Achieving efficiency and regulatory compliance
As the industry tackles the biggest challenges to its ecosystem since the financial crisis, Simon Davies of Pirum explains that new regulation, reduced income and increased competition all present headwinds
The securities finance industry is currently grappling with what amounts to be the biggest challenge to its ecosystem since the financial crisis. New regulation, reduced income and increased competition all present headwinds, while complex and inflexible operating models create further challenges.
At Pirum we’re increasingly being asked by our clients, how we can help them meet these trials and here we explore some of the key issues that our clients are facing and how they are dealing with them—including how to increase process efficiency and straight-through processing (STP) rates close to 100 percent, better manage costs and improve data usage in pre and post- trade processing.
Firms will be successful in adapting to the new world of regulatory transparency and efficiency if they maintain a high degree of agility and flexibility. While enormous benefits can be accrued, they will only be achieved after a period of flux and adjustment. With increasing transparency, there will be a drive towards better quality data to meet the compliance requirements, however, this will benefit trading decisions and post-trade processes from trade execution and collateral management through to settlement and reconciliation.
Additionally, in order to meet many of the regulatory requirements of the Securities Financing Transactions Regulation (SFTR) and the Central Securities Depositories Regulation (CSDR), firms need to improve front to back processes, increase automation and introduce standardisation in order to achieve efficiencies in their operating models— particularly processes and controls. This will allow firms to manage costs and increase business activity, which in turn will benefit profitability and competitiveness.
As noted, change is never particularly easy to implement, and there needs to be a clear agenda and impetus. Regulation is setting this agenda today, and this is creating opportunities for firms to improve how and what they do, but businesses need to recognise this driver and embrace it.
In order to remain competitive, firms need to develop capabilities to help them improve data quality and processes, and there are some choices to be made—particularly around what firms should be focusing on in the short and long term. When looking at the solution to some of these problems, firms clearly need to consider the functionality required but should also look at their connectivity within the ecosystem. It is around the interactions with the industry where we believe most efficiencies can be driven, that will drive benefits now and in the long run, or in other words how your firm interacts with the securities financing ecosystem.+
What is the ecosystem?
If we look at the number of market participant interactions that a typical agent lender must deal with, we’ve calculated it’s around 11,000 and increases to about 30,000 for borrowers/ brokers. These figures come from the interactions a firm has at the beneficial owner level (the sub-funds on both demand and supply side), their asset managers, the treasury counterparts— both corporate and banking, other market counterparts and their entities, multilateral trading facility platforms, triparty agents, central counterparties (CCPs), data providers, global and local custodians, trade repositories, vendors (such as ourselves), etc. Each of these interactions creates a link, information exchange and latency as well as the need for data and processing.
Clearly, firms look to dramatically reduce the level of interactions and complexities in order to increase efficiency, through standardised contracts, feeds and the creation of ‘hubs’. This is nothing new, markets have evolved in this way and our industry depends on this too, although it hasn’t taken full advantage of the opportunities that it could provide. Securities finance, as a structured product, has numerous life-cycle events and dependent processes to manage exposure and profit and loss that rely heavily on these interactions, and it is here that we see firms struggling to gain efficiency.
Despite efforts, getting connected to the various actors within the industry can still be a hugely difficult task, and firms are looking for services that make this as seamless as possible and enable a plug and play into this ecosystem in a quick and cost-effective way. Once connectivity is established, firms can start to automate processes between them, and extend this to automate internal processes, focusing on exception processing—whether based on established bilaterally agreed rules or more sophisticated machine learning or artificial intelligence.
We see that 30 of the 35 industry lifecycle events can be automated in this way, increasing STP up to nearly 100 percent and reducing breaks by 98 percent compared to typical pre- automation processes.
Clearly, this will have enormous benefits when it comes to achieving Securities Financing Transactions Regulation (SFTR) and Central Securities Depositories Regulation (CSDR) compliance, improving data quality, reducing overall processing costs for firms from our calculation up to 30 percent and significantly increasing collateral efficiency. Additionally, firms can better manage their counterparty risk, by managing exposure with existing counterparts, but also allowing further diversification through increased capacity and enhanced controls.
What should you be doing?
Since firms have been preparing for SFTR we’ve seen a large increase in effort around pre-matching trades and automation— from additional counterparty reconciliation, new clients and cross product coverage—with securities-based lending (SBL) clients adding in repo reconciliation and vice versa, partly due to preparation for SFTR and more recently for CSDR, but also due to increasing complexity in their operating model from Brexit—where we’ve seen an increase in the number of entities firms have.
Many firms we’re talking to have designed and are actively implementing their SFTR solutions and are now turning their attention to streamlining their operating model in order to support their compliance go live, but increasingly to drive through cost efficiency. For example, we’ve been helping firms fully automate real-time processing for their marks agreement, returns and recalls, exposure management—including triparty required values (RQV) processing and linking settlement to collateralisation, security payment orders (SPO) payment and corporate action management along with providing services to optimise collateral management. In turn, firms are building in data flows to their front office pre and post-trade decisions and we’re seeing increasing demand for new industry links—whether additional CCPs or trading venues to help streamline the data flows and increase the value firms can extract from the ecosystem.
Firms are also looking at adopting new technology, such as machine learning, robotics and there is often a focus on distributed ledger technology (DLT). At this year’s conference, the concept of a Common Domain Model (CDM) is being introduced. This will help support the adoption of some of this new technology and will certainly help with defining the model the industry can work towards adopting, although the definition is the relatively easy part and while the adoption itself will be difficult and we’ve seen with the ISDA CDM, firms have struggled to adapt to this model. As new technology develops—such as artificial intelligence and DLT firms will need to move towards a CDM in their operating model to leverage new technology, and move away from legacy technology. A defined CDM will help, but firms need to plan to adopt it in the long term, and leveraging services such as ours will certainly help, with the transformative potential that they can provide by aligning the ecosystem.
So, firms should now be looking at the functionality that is available to automate processes and enrich data, particularly those that can be utilised to make changes that help achieve regulatory compliance and at the same time increase efficiency with the aim of improving both revenues and reducing costs.
How long do you have?
SFTR will go live, for the first phase of reporting firms in April 2020 with roll out into Q1 2021 (with phased-in reconciliation beyond), CSDR will go live in September 2020. Both regulations pressure firms to improve their processes and here we have given a high- level overview of how we’re helping our clients to achieve that goal. This doesn’t give firms much time to deal with regulatory compliance, let alone manage changes to data and processes to help achieve this.
Clearly, some issues can be dealt with relatively effectively, particularly if you can take advantage of existing services within the industry where they offer support to get connected in a quick and efficient way. Other things like new technology adoption will take longer, but decisions made now will undoubtedly have ramifications on how a future model operates, so shouldn’t be taken lightly.
As part of the industry ecosystem, Pirum supports firms with their pre and post-trade services across the securities finance industry globally, including securities lending, repo and collateral management. We have developed our solutions by acting interoperably with the industry and allow firms to seamlessly and effectively plug into the market with connectivity to trading venues, counterparts, CCPs, custodians, triparty agents and trade repositories