. Interesting to see an audience poll reveal that Distributed Ledger Technology (DLT) would (in their opinion) be mainstream within 5-10 years, as Alina discussed new technologies, and in particular ESMA’s DLT pilot regime and the perceived benefits this technology could bring to settlement cycles in terms of speed, efficiency, and transparency.
Some of those sentiments were expressed by representatives of the UK Accelerated Settlement Taskforce as well as the Bank of England (BoE) Securities Lending Committee, who are looking at T+1 migration and current settlement efficiencies in the UK market retrospectively. With candour, and notwithstanding the time zone conundrum that all participants face, they talked about investment in ‘settlement conviction’ – firms having confidence in their books and records, and the right technology, discipline, and culture in place to pivot when markets do move to a reduced cycle.
Delving further into the detail, two related but quite different practitioner sessions went onto consider the longer-term aspirations and practical requirements to support an accelerated settlement environment, as well as the direct implications of T+1 on important events such as recalls and corporate actions. First to KYC and client on-boarding, where without fast and efficient on boarding, including the setup of static data, it is inconceivable that firms will be able to improve downstream processes and deliver T+1 without significant and unsustainable increases in costs. What was clear from the discussions is that continuing to do the same as we do today, but at pace, is simply not an option to meet the demands of accelerated settlement. The second of the two sessions also highlighted the very real need to look at how our markets interact with others. The importance of coordinating with other markets and sectors such as the cash equity, debt, and global FX markets underpins cross-currency investment flows. Herein lies the issue with time zones and the problem faced by global players in trying to manage T+1 settlement where we see a 14-hour time difference in the winter between Tokyo and New York. This may lead to not only an increase in systemic risk, as firms grapple with increasingly small and compacted settlement windows, but may push investors to become less global and more regional in their investment decisions to insulate themselves.
To what extent technology can support the transition, the afternoon began firstly with a fascinating presentation from the ValueExchange, where Barnaby Nelson presented the initial findings of a survey entitled ‘Securities Lending Transformation’, and amongst other things, the costs, friction points, and digital trajectory firms are exploring to improve their operating models. A number of fascinating statistics emerged, including ‘59% of market participants see meaningful operational challenges today’, ‘36% of firms see the elimination of reconciliations as a major P&L driver’, but also that ‘40% of firms seriously struggle to manage their legacy platforms’. The survey highlighted the top three costs as regulatory reporting, treasury costs and collateral management, with a clear direction that ‘63% of the market believe that DLT can have a major impact’ in reducing or removing costs.
In reference to the incumbents, the next session provided the opportunity for the first time during the day, to hear from the vendors that support our industry. They have always been a vibrant part of our marketplace driving significant innovation and change throughout the industry. In some ways the imminent arrival of accelerated settlement regimes will only create greater demand for the development of new and novel products, as we continue to see a world where larger, often prudentially regulated entities, find it hard to move quickly and apply agile product development methodologies, with an increasing reliance on vendors to deliver that change. In thinking about how innovation is funded, they themselves recognised that capital expenditure to support post trade enhancements has tended to be regulatory driven, making it often easier to fund that development through equity investments in vendors or platforms rather than from capex budgets. Furthermore, the challenges of being a commercial business, often with either shareholders or private equity owners, and the demands to meet sales targets, has to somehow be reconciled with the need to support the greater needs of the industry. In effect by delivering interoperability and all of its potential efficiencies for the benefit of the wider marketplace, one could undermine existing business models and inevitably profitability. As a consequence, we are seeing a series of often disparate standards in favour of base line ones, which may in time force the hand of policy makers to regulate these entities, and coalesce around a regulatory preference, such as the Common Domain Model (CDM).
The final session of the day gave the audience an opportunity to look out into what we might expect from our markets as they progressively embrace digitalised technologies, including DLT. What struck me from this debate was that firstly we are seeing a typically immature market where new arrivals into the space are jostling for position, with major players having the ability to execute issuance on chain using their own platforms. To realise the tangible benefits of these new ways of doing business, we will need to see scale and probably consolidation come into the sector. Traditional economics will in fact dictate whether these new products develop or fade away. The session also considered the work that ISLA is leading on to prepare the Global Master Securities Lending Agreement (GMSLA) for this new world, where we must think about how we apply traditional legal techniques to these new asset classes. Although tokenisation is seen by many as the answer to both collateral availability and liquidity challenges, it is vitally important that we place the right governance frameworks around these activities.
Standards are universally agreed to be the biggest issue, and the answer to most challenges as we try to modernise financial markets. Notwithstanding this and to my earlier comments, it is disappointing to see just how many standards there are. Not just ones set by standards’ bodies and associations, but across different markets and products. During the preparation for Securities Financing Transactions Regulation (SFTR), working groups across the market agreed that the only place a best practice should exist is within a trade association. In that way, the market defines the practice so that vendors and firms build to that consensus. Supervisors and regulators recognise the benefits of trade association best practices, as we have heard in multiple keynote addresses. That community has also started wondering out loud whether some firms are not adhering to those best practices, and to what degree that has reduced settlement efficiency.
In a similar vein but different context, the necessity for standards can also be seen through the lens of Diversity, Equity, and Inclusion (DEI), where to encourage a level playing field, regulators are now looking at new requirements for financial firms. It is important that this is front and centre of our agendas as an industry, alongside the technical topics, as not just encouraging new entrants but also supporting diversity of thought and approach, amongst other things, which may bring fresh thinking to resolving some of the legacy challenges we continue to grapple with. Some of the questions posed to Caroline Dawson, Partner at Clifford Chance, whose presentation provided the background to the recent DEI consultation papers and proposals published by the Financial Conduct Authority (FCA) and BoE, really emphasised the need for change in this area. ISLA certainly remains committed through its events but also other initiatives to ensure it is part of the debate.
I would once again like to take this opportunity to thank everyone who supported this year’s event, including sponsors, speakers, and the delegates who and attended and participated through the day.