Staying the course
MiFID II is behind us, but SFTR and CSDR lie ahead. The message from the Deutsche Boerse Global Funding and Financing Summit is that not the time to take your eye off the ball
The mood at last week’s Deutsche Boerse Global Funding and Financing Summit in a very rainy Luxembourg was a mixture of relief and apprehension. Despite weathering a slew of regulatory deadlines in 2017 and the beginning of this year, the securities financing industry was warned that it must keep both eyes on the horizon as the worst is yet to come. Several conference panels assessed the leaps and bounds that the European market has made since the financial crash, with Target2-Securities (T2S) and the second Markets in Financial Instruments Directive (MiFID II) both successfully bedding down in recent months, to name just a few of the successes. Efficiency is up, liquidity, for now at least, is acceptable and other technological innovations are jostling to improve the lives of market participants. However, commentators warned that dark clouds are forming on the horizon.
Challenges big and small, new and old, persist in the market, and multiple conference speakers stressed the importance of not getting swept up in the hype around the development of ubiquitous speculation around blockchain, or distracted by the likes of Brexit. Throughout the two-day event, speakers were not overtly concerned about the significant threat that blockchain could pose to the status quo of the market, largely relegating it to be “a good topic for a panel next year,” as one speaker put it.
Instead, panellists called for solutions to well-established kinks in the market structure that should be addressed before investing in new, potentially disruptive technology.
At the same time, the Securities Financing Transactions Regulation (SFTR) is an ever-present feature on the horizon, along with the lesser known challenges around the Central Securities Depositories Regulation (CSDR), and a host of other regulations coming down the pipeline. A poignant graphic offered by The Field Effect, provided a visual on what many described as the “spiderweb” of regulations that touched multiple areas of the securities lending industry, from best execution, to clearing to transaction reporting—and much more in between.
Storm’s a brewing
When asked what the next big wave of evolution will be in the market, an increase in automation and centralisation was repeatedly highlighted as the most likely feature of tomorrow’s trading landscape, with all the obvious consequences that such a development would bring. Primarily, the headcount of securities lending market will shrink as automation takes over the heavy lifting of the back office, stated one panellist.
Speakers explained that the regulatory drive for standardisation in all aspects of the market will inevitably open the door to automation, as legal documents no longer require negotiation or physical signing and collateral management is the responsibility of formidable algorithms instead of teams of traders.
Another panellist agreed that standardisation was the likely big trend of the future, and added that it “means plucking the human out of
“Technology is becoming increasingly disruptive and it’s coming faster,” explained another speaker representing a large US agent lender.
Speakers noted that the challenges of onboarding and know-your-customer obligations, which are particularly acute for those trying to connect to Eurex’s Lending CCP, could also benefit from automation innovation in the near future. It was noted that the cleared space offered the perfect sandbox for standardisation and automation to develop a greater role that could then filter out into the wider market.
Two panellists agreed that UCITS funds, which are currently bursting at the seams with capital but are hamstrung by strict lending and collateral requirement rules when it comes to securities lending programmes, may benefit from standardisation and automation as a way to manage risk and compliance hurdles more efficiently.
The UCITS conundrum fed into a wider discussion around the fragmentation of collateral in Europe that even T2S has not managed to solve, which is as bad today as it was 10 years ago, according to one speaker. An audience poll suggested that collateral management had become more of a “business critical” issue today than it was a year ago for more than 77 percent of attendees, meaning this issue is not going to go away, and the solution isn’t clear.
CCPs: resisting dilution
European central counterparties (CCPs) were warned against undermining their fundamental security principles to allow more buy-side participants to become members, according to conference panellists. Despite a dearth of buy-side members engaging with central clearing currently, the nature of the challenges that the buy side face in joining mean that CCPs cannot lower the bar to allow them in, explained panellists.
One speaker, representing an EU-based clearinghouse, outlined the main hurdles sitting between the buy side and participation in the clearing space, namely: day to day trading costs, resource constraints connected to contributing to the default pools, and risk management. From the CCP’s point of view, according to the speaker, there are significant challenges involved in allowing non-EU based, non-bank entities into central clearing due to the inherent risk that such counterparties bring.
Panellists discussed the trade off of offering bespoke memberships for resource-challenged buy- and sell-side participants, that could not, or would not, contribute to the various default defences CCPs must employ. At the same time, another panellists highlighted that non-EU counterparties could also offer a major boost to market liquidity if a viable solution was found and the issue warranted further discussion.
A speaker representing a European CCP concluded the panel by reminding audience members that, at their core, CCPs offer protection against the risk of a defaulting member and the moment you start deconstructing the core pay-in requirements of members that security is undermined.
Taking on the thorny subject of Brexit, keynote speaker Pierre Gramegna, minister of finance for Luxembourg, commented: “We must be realistic on our future with London, but there are many possibilities for positive future bilateral relations.”
Looking to the continent, Gramegna declared that “Europe is back”. After what could have been a troublesome year for the EU, both politically and economically, the union has begun 2018 on a much surer footing. Growth is up, unemployment is down, and major projects such as the Capital Markets Union are beginning to gather pace again, he stated.
Despite being more than a year into the negotiations very little light has been shed on what the final deal will look like. The current political climate points towards a hard Brexit option being pursued, which for UK-based securities lending participants primarily means liquidity issues are ahead, along with and a lack of MiFID II passporting. However, Gramegna was optimistic that when 2019 rolls around solutions will be found to keep the markets ticking over.
Gramegna closed by calling for a “de-dramatisation” of the Brexit negotiations in order to ensure a cordial and mutually agreeable solution. “If we build walls around London, then we will only punish ourselves,” he concluded.
Although many in the industry may not remember a time before the ominous shadow of SFTR was looming overhead, there is still some time ahead before it joins the ranks of implemented post-crisis rulesets, which is good news for some. Of those in attendance 17 percent admitted to not having started to develop an SFTR compliance solution, with roughly 18 months to go before it’s expected to go live. A further 22 percent had only just started, according to an audience poll. Andy Dyson, CEO of the International Securities Lending Association (ISLA) put this down to the “MiFID II-effect”, meaning that resource-constrained firms were, until recently, devoting everything to hitting the January deadline, with nothing to spare for something as far of as 2019. Of the remaining voters, only 10 percent claimed to possess a defined solution and a further 17 percent were able to define and understand the business impact SFTR posed to their business.
However, although much of the event was dedicated to assessing the next hurdle in the path of the securities financing industry, an earlier threat lurks down the road that also requires the industry’s attention—CSDR.
The European Securities and Markets Authority claims CSDR will play a “pivotal role for post-trade harmonisation efforts in Europe, as it will enhance the legal and operational conditions for cross-border settlement in the EU”. However, for the securities lending community, CSDR represents new fines and mandatory buy-ins for settlement failure, which could wipe out the incremental gains offered from a lending programme. ISLA, among other industry bodies, is working to highlight the risks that such a penalty would mean for market liquidity as, according to ISLA, many participants would cease to trade in such an environment.
“Most of you are blissfully unaware this regulation [CSDR] is coming,” commented one speaker.
In his concluding remarks, Philip Brown, co-CEO of Clearstream Banking, said: “Don’t get overwhelmed by the waves of regulation but instead ride the wave of change.”
Despite the challenges such a framework represent, Brown added: ”CSDR is another important piece in the puzzle to further bolster safety and stability across European capital markets in the post-financial-crisis world.”
According to Brown, the solution to CSDR was a renewed focus on data, as a way to discover the cause of fails and eliminate them from the marketplace. The buzzword of the past was “big data” explained Brown, going forward the industry needs “smart data” to solve tomorrow’s challenges.
Brown also used the final session to call on the industry to work together to enhance interoperability within the market as a way to reduce fragmentation. He noted that regulation had helped bring the the industry together and improve standardisation but that a market-driven solution to its own problems would be the optimal way for everyone to benefit.