Beyond tomorrow: What to expect in 2017
Pirum’s Philip Morgan looks at the biggest events of 2016 and how they will affect securities finance in 2017
As we head into another new year, it is commonplace to reflect on what has passed and, more importantly, consider what our resolutions will be for the coming year.
As TS Eliot wrote: “For last year’s words belong to last year’s language. And next year’s words await a new voice.”
Last year will be remembered as the year of the unexpected, with the UK referendum on EU membership and the result of the US election stealing the headlines.
The securities finance market paralleled this volatility with political and energy sector upheaval, leading to record revenues in North America and steady rises in Asian activity and revenues.
In Europe, the story was not nearly as positive, with the German market leading a revenue slump in the Europe, the Middle East and Africa (EMEA) region despite isolated positives, such as UK revenue rises.
With further political uncertainty expected in 2017 in Germany, the Netherlands and especially France, it will be interesting to see if this trend continues.
Market instability has been reflected in participant activity, with a number of sell-side participants actively growing their global and product footprint following a period of financial resource optimisation and reduction. At the same time, we have seen a number of high-profile market participants significantly reduce or cease activities entirely.
On the buy side, despite an extended run of positive performance, hedge funds were beset by significant investor redemptions across the industry, seeing record outflows of $67 billion through the first three quarters of 2016.
On a more positive note, the alternative space did grow by approximately 3 percent overall and finish the year in excess of $3 trillion assets under management.
Against this backdrop of opacity, there are a few common and consistent messages emanating from the market. There is a demand for greater connectivity, agility, digitisation and operational efficiency.
In 2017, the level of uncertainty remains high and only adds to the daunting prospect of complying with a seemingly unceasing barrage of compliance and regulatory demands, let alone the effort required to drive revenue in a period of market turbulence.
Increasingly, institutions seem to be making a distinction between commoditised functions that could be outsourced versus areas where they can deliver competitive advantage to their customers. “Compete in the front end and collaborate in the back end” is increasingly being used as a tagline for managing this non-differentiating technology.
In managing their burden, firms are increasingly looking for solutions to help them meet and manage their reporting requirements under regulatory regimes such as the Markets in Financial Instruments Directive (MiFID), money market statistical reporting, and the Securities Financing Transaction Regulation (SFTR).
Where there is no revenue opportunity or competitive advantage, centralised regulatory technology (regtech) solutions are being considered to socialise cost and transform it into a variable line.
The complexity and frequency of regulatory reporting requirements to meet MiFID, SFTR and liquidity standards continues to stoke demand for robust and interoperable data solutions.
The drive for automation and digitisation has increased the importance of technology solutions. Last year, we saw a steady flow of sell-side figures transferring to technology roles to assist in system design and product development, and this is likely to continue in 2017.
As well as regulation, efforts are centring around the creation of greater efficiency in operating models, to enable focus on outperformance and growth. Many sub-optimal processes remain in the securities finance industry with significant opportunities for improvement and automation through collaboration.
Increasingly, business owners are realising that, given challenged revenues, cost is a variable that in many ways is more controllable and under their direct influence.
One fascinating area of development in securities finance is where trading is taking place and how institutions are connecting to these new venues. We have heard much about the transition of business to a central counterparty and its potential as a panacea to all.
While the benefits are being debated and analysed, Pirum is seeing a continued migration of business to this capital efficient clearing vehicle, which is likely to continue in the coming year.
The development of so-called ‘all-to-all’ trading via multilateral trading facility platforms that offer to unlock ‘golden sources’ of high-quality liquid assets to the market will be an interesting 2017 trend.
The move away from over-the-counter/voice execution towards an electronic disintermediation model seems to be gaining favour, however, when and where this liquidity will go remains to be seen. So the need for robust and agile connectivity will remain a crucial requirement.
The requirement to build brings its own complexities and comes at a time when the demands on a finite technology resource have never been greater. When you consider the multitude of connectivity variables in the market, unless you have an agile solution, the importance of placing your bet at the correct table is critical.
In the coming year, we are likely to see a continued blurring of lines between the front, middle and back office where operational complexity coupled with financial resource consumption increasingly defines the medium of execution.
This hybrid of technology-led market evolution has been described as ‘the rise of the coder’, with front-office traders and sales teams being enhanced and in some cases substituted by coders and other technologists.
But fear not, it is not all negative in 2017
We are likely to feel a few tailwinds improve market conditions.The recent rate increase in the US has finally seen a move away from low rates that will hopefully translate into a period of upward fee trajectory across the full range of the securities finance market.
While this positivity is only seen in the US currently, it is hoped that European and Japanese rates may lift from their current levels in time. In addition, we should not forget that important fundamentals such as GDP continue on a positive trajectory in the US and EMEA markets.
Potential regulatory changes around non-cash collateral in the US could potentially provide an uplift to the market and reduce overall costs for borrowing securities, albeit with some market infrastructure challenges to get businesses ready for this non-delivery-versus-payment environment.
Critically, if we turn the clock back 12 months to January 2016, when analysts told us to sell everything except high-quality bonds, because it’s about return of capital, not return on capital, take into account the tumultuous events of 2016.
It is interesting and encouraging to note where markets have ended the year, with many major indices closing in on all-time highs and a potential post-Donald Trump inauguration boost expected.
Furthermore, it seems increasingly likely that key regulations may see delays and in some cases repeal in the coming period, which would offer the market a chance to catch its collective breath.
As we start to ‘think beyond tomorrow’, it has never been more important to have a clear strategy and, of course, the resources to enable its execution. In this regard, Pirum will continue in its commitment to the market to improve connectivity, automation and strive to make the complex simple.
Therefore, we do consider there to be more than a few reasons to be cheerful. While 2016 will go down as the year of the unexpected, we hope 2017 will be remembered as the year of collaboration.
Happy New Year from Pirum Systems.