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We had the final 2012 plenary meeting of the Financial Services Club
Clearing & Settlement Working Group (CAS-WG) yesterday.
Well attended by industry luminaries, the debate was all
about the usual stuff: regulations, standards, risk, issues, frustrations and
opportunities.
What was particularly interesting for me is that we now have
three subject groups working in unison to solve many of the issues and
frustrations in order to identify and leverage the opportunities.
We had a great meeting at the Financial Services Club Clearing & Settlement Working Group (CAS-WG) plenary this month.
The CAS-WG is rocking and rolling forward, with four subject groups meeting regularly between the plenary meetings.
The four subject groups focus upon the challenges of clearing and settlement to deal with risk, regulations, standards and market infrastructure operations. Each group has nominated chairpersons:
Risk Subject Group Chair: Paul Young, Associate Director for Business Risk Services, Grant Thornton
Regulations Subject Group Chair: Rory Webster, Director with CapitalTrack Ltd
Standards Subject Group Chair: Virginie O’Shea, Lead Analyst with Aite Group
Market Infrastructure Subject Group Chair: Kathleen Tyson-Quah of Granularity Ltd
and are moving forward with focus.
At the July plenary each Chair gave an update of their group’s progress, along with two panel discussions in between.
The first panel discussion debated the merits of the European Market Infrastructure Regulation (EMIR) which is now in consultation with the European Securities and Markets Authority (ESMA) through 5th August, before ratification by the European Parliament at the end of September for implementation in 2013.
The second panel picked up on the ISO17442 standards for Legal Entity Identifiers (LEI). These are agreed for rollout from March 2013, and should make it far easier to track and monitor OTC Derivatives and other financial instruments as they move between different clearing systems.
This area was discussed in depth by:
Graeme Austin, CEO of ISITC Europe
James Whittle, convenor of ISO/TC 68 working group WG 6 responsible for the LEI standard (amongst many activities),
Richard Young, Head of Regulatory Affairs for Securities Markets at SWIFT
Virginie O’Shea, Analyst with the AITE Group and Chair of the CAS-WG Standards Subject Group
So I’ll start by writing up a little bit on this debate.
By way of background, Legal Entity Identification (LEI) is a new ISO standard (ISO17442) which will apply to all Financial Contracts from 2013, according to an agreement made by the G20 earlier this year.
This means there will be a single, universal standard for identifying all parties involved in a financial contract, and will make it far easier therefore to see counterparty positions should another crisis occur such as the Lehman’s crash.
The standard has been established by the U.S. Treasury's Office of Financial Research following proposals by the Depository Trust & Clearing Corporation (DTCC) and SWIFT.
SWIFT will act as the registration authority, acting on behalf of the International Organisation for Standardisation (ISO) to assign the ISO 17442 LEI standard. The DTCC will act as the facilities manager which will receive, review and publish entity information.
The development of a single global standard for LEIs is a key element in the broader effort to understand and monitor systemic risk across banks and capital markets.
Furthermore, LEIs will allow Trade Repositories to keep a single record of a financial instrument, which will make it far easier to sort out a liquidity or counterparty collapse.
For a comprehensive background of the development of this standard, you can checkout this document: download LEI timeline of events.
Interestingly, in Virginie’s update on standards, she had picked up this chart from the Financial Stability Board’s list of recognised and approved trade repositories:
It shows the DTCC’s strength, which some are calling a monopoly, and a lot of discussion took place about concentration risk when so much dependency is placed upon one CCP.
On the other hand, some argued that concentration of monitoring is a good thing, as the more centralised a single record of risk, the easier it is to manage.
The general discussion however was the feasibility of implementing a single global standard for LEI’s.
James was adamant that this has been agreed and is being rolled out, no matter what other standards are mooted.
In the earlier panel:
Robin Poynder, Head of Regulation, Marketplaces, Thomson Reuters
Peter Randall, CEO, Equiduct
Kathleen Tyson-Quah, CEO, Granularity Ltd
discussed EMIR, the European Market Infrastructure Regulation.
EMIR has three objectives.
First, to reduce counterparty risks by:
defining the framework for the application of the clearing obligation;
specifying the risk mitigation techniques for OTC derivatives not centrally cleared; and
laying down the requirements for the application of exemptions to non-financial counterparties and intragroup transactions
Second, to create safe and resilient central counterparty systems (CCPs) by developing a comprehensive set of organisational, conduct of business and prudential requirements for CCPs.
Third, to increase transparency by:
specifying the details of derivatives transactions that need to be reported to trade repositories;
defining the trade repositories’ data to be made available to relevant authorities; and
setting the information to be provided to ESMA for the authorisation and supervision of trade repositories.
The text of EMIR was issued on 25th June 2012 for consultation, and the consultation will close on 5th August. At this point it moves into Parliamentary submission for full EU endorsement on 30th September 2012.
That’s a rapid cycle regulation and led to a lengthy dialogue around the effectiveness of the rapid cycle consultation process taking process around EMIR, and whether with Basel III, Dodd-Frank, the LIBOR crisis and other issues, the regulatory framework was being too rushed and fragmented or whether it could actually work.
In particularly the whole notion of transparency was questioned as to whether it was a good or bad thing. Peter Randall was particularly dismissive, describing it as being like an airline security system. The idea of a secure airline is one where all passengers fly naked. You know you’re safe as everyone can see what everyone else is carrying with full transparency. However, there wouldn’t be many passengers.
That is the fear for the impact of EMIR: that it creates transparency but all trading and liquidity disappears.
Robin Poynder made the position clear when he said that you may not like the regulatory framework, but the regulators are pushing through their changes whether the markets like them or not, and are even willing to see markets collapse if that’s what it takes to make them effective.
In other words, whether liquidity is there or not after the regulatory process, they really don’t care as long as the markets are safe.
Kathleen responded by saying that this is more likely to result in a flight from the markets, where these regulations force full transparency and movements to other geographies. What that means in reality is that you see liquidity disappear in the markets where they are needed – Europe and America – leaving only higher risks for the pension funds and corporates trying to manage their collateral.
From the Subject Group updates, the main highlights were their progress in creating future agendas.
The Risk Subject Group was discussed by Shaun Cooke, and has four focus areas:
Enterprise Risk Management (ERM);
The calculation of complexity and the increasing reliance on quantitative analysis to manage risk;
A “liquidity famine” as banks and many of their clients are being forced to reserve increased levels of capital which could lead to an asset scarcity; and
Issues around the holding of deposit insurances and collateral, as this could lead to increasing moral hazards.
The aim is to develop these areas into working papers and recommended best practices to share across the Subject Groups and other interested parties.
The Regulations Subject Group update came from nominated Chair Rory Webster, a Director with trade repository CapitalTrack Ltd.
The Subject Group is working in two key areas today:
to inform and educate the marketplace and all institutions affected by EMIR on what it means and how it might impact their businesses; and
lobbying the regulatory authorities to ensure EMIR is not a single conversation from the regulators but one that is two-way with all parties impacted included in the dialogue.
In particular, the group has initially focused upon EMIR and how it affects non-financial counterparties: will they be caught up or caught out by the regulation?
Bearing in mind the short-term focus for input to the consultation process by 5th August, the Subject Group asked for all input to be sent to the CAS-WG Chair by 2nd August 2012 to ensure our views are represented effectively to ESMA.
The group has also drawn up a matrix of regulations and how they impact different market functions, which is available from group co-chair Greg Caldwell of aSource Global Ltd if required.
The Standards Subject Group has focused upon trade repositories and the DTCC, and their slides – compiled by Standards Subject Group Chair Virginie O’Shea, Lead Analyst with Aite Group – can be seen below (from Slide 15):
highlight work that is currently on-going within the industry around data standards and market practices in the post-trade space
identify the common points of interest/pain within these groups and facilitate communication across groups (buy-side/sell-side etc) – reduce duplicative work
examine how all of this work will impact the clearing and settlement lifecycle as a whole – are we pushing risk further down the process?
With the aim to:
track industry standards and market practices progress as a “living document”
identify areas of common interest
map to clearing and settlement lifecycle – where are groups missing a trick?
discover which data standards are currently being used by the incumbent market infrastructures
regulatory influence – which pieces of regulation can we have a material impact upon?
points of interaction between clients and firms – how do we change downstream issues? Can standardise internally but point of entry remains a problem
cultural issues internally – raising the profile of these standards issues for C-level
global dynamics – are we on the same page?
And the Group will identify:
which pieces of regulation can be influenced?
where are market practices lacking? Review common areas of focus across working groups
what can be learned from other markets?
how do we make post-trade teams’ lives easier?
In their on-going meetings.
Last, but not least, the Market Infrastructure Subject Group chaired by Kathleen Tyson-Quah of Granularity Ltd, are looking at the models for market complexity and are creating their own map of these structures to avoid any surprises.
The model the Group has developed will track the harmonisation of regulations and standard, and identify any overlaps or conflicts these create in the market infrastructures.
This is something I have advocated for a while now: we need a clear map of how the changes to system, structures, standards and regulations relate to each other.
Price formation is also on the group’s agenda, as the current LIBOR crisis will expand how pricing is set. Historically, prices have been set using mark-to-market reference rates, but self-certifying reference rates for derivatives pricing will now be called into question and change demanded. What will this mean for markets?
The group also recognises that there are 20 new CCPs being built today, with six in London alone. Does this mean too much concentration risk? It certainly means that there are changes to the way CCPs are capitalised.
Finally, the group is reviewing the impact of the new rules for clearing and settlement announced in April, when CPSS-IOSCO released three reports:
The new principles are designed to ensure that the infrastructure supporting global financial markets is robust and well placed to withstand financial shocks, with the new rules applicable to all systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories (collectively “financial market infrastructures” or FMIs).
These FMIs collectively clear, settle and record transactions in financial markets.
As mentioned, the Group’s deliverable will be a model that maps out all such changes, and makes clear the implications.
So there you have it.
Four Subject Groups and two Plenary Panels.
The Subject Groups will continue to meet through the summer and the next plenary meeting will be in September.
If you’re interested in joining in, just let me know.
Following on from the recent CAS-WG plenary session we are pleased to advise of the following dates, venues and times for the next Subject Group meetings.
Regulation: Monday 18th June, 4.30 - 5.30pm at SNR Denton, One Fleet Place, EC4M 7RA Register here
Standards:Tuesday 19th June, 4.15 - 6pm at BT, Faraday Buildings, 1 Knightrider Street, EC4V 5BT Register here
Risk:Wednesday 20th June, 3 - 5pm at Grant Thornton, 30 Finsbury Square, EC2P 1AG Register here
Market Infrastructures:Thursday 21st June, 4 - 5pm at The London Stock Exchange, 10 Paternoster Square, EC4M 7LS Register here
The meetings will confirm Chairs for these Subject Groups and would like to remind you that these sessions are open to all and free to attend.
You are also reminded that the next plenary meeting will take place on 18th July at BT's Head Office in Newgate Street. Register here
Yesterday marked another milestone in the progress of the Clearing & Settlement Working Group (CAS-WG), with our second plenary meeting.
This time it was held at the London Stock Exchange ...
... and discussed the progress of the four Subject Groups that were created after our first meeting at the beginning of March.
Since then, the four groups have met twice and created a rough agenda of their focal points.
It should be noted that these groups are still fledgling however, and until our next plenary on 18th July are open to influence. For example, two are still without confirmed Chairs and the other two Chairpersons will only be confirmed at the next meetings to be held in mid-June (if you want to Chair or Co-Chair any of these groups, then you need to attend or put your name forward for these meetings).
The four groups are looking at the impact of change in clearing and settlement infrastructures and cover:
Risk;
Regulation;
Standards; and
Market Infrastructures.
The aim of the four groups is to take the mass of regulatory change – Dodd-Frank, FATCA, EMIR, MiFID II, Basel III and more – and work out:
what the regulation means and is trying to achieve;
how joined up the regulation appears alongside other regulatory changes;
if it achieves the regulatory objectives it sets out to achieve;
if it is appropriate and feasible to implement as a result;
how it will be implemented;
I
what it means for systems and operations, and the changes required;
what it means for products and services, and the changes required;
with the intent of arriving at conclusions which can be communicated to all parties.
The Subject Groups are open for anyone to attend, and are intended to generate a 360o view of the changes required for Clearing & Settlement over the coming years.
This is why we fully expect CSDs, CCPs, buy-side, sell-side, solutions providers, fund managers, corporates and more to get on board with the CAS-WG over time, many of whom were represented in the room yesterday.
The meeting covered the four working groups, who outlined the initial themes explored.
Enterprise Risk Management versus the silo approach
Senior management engagement in risk management
The Group has nominated Paul Young, Associate Director for Business Risk Services at Grant Thornton as its Chair, and the next meeting of the Risk Subject Group will be on 20th June 2012.
The Regulation Subject Group is focused upon:
Understanding new regulation, the impacts and cross-border inconsistencies
Basel III and the treatment of collateral
The European Markets Infrastructure Regulation (EMIR) and how it impacts both Over-the-Counter (OTC) Central Counterparty (CCP) clearing and Central Securities Depositories (CSD) regulation
The Markets in Financial Instruments Directive revision (MiFID II) and its impact on internal infrastructures and the market at large
The Financial Services Authority (FSA) break-up and how the new Bank of England regulator will change the City
Dodd-Frank’s impact upon OTC derivatives CCP clearing
Trade Repositories
The Group has Kiri Self of the Realisation Group as Acting Chair, and is open to nomination for this position. The Group’s next meeting will be on 18th June 2012.
The Foreign Account Tax Compliance Act (FATCA) and payment standards
The move to T2S – Will this aid or hinder global standards?
Unique identifiers in trade messaging
CCP’s & the use (or not) of existing standards
Retail banking implications as a result of FATCA developments
TARGET2 for Securities (T2S) & post-trade compression
The Group has Darren Pearson of the Realisation Group as Acting Chair and is open for nomination for this position. The Group has its next meeting on 19th June 2012.
Finally, the Market Infrastructure Subject Group is focused upon:
The impact to margin processes and valuation-risk of CCP’s
The practical realities of clearing interoperability between differing clearing models
Further entrants into the CCP space
The impact of T2S in 2015 to post-trade functions
The various aspects of the impact of trade repositories
The Group has nominated Kathleen Tyson-Quah of Granularity Ltd as its Chair, and has its next meeting on 21st June 2012.
After the outline of the discussions of each Subject Group, the plenary also had several panel discussions about the emerging themes under discussion and debate.
The first panel comprised:
Kathleen Tyson-Quah, CEO of Granularity;
Matthew Coupe, Director with Redkite Financial Markets; and
Paul Young, Associate Director with Grant Thornton.
What came out of this for me was a lot of discussion about:
how Value-at-Risk models are fundamentally flawed, vis-à-vis the JPMorgan Whale and more;
the fact that we don’t even know what the problems are in financial markets, let alone solutions;
that technology is making everything far too complex, vis-à-vis Andy Haldane’s reference to the fact that to understand a CDO these days requires reading 1,125,000 pages of documentation;
that concentration risk is increasing as regulations drive more product clearing to fewer clearers; and
that liquidity risk is increasing as Basel III, Dodd-Frank, Trade Repositories and more increases the likelihood that corporates and counterparties will just stop hedging or, even more worrisome, trading.
The outcome overall of this first panel was a clear view that markets have to wake up to the fact that if they cannot quantify and measure risk, then they should stop trading those products that create such risks.
That would be an awesome change of attitude.
The second panel comprised:
Andrew Simpson, formerly with EuroCCP;
Graeme Austin, CEO of ISITC Europe; and
John Tanner, Manager with the London Stock Exchange.
This panel continued the dialogue with specific commentary around:
how can we have a single global LEI referencing system when ISO, the FSB and the CFTC all seem to have different agendas?
the fact we have more CCPs in Europe today than we had twenty years ago, regardless of European harmonisation and regulation to standardise and consolidate;
the corporates do not see themselves as part of the financial markets, when they clearly are;
that OTC Derivatives are moving through regulatory requirements towards being both on exchange and cleared, and whether the two parts could be separated or not;
the EMIR is already going to miss its January 2013 deadline, according to EU head of the unit that drafted EMIR, Patrick Pearson;
and more.
The end result of these discussions included further questions from the floor, including a few challenging ones:
as we have never had a CCP failure, what is the issue with CCP concentration risk?
most banks are not even standardised and interoperable internally, so how can you expect the market to achieve standardisation?
and more.
All in all, a very positive start and lively future for the CAS-WG.
If you want to join in, attendance is free. The dates of future meetings are:
The Regulation Subject Group’s next meeting will be on 18th June 2012
The Standards Subject Group has its next meeting on 19th June 2012
The Risk Subject Group will be on 20th June 2012
The Market Infrastructure Subject Group has its next meeting on 21st June 2012
The Next Plenary Meeting will be at the BT Auditorium on 18th July 2012
Oh, and there is an informal lunch on 10th July at Canary Wharf about Central Bank Systems for those interested too.
I’ve been getting around a bit this week. Having had long conversations with cybersecurity experts, I’ve also been having long conversations with treasurers.
Many of them.
Many of them, mainly with the world’s largest corporations.
And it’s been interesting, as they all share one over-riding common concern.
Regulations.
Now I thought bankers were the only ones worried about changing regulatory regimes, but corporates are just as concerned as it impacts their working capital, cashflow and liquidity as much as, if not more so, than banks.
All of this is intertwined in the increased capital requirements of Basel III, the Capital Requirements Directive (CRD) IV here in Europe and the use of OTC Derivatives generally.
Now I’ve blogged about this concern before, but these dialogues made it abundantly clear that the new regulatory regime draft of Basel III and CRD IV is unworkable.
Why?
Because it’s in cloud cuckoo land, away with the fairies, up a gum tree and will leave most banks and businesses up the proverbial creek without a paddle.
Here’s the issue.
If corporate treasurers use OTC Derivatives to hedge FX, commodities, future risk or related speculative needs to protect against future market uncertainties, the regulatory regime requires that they put up more collateral to enable this.
Posting collateral pre-trade for future trading does not make sense for a corporate, according to treasurers, so why is it needed?
Well, it’s all a bit complicated involving lots of three letter acronyms and knowledge of treasury (you can read the detail over on risk.net if you’re interested in this area), but the core of the issue is that corporates have traditionally traded on an uncollateralised basis but an unintended consequence of the European interpretation of Basel III, the CRD IV, is that they will now need to post collateral.
In fact, the co-axial elements of EMIR (the European Market Infrastructures Regulation), CRD IV and Basel III is a bit of a bugger’s muddle all in all.
As one treasurer said to me: “what it means is that banks have less liquidity, as they need to withhold capital, and corporates have less liquidity for the same reason. We simply will not post collateral and markets will therefore disappear overnight.”
Hmmm … don’t like the sound of that.
Interestingly and unsurprisingly, this was a core topic of debate at the Association of Corporate Treasurers (ACT) annual conference in Liverpool last month.
Again, risk.net covers the discussions well and I think these few paras summarise the exact situation today nicely:
Those fears have already kicked off a second round of lobbying, with corporates arguing extra capital charges on uncleared trades – which come primarily from Basel III's new levy on credit value adjustment (CVA) – would undermine the clearing exemption. In essence, corporates could avoid the liquidity drain associated with the need to post initial and variation margin to clearing houses, but only at the cost of more expensive hedges.
Further to the launch of the Clearing and Settlement Working Group (CAS-WG) two months ago (read more here), we have been a little quiet as the core membership of the group determined to map out details of subject groups and next steps.
Each subject group held initial meetings in April and are now ready to move forward with nominations of Chair, Co-Chair and Rapporteurs for the four groups that have been agreed.
The four Subject Groups are:
The Market Infrastructures Subject Group
The Risk Subject Group
The Regulation Subject Group
The Standards Subject Group
Each Subject Group aims to absorb, debate and discuss the implications of change from the European Market Infrastructures Regulation (EMIR) along with other changes introduced by the FSA, European Commission, Bank of International Settlements (BIS) Basel Committee and more.
If you wish to join these Subject Groups or would like to put your name forward as Chair, Co-Chair or Rapporteur (Notary), then now is your change.
The Market Infrastructures Subject Group meeting will be held on Wednesday 9 May from 4.30 – 5.30pm at The London Stock Exchange, 10 Paternoster Square, EC4M 7LS.
The Standards Subject Group meeting will be held on Thursday 17 May from 11 – 12pm at the offices of BT, Faraday Building, 1 Knightrider Street, EC4V 5BT.
gather nominations for the key roles of Chair, Co-Chair and Rapporteur.
If you wish to attend and can actively contribute to these meetings, please register by following the respective links. We would like to remind you that you can participate in more than one Subject Group if you so wish, and that all Subject Groups are open to membership from anyone at no charge.
We are also pleased to announce that the next CAS-WG plenary session will be held onWednesday 30 May from 2 – 5pm at The London Stock Exchange, 10 Paternoster Square, EC4M 7LS.
This second plenary meeting will update all attendees on the progress of each subject group to date, and will formally announce nominations for the Chair, Co-Chair and Rapporteur for each Subject Group, plus other key roles.
Again, the plenary meetings are open for anyone to attend at no charge.
Following these meetings, further subject group meetings will take place in June with the next planned plenary session to take place at BT's offices in Newgate Street, London EC4 in mid-July.
We would like to thank you for your interest and support to date and look forward to your continuing participation and contribution.
This week saw the inaugural meeting of the Clearing & Settlement Working Group (CAS-WG), which was well attended by over 100 industry figures from all parts of the investment markets and hosted at BT’s City Head Office in St Paul’s (BT are the first sponsor of the CAS-WG).
The CAS-WG has been initiated by the Financial Services Club to provide an opportunity for open discussion and debate amongst senior market practitioners and service providers on issues affecting Clearing and Settlement, and is created in partnership with the Realization Group who facilitate our Subject Group meetings.
The aim is to provide specific input to the regulatory bodies – including the FSA, its successor bodies the PRA and CBA, and Michel Barnier’s team in the European Commission – on the technology implications of regulations in draft and final form that affect Clearing and Settlement operations, such as EMIR and MiFID II, with the intention of ensuring these regulations are practical, appropriate and effective.
At the first meeting, we covered the four big topic areas of Regulations, TARGET2 for Securities (T2S), Giovanni’s barriers and Standards.
In the first discussion:
David Bailey, Acting Head of Department, Market Infrastructure & Policy, the Financial Services Authority (FSA)
Andrew Rogan, Policy Director, Capital Markets and Infrastructure, the British Bankers Association (BBA)
Karl Spielmann, Head of Legal & Compliance, EuroCCP
debated the impact of regulations on post-trade operations and IT, particularly with regards to OTC Derivatives clearing.
EMIR is part of the EU’s regulatory response to the global financial crisis and has a two-fold purpose:
to recognise and reinforce the role played by CCPs in mitigating certain aspects of market and counterparty risk, CCPs have been recognised as a critical resource that helped protect the stability of the financial system during the financial crisis.
the G20 new agenda stresses that new regulation should aim at improving transparency and regulatory oversight of over-the-counter derivatives (OTC) in an internationally consistent and non-discriminatory way.
David, Andrew and Karl discussed this in depth under the Chatham House Rule, so I can’t quote their words here. There was also a lively debate with the audience, and the net:net is that there’s EMIR, Dodd-Frank, MiFID II, Vickers, Volcker and more coming into force today.
All of these affect clearing and settlement but none of them are joined-up and, in many instances, it’s more putting the cart before the horse as we’re implementing huge post-trade changes before the basics are agreed and implemented.
The basics being Basel III – the rules for capital which will impact all of the ways in which banks collateralise and leverage their future operations.
In addition, the rules of EMIR appear to be too prescriptive. We’ve moved well away from the days of principles-based regulation and the Napoleonic rules now seem to apply.
Notably, regulations are far more in vogue today too – gone are the days of Directives – and no-one seems to have worked out (a) will the regulation work to address the issues it seeks to address or (b) how much it will cost to implement these changes.
These are the things that the Working Group will debate as we look at Risk and the first Subject Group spinning out of the CAS-WG meeting is a Regulatory Group.
The CAS-WG Regulatory Subject Group will focus upon interpreting the implications of EMIR on the clearing and settlement technology infrastructures of the City and Europe, and will work closely with other groups such as ISITC’s Working Group which focuses on the impact on operations of new and changing regulation and legislation.
In the second panel:
Kevin Milne Director, Post-Trade Services, the London Stock Exchange (LSE)
Henry Raschen, Head of Regulatory and Industry Affairs, HSBC Securities Services
T2S is one of the largest infrastructure projects launched by the Eurosystem so far, and hopes to bring substantial benefits to the European post-trading industry by providing a single pan-European platform for securities settlement in central bank money.
The system is due to go live in June 2015, several years later than originally envisioned but this is because the program is far more ambitious and challenging than first imagined.
As a result, there’s some doubt that June 2015 will be achieved, although the panel all concurred that T2S would go live one day – probably around 2018 – as it will force through change that is necessary if Europe is going to be efficient and effective.
Namely, it will force the Central Securities Depositories of Europe to compete and no longer be protected by national boundaries.
Part of the discussion got into the pro’s and con’s of T2S, with a clear plus being that it is multicurrency. T2S will process not just euros, but also Danish Krona and the Romanian Leu. Shame that GB pounds sterling isn’t included.
Another T2S pro is that it may be a hammer to crack a nut, considering the cost of its development and deployment, but the hammer is a worthy cost as T2S ensures that many of the Giovannini barriers are removed.
Having said that, one of the con’s is that T2S does not incorporate Corporate Actions, but then that’s partly because these are also part of the Giovannini barriers as discussed in the third panel which comprised:
Dermot Turing, Partner, Clifford Chance
Rob Fair, Director, Product Management, Euroclear
Robert Barnes, CEO, UBS MTF
Andrew Douglas Head of Public Affairs, Europe, DTCC
There are 15 major barriers to create a transparent, seamless, pan-European clearing and settlement market that were originally identified by the Giovannini Group, which was chaired by Alberto Giovannini who released their final recommendations in a detailed report in 2003.
T2S will solve six of the barriers:
National differences in information technology and interfaces
National clearing and settlement restrictions that require the use of multiple systems
Differences in national rules relating to corporate actions, beneficial ownership and custody
Absence of intra-day settlement finality
Practical impediments to remote access to national clearing and settlement systems
National differences in operating hours/settlement deadlines
and five are being addressed by legal changes already in play through Directives and Regulations, such as MiFID II and EMIR.
That leaves four which are here to stay as they are too politically charged to change. Most of these are around Company Law and fiscal policies for example, which is why Corporate Actions is missing from T2S and most discussions of European Clearing & Settlement standardisation.
However, when the panel got into the meat of the discussions, it turns out that the Giovannini barriers are no longer relevant anyway as technology, regulatory and market changes are creating a transparent and seamless pan-European clearing capability, regardless of the national borders and barriers.
This would certainly be true if German companies could post their securities settlement through CREST for example, but that’s barrier number nine which discusses the national restrictions on the location of securities. Until that barrier is solved, even with all the technical will in the world, pan-European processing is not going to be possible.
This led to the final debate around Standards with:
Richard Young, Regulatory Affairs, SWIFT
Kevin Houstoun, Co-chair – Global Technical Committee, FIX Protocol Ltd
George Handjinicolaou, Deputy Chief Executive Officer and Head of Europe, ISDA
Chris Pickles, Head of Industry Initiatives, Global Banking & Financial Markets, BT
in debate.
This panel agreed that standards were being resolved across global markets through things like the investment roadmap.
The investment roadmap affirms the commitment of each organization (FIX, FpML, SWIFT, XBRL, ISITC and FISD) to the ISO 20022 business model by laying the groundwork for defining a common underlying financial model and ensuring some level of interoperability by producing a consistent direction for utilization of messaging standards and communicating that direction clearly to the industry.
A key to ensuring this roadmap works is that the regulators are behind it, as global markets cannot be globally fragmented and if global standards avoid global fragmentation then that’s in the G20’s interest.
That is why a shared business model with a shared vocabulary is so important.
There was a little scepticism in this context as UNIFY and other projects have tried to do this in the past, but the regulatory stick is a key one.
If the markets cannot standardise voluntarily in the way they want, then the regulators will force it through in the way they might not want.
This is why the CAS-WG concluded with a call to action through the creation of a number of specialist Subject Groups, facilitated by the Realization Group.
Anyone can be a member of a Subject Group and anyone can suggest areas that the Subject Groups should focus upon.
At the inaugural meeting, five Subject Groups were suggested, themed around the following areas:
Regulation: interpreting the implications of EMIR on the clearing and settlement technology infrastructure.
Risk: assessing the ability of the clearing and settlement technology infrastructure to handle a complete counterparty default of a major bank, CCP or CSD.
Standards: addressing the development of technology standards to incorporate change, specifically assessing the implementation and operation of the investment roadmap.
Transaction Reporting and Trade Data Repositories: identifying the structure for technically reporting through the clearing and settlement technology infrastructures the full transaction history of all financial instruments and, specifically, the methodology for tracking OTC Derivatives from trade to repository.
Technology: what are the developments in technologies, software, networking, telecommunications and any other capabilities that are relevant to clearing and settlement operations.
These are not specific, limited or exclusive, and there may well be others you believe should be included. Just let us know what they are, and whether you would like to join them.
There are also a number of Subject Groups already in existence with other organisations.
For example, the Realization Group established the Counterparty Default Management Working Group.
The Counterparty Default Management Working Group has a range of objectives, namely to:
Identify key challenges and barriers to harmonisation and standardisation of default management practices across major market infrastructure providers e.g. exchanges, clearing houses, central securities depositories.
Prioritise the key challenges and barriers in terms of impact and importance to markets and its participants.
Define an approach to removing the barriers and addressing the challenges with the aim to establishing harmonised and standard practices across all markets and underlying infrastructures.
Establish best practice frameworks for market participants to manage counterparty defaults effectively minimising market, credit, liquidity, operational and capital risks.
ISITC also have three key groups in existence today.
A long-standing working group which focuses on the impact on operations of new and changing regulation and legislation.
A Post-Trade Operations group focused upon the operational impact of T2S, T+2 and local versus central matching issues.
An LEI working group, which looks at the practical considerations of using LEIs.
CAS-WG believes in supporting these groups, rather than reinventing them, and hence the regulatory group suggested at the inaugural meeting we will integrate with the ISITC program wherever possible.
We also expect that these groups will report back their activities to the CAS-WG at the next plenary meeting, which is planned for late Q2 2012.
If you would like to be involved in any of these Subject Groups, or want to suggest other Subject Groups, please let us know.
Next Steps
As can be seen, this is just the start of a process and we now need to discover if you have the appetite to get involved. We will advise all concerned of the progress of these discussions, the dates for meetings of the Subject Groups and the next plenary meetings as these are agreed, and all other dialogue around the development of the CAS-WG.
Please bear in mind one key thing: this is your group. You shape it, you form it, you develop it. Nothing is fixed at this stage, so please let anyone who has an interest in clearing and settlement know about the CAS-WG so that, over time, we can develop a clear mechanism of feedback to the regulatory authorities in London and Brussels of the development of new regulations and their impact on our technology operations.
Finally, we aim to run the CAS-WG so that attendance and involvement is completely free and open. As participation is intended to be free, we aim to cover the costs of running the CAS-WG through sponsorship. Sponsorship is open to any organisation that wishes to be seen as a thought-leader in this area, or who wishes to engage and influence the market participants outlined above. If you are interested in sponsorship, please let us know.
Yesterday, we talked about the economic outlook for 2012. What about the banking outlook?
Well it’s also challenging, with five clear things happening:
Regulatory change will still be high on the agenda
Investment banking will get a radical overhaul
Clearing and settlement will become a much bigger focus
Reconstructing distribution will be a big challenge
Contactless mobile will reach a tipping point in retail payments
Regulatory change will still be high on the agenda
It’s pretty obvious that the world’s regulators are continuing to struggle with how to manage the financial system, as most cannot even agree on a definition of what is a commercial versus speculative trade.
They’re getting there … but it’s taking time (three years so far).
Maybe that’s good, as we don’t want to rush into senseless change, but it’s also bad as every regulator has a different idea of how to tackle this crisis.
For example, in the USA Paul Volcker, the wonderfully outspoken former Chair of the Federal Reserve and creator of the Volcker Rule which bans proprietary trading in investment banks, says that working out what is speculative or not is easy: “Bankers know when they're doing a proprietary trade, I assure you. If they don't know, they shouldn't be in the business. If there are big unhedged positions constantly, then it's proprietary trading.”
That’s the rule: if it's not hedged, it's pure speculation.
But this rule will cost, and cost a lot according to Oliver Wyman , who found that the decrease in market liquidity will deliver a $315 billion paper loss for investors in US corporate bonds.
Certainly, it will reduce trading volumes with the Financial Times quoting Brad Hintz of Sanford C. Bernstein, who reckons the Volcker Rule will see Wall Street’s fixed-income desks experience a 25% decline in revenue and a 33% cut in pre-tax margin. That ain’t good for jobs, and will only pile more misery on top of the 200,000 jobs lost on Wall Street in 2011 (compared to 174,000 in 2009).
London’s going through the same, but the challenges are different as the approach is different.
Here in the UK, we are ring-fencing investment and commercial banks under the Vickers report recommendations, which now have the government’s backing.
The idea is that banks are separated into two – an investment bank and the commercial retail bank. The idea is that if the investment bank dies, it can be killed without murdering its sibling.
That’s great in principle, but in practice is far more difficult.
For example, the separation will cost anything up to £8 billion a year and it doesn’t even achieve the derisking it seeks.
The Vickers Report is designed to get rid of the results of casino capitalism, if it causes death to the investment bank; whilst the Volcker Rule is designed to get rid of casino capitalism.
The Vickers Report tackles the issue without recognition that it is often poor practices in commercial and retail banking that messed up our biggest banks. Nothing to do with casino capitalism at all.
HBOS’s commercial lending portfolio, secured through easy access to wholesale funding markets, is the reason why it collapsed. Same with Northern Rock and Bradford & Bingley with high risk mortgages.
So the idea of keeping the commercial and retail banking system ‘safe’, by ring-fencing it from the investment markets, is not something most people accept or believe.
Paul Volcker doesn’t believe it: “I don’t believe in a firewall or Chinese wall between them, as you need a very high ring fence to stop the deer jumping over.”
Then there’s the human cost of these proposals, with many thousands more losing their jobs in the City, and some estimating it could be up to forty percent of the total workforce in the City. RBS, for example, has already shed a quarter of their workforce, with another quarter expected to go after Vickers.
Unintentionally, there is a belief that the Vickers reforms will also be a gift for foreign banks.
Add to this the lurking storm of Europe and the UK’s veto over reforms due to City concerns, and it is no wonder that regulatory matters are still high on the agenda in 2012 … and 2013, 2014, 2015 …
Investment banking will get a radical overhaul
I’ve only put this heading in there as a follow-on to the regulatory piece that preceded this paragraph.
Personally, I have a vision that investment banking will end up being a facilitative role, with platforms and technologies to enable trading, but no trading in the bank itself. Instead, all the speculators and traders will be out there in private equity and hedgeland, not in the banking system.
Just a thought.
Clearing and settlement will be the big focus
Due to the changes taking place across the spectrum of investment banking and capital markets, clearing and settlement infrastructures will become a big focus.
This is partly down to the new regulations for OTC Derivatives and more, but also due to increased focus upon liquidity risk and collateral management.
Markets have an extreme between the high risk and high leverage we saw leading up the crisis – when Lehmans collapsed, every $1 of debt was leveraged twenty times across the markets so their $400 billion of losses escalated to near $10 trillion of risk – and minimal risk and leverage you see in markets like Russia.
When I visited Russia’s exchanges in 2009, here’s what I wrote about SPIMEX and RTS:
“Both exchanges proudly talk about their focus upon real-time analysis of traders’ positions. In the case of SPIMEX, they offer real-time settlement and straight through processing, so there is no risk for trading. In the case of RTS, they offer real-time positioning of every trader and every trader’s client portfolio, not just in real-time for their own trades but also for the knock-on effect of their dealings in derivatives down the line.
“I asked RTS about their risk management, and they made clear that for each transaction, the risk is calculated for the trader’s portfolio, including all orders to be filled, in real-time. There are then two clearing sessions during the day. One at 14:00, which takes three minutes to process, and the second is at end of day, and takes fifteen minutes. If a margin call is made, the broker must cover their position within two hours or, if at end of day, before the start of the next day’s trading.
“This discussion got interesting, as RTS and SPIMEX appear to be developing systems that ensure no trader can leverage risk to the levels where the market implodes, and they do this in real-time.”
So we’re now seeing US and European markets grappling with how to implement clearing and settlement systems that enable liquidity, minimise risk, and strikes a balance between unbridled speculation and zero risk.
This is an area that has grown in interest with our clients and sponsors, so much so that on February 29th the Financial Services Club is launching a Clearing & Settlement Working Group (CAS-WG).
The CAS-WG will hold its first meeting at BT’s offices in Newgate Street, and is organised in association with the Realization Group.
The aim of the CAS-WG is to debate and discuss all aspects of clearing and settlement infrastructures, and the first agenda will have four panels discussing:
Volker/Vickers/MiFID II and impacts on post-trade operations and IT, particularly with regard to OTC Derivatives and Clearing
T2S – problems of change and implementation for settlement
Giovannini Group Recommendations, Innovation & Technology – what progress has been made?
Standards in Post-trade operations
Panellists from organisations including Euroclear, LCH.Clearnet, EuroCCP and EMCF will be attending. If you would like to attend, then let us know.
Reconstructing distribution will be a big challenge
Moving away from investment markets, retail and commercial banking is still undergoing big changes. As discussed all the time here, branches specifically are a problem.
Banks will have to deal with this problem in 2012, as they cannot sustain loss-making operations anymore.
In some regions, six out of ten branches have closed (Iceland); in others three out of ten (Denmark); in the USA, four out of ten branches are loss-making; whilst in the UK, some analysts (me) estimate that as many as four out of five bank branches could close by the end of the decade.
The fact at the core of this change is that banks are electronic businesses distributing through electronic media, and the branch just does not fit that model of business.
As banks need to be the most cost effective they can, why have a branch?
It would be like bookshops fighting to keep their stores open, when it’s obvious they’re dead as they’re all losing money; or travel agents, record shops, video rental stores, etc, etc.
When your business model is dead, admit it and move on.
Contactless mobile will reach a tipping point in retail payments
Speaking of new business models, the one that most retailing banks will move towards is contactless mobile and contactless tablets.
The experience is highlighted well by various firms, but my favourite contactless illustration is from Discover Card and Square:
The reason why I use this one is that everyone assumes contactless = NFC chips. It doesn’t have to be. Contactless in my world, is any payment that is simple, automatic and wireless.
That’s what the Discover video shows.
However, NFC is a key part of most contactless plans, so it is also a key part of the process of evolution.
Contactless chips have been around for ages but, on their own, are relatively useless. We then put chips in cards, but these again are not great.
But put a contactless chip into a mobile and then we’re rocking.
That’s again illustrated well be Google.
The tap-and-go experience is good one, and one that provides major convenience for the customer – whether the customer is a corporate who wants to drive higher sales through their checkout points, or the consumer who wants speed, ease, convenience and value.
It can focus upon not just turning phones into higher volume purchasing points, but into point of sale points too, and all geolocated as contextualised point of focus.
That’s why Movenbank is launching in 2012, as the first cardless and cashless bank.
So, if the major conversation of 2010-11 was mobile, the focus in 2012-13 will be contactless mobile.
2012 set to be the tipping point for mainstream contactless adoption
77% of contactless owners across all three markets agreed or strongly agreed that contactless technology would ultimately become more commonplace than cash as a payment method (UK: 73%, Poland: 79%, Turkey: 79%)
87% also agreed that contactless will be instrumental in bringing mobile contactless payments to market in the near future (UK: 84%, Poland: 89%, Turkey: 89%)
And, just in case you want any further detail, checkout this infographic from NFC rumors:
‘Nuff said.
So there you go, the five biggest things that will happen in 2012 in banking:
Regulatory change will still be high on the agenda
Investment banking will get a radical overhaul
Clearing and settlement will become a much bigger focus
Reconstructing distribution will be a big challenge
Contactless mobile will reach a tipping point in retail payments
This is not exhaustive of course, as there’s plenty of other things happening, such as Fred Goodwin being brought to trial for breaching company rules (a sure vote winner for the coalition government).
Anyways, a final set of predictions tomorrow about how and which technologies to watch in banking in 2012.
Investment banking has had a rocky year all year. Pilloried by politics, public and the media, the investment banker is currently about as popular as a Vampire at a Blood Bank ... not a bad analogy as the refrain all year has been about that giant Vampire Squid that is known as Goldman Sachs.
Goldmans do bring it upon themselves though, as paying $111 million in bonuses this year sits badly with the average Joe. And I must admit that any bank that makes $100 million a day in profit most days, along with an admittance of how they manipulate markets and screw customers, has to be suspect.
The trouble with this is that it brings a whole cloud over the industry, as all banks are now viewed as being casino capitalists, robbing the economies to line their pockets with cash.
However, it does mean that most of 2010 has been taken up with regulators and politicians wondering what to do about things like ‘dark pools’ and ‘high frequency trading’.
DARK POOLS
In the case of dark pools, they suspect these of being suspect because of the market manipulating suspicions created by the world’s leading investment bank, Goldman.
It means that regulators have been looking with deep scrutiny at trying to raise the illuminations on dark pools, even though these pools are argued to be good for markets as they increase liquidity by allowing block trading to occur that would otherwise be avoided if such trading was transparent.
Certainly, in Europe, the new revisions to MiFID could damage such trading, as illustrated by this May article from Financial News:
“NYSE Euronext and Deutsche Börse, have argued the regulators should use MiFID II to clamp down on the trading venues, known as dark pools, arguing they lack transparency and are open only to institutional investors, but not retail investors.
“But Rolet, who this week marks his first anniversary as chief executive of the UK exchange, said: ‘The biggest challenge is transparency and the balance between retail and institutional needs. Without institutional crossing networks (the so-called dark pools) some of the latent wholesale liquidity would go unexecuted or be simply more difficult to execute.’
“He said bank dark pools, which enabled customers to trade large orders privately away from the glare of the public exchange order books, served a valuable function in a market where there had been a sharp reduction in average trade size resulting from algorithmic and arbitrage activities.
“He added: ‘Transparency may have diminished in some areas but in formulating a response we should be careful to ensure that the differing needs of wholesale and retail participants are properly recognised.’
“The LSE chief executive and the exchange’s largest investment bank members, believe strict rules on bank dark pools would make it more expensive for institutional customers, such as pension scheme managers and hedge funds, to execute business.”
The result is that the European Parliament took on board a report produced by Kay Swinburne, rapporteur to the Economic and Monetary Affairs committee of the Parliament, during the summer recommending that dark pools be reclassified as multilateral trading facilities (MTFs) or systematic internalisers (SIs), and therefore lit.
The report has now been adopted as part of the MiFID review, and also places limits on order sizes. In other words, it wipes out the very reason for dark pools, as in large block orders placed outside the general exchanges to avoid market movements in advance of the order placement and processing.
HIGH FREQUENCY TRADING (HFT)
Swinburne’s report goes further and recommends a number of other restrictive changes, including:
Making High Frequency Trading (HFTs) subject to mandatory liquidity provisions;
An “ongoing regulatory review” of the algorithms used by HFTs;
Making Multilateral Trading Facilities (MTFs) such as Chi-X Europe, subject to the same level of supervision as Regulated Exchanges.
In particular, there is a focus upon HFT, which has been augmented after the issues in America in May that created the conditions for the ‘flash crash’, something I’ve blogged about too often this year.
Therefore, I won’t do it again, except to say that between targeting dark pools AND HFT, the regulators are doing their utmost to kill any market liquidity and alpha investing strategies that exist.
Is that a good thing?
No, because the regulators are in danger of throwing the baby out with the bathwater.
REGULATORY NIGHTMARES
This was demonstrating by the reactions of the corporates, where they made it clear that the discussions of regulators about ‘systemically important’ and ‘commercial activities’ was purely speculative wording with no practical implementation ability.
In fact, it is concerning that the regulations being developed will more likely kill the markets:
By clamping down on bonuses, investment bankers will all move out into hedge funds and private equity;
By eradicating risky activity, regulators are also eradicating worthwhile investment activity;
By locking down trading pools and practices that create liquidity, markets will seize up and cough and die;
By demanding collateral placement to cover trading exposures, markets will be more restricted to just the largest players with deep pockets; and
By banning prop trading, market makers will no longer make markets and trade and investment flows that fuel economies will disappear.
And none of the above really addresses the issue anyway, which was how the risk models created by the markets enabled massive risk exposures to be allowable when they were clearly, in hindsight, untenable and unworkable.
Where’s the regulation that addresses this area?
Which part of the regulatory structures of Dodd-Frank in the USA and MiFID II in Europe is addressing the fundamental question: how to eradicate products in banking that fuel risk, if the risk model has not been proven, tested and is comprehensible and comprehensive.
Meanwhile, we have had a few other key areas of regulatory focus, such as how to unravel a major global bank in 48 hours so that we can allow the too big to fail banks ... to fail.
CLEARING AND SETTLEMENT
Finally, there has to be a nod towards clearing and settlement. The whole clearing and settlement field is still a mess, with most of Giovannini’s barriers still unaddressed. That’s because of national market interests and focus.
During SIBOS, this all became clear as we spent so much time discussing interoperability that it became a buzzword, and we all know what you do with buzzwords don’t you?
Yep so, to finish the year, here’s a nice little buzzword bingo card for y’all to play with when you get back to the office in January (doubleclick to enlarge) ...
Oh yes, and if you're a real MiFID freak then Dechert produced a nice four-page PDF detailing the revised regulatory regime they anticipate this month.
I recently chaired a conference focused upon FXMM, or foreign exchange money markets for those unfamiliar.
It’s a strange territory full of hedging and algo’s, but the bit of the day that really caught my attention was when Heather Pilley from the OTC Derivatives and Post-Trade Policy Division of the FSA, presented the plans for new regulations in this area.
She began by saying that the G20 has made it clear that by the end of 2012 there needs to be global regulations in place to ensure that OTC derivatives are traded on regulated exchanges.
This agreement is a drop dead date that the FSA, the EU and the USA are all working to such that, by 31st December 2012 or before, global markets will have fully regulated OTC derivatives markets.
On the 15th September, the European Commission released their proposed European Market Infrastructure Regulations (EMIR), and Heather made it is clear that these are similar, but not the same as, those proposed in the USA.
For example, EMIR includes FX exotics and forwards if they are being used for investment rather than commercial purposes. The US excludes FX forwards, so it’s different.
America restricts bank ownership of CCPs but Europe does not; EMIR instead strengthens the governance and surveillance requirements of CCPs but does not stop banks having ownership.
Similarly, smaller financial counterparties who are ‘not systemically important’ are excluded in American rules, but Europe bases ‘systemically important’ on a clearing threshold rather than the size of the counterparty.
This creates the shadiest area: the actual definition of what is ‘systemically important’.
Equally, a large OTC derivative contract for hedging based upon ‘commercial activity’ is excluded, whilst the same derivative if it is for investment purposes is included. Question: how do you separate and define these activities?
When a contract is made by an airline to hedge against oil price rises, is that commercial activity or investment activity?
This has not been defined in EMIR and are ‘still being worked upon’, hopefully in time for an agreement before the end of 2012.
Other areas that may confuse are that clearing obligations for these contracts are in two forms.
First, from a bottom-up view, the Central Counterparty (CCP) in Europe must be named and authorised by the national regulator, which will be identified through registration with the European Securities and Markets Authority (ESMA). This also determines the competent authority responsible for the contract, based upon the country of the CCP’s location.
Second, from a top-down view, ESMA determines which contracts must be cleared centrally and once a contract is in, it’s in 100%.
This begged the question as to whether that means every contract is reviewed on a contract-by-contract basis, or whether it is by definition of the type of OTC contract being made. According to Helen, it is based upon the class of contract, not every contract one by one.
Bearing in mind the confusion of the above, Helen then said that the legislation is likely to be ready by April 2011, the technical standards by Spring 2012.
With all of these things still to be defined, such as thresholds, this seriously worried the corporates in the room, especially the definition of ‘commercial activity’. For example, Malcolm Cooper, Global Tax & Treasury Director for the National Grid, asked a range of questions including: can we ensure that commercial activity includes cross-currency swaps where there is no trade involved, but it is a valid hedge of commercial activity? Has anyone looked at the cost implications, as few treasury departments will have the resources to cover intraday margin calls if that’s the direction such regulations take?
Heather reassured by saying that most legitimate trading would be allowed and that it is only the systemically important areas that are the focus of the regulation.
This led to Mike Hazell, Group Treasurer with Debenhams, asking whether a $500 million currency swap is systemically important, as that’s a pretty regular and common deal for his firm.
Heather responded that they would be looking at net exposures, and that this still needs further definition.
Another audience member asked why OTC regulations will apply to FX forward contracts for investment purposes which operate on a three-day cycle, but do not apply to FX spot trading which operates on a two-day cycle. Is it fair to exempt one and not the other, just for one day’s difference?
All in all, the whole conversation left me with the sense that those who are developing the regulations really do not know what they’re doing.
There are massive inconsistencies between the European Commission’s papers and views, and those of member states. Equally, there are big incongruence’s between the US view and the EU view.
Finally, the fact that the G20 has laid this down as drop dead by end of 2012, there’s a big danger of creating something so full of holes, that Emmental Cheese will look positively robust by comparison.
One of the big topics in capital markets is intra-day liquidity and post-trade transparency.
Such discussions are far more noticeable now because the whole reason for this crisis, according to some, was the loss of trust between counterparties. That loss of trust was based upon counterparties not having enough liquidity to cover their positions. After all, if Lehmans could collapse with billions of dollars of debt – and they were AAA rated – then anyone could collapse.We then had this dialogue around the right levels of counterparty cover and collateral required in the markets at start of day, end of day and intraday to enable effective trading. There were discussions of whether it should be like the Russian markets, where collateral has to be pre-posted every morning to cover the day’s trading.Or whether there was a way to just put circuit breakers on the markets, like the Eurex Clearing model discussed last week, although that liquidity control is based upon self-management.There have been other discussions about regulatory controls of liquidity risk, such as those provided by the UK’s FSA that requested real-time reporting of liquidity positions, at an estimated cost of £2 billion in new technology spending.Meantime, Europe announced the de Larosière reforms a year ago, and these reforms are now coming into play as the three new regulatory authorities- the European Banking Authority, the European Insurance Authority and the European Securities Authority - come into play.And, of course, America is trying their darndest to sort out the mess of OTC Derivatives and fragmeneted trade reporting.
So, in summary, we have global, regional and national regulations working together and apart to try and lock down this space, as illustrated by this slide (doubleclick image to enlarge):
Stolen from Harald Keller’s (Senior Manager, Payments Markets, SWIFT) presentation – for more click here
Overall, the focus of all these regulatory changes is around liquidity risk, which brings in several other key elements including collateral management, clearing and settlement and post-trade reporting.For example, at last week’s meeting in Germany, Robert Barnes of UBS kept using the line: “post-trade reporting is the next pre-trade”.What he meant by this is that if you have real-time trade reporting, then that helps the markets with transparency of investment strategies and where the next trades will come from. Therefore, if you can immediately see who traded those two million Apple shares on the dark pool, then you can immediately alter your algo strategies to suit.Bring in the algo news feeds et al and he’s right.The trouble with this is that post-trade reporting is good if people do it, but a lot of trading operations ignore trade reporting. In fact, the only post-trade reporting market that seems efficient is London thanks to Boat. In some other markets, T+3 is the order of the day ... or even worse.So one thing that MiFID II is likely to do is to bring in some mandatory trade reporting requirements that strengthen the moves where the first version of MiFID failed.Another facet to MiFID II will be some form of mandatory real-time reporting of trades, and a clearing and settlement directive incorporated as part of this.Now that’s a leap of imagination –real-time trade reporting, real-time liquidity positioning and real-time clearing and settlement.I’ve blogged about real-time opportunities before, and do NOT think that the European Securities Authority, the European Commission or the ECB would be silly enough to mandate real-time everything, but I do think they will want to see true interoperability across all clearing systems.
The LinkUp Alliance and Code of Conduct has gone some way down this route, but the situation is still pretty fragmented as can be seen from this chart, courtesy of Robert Barnes at UBS:
Sure, this is slightly out-of-date, but things haven’t changed that much and so transparency of trades, simple and straight through clearing and real-time liquidity management are definitely order of the day for the regulatory agenda.
This is Part Four in a Series of Posts on the Regulatory Agenda for Capital Markets:
I’m continually impressed and amazed by the speed of change in the technology of the investment markets.
For example, last year was all talk about low latency and lit versus dark pools. This year, it’s all about private cloud-based services based upon colocation and proximity services. Next year, it will be all about real-time liquidity and settlement. Equally, the change from old to new trading venues is quite surprising. I was chatting with one of the MTFs yesterday for example. An MTF is a Multilateral Trading Facility, a new class of exchange introduced by MiFID, the Markets in Financial Instruments Directive. The conversation reminded me that only two years ago, everyone was saying that liquidity doesn’t move and there would be no threat to traditional exchanges from these new trading venues.
Two years later, Chi-X has more trading and market share than the London Stock Exchange (LSE); BATS is in the Top Ten ...
... LSE has acquired Turquoise and completely changed strategy and direction; Euronext has launched a major dark pool; Deutsche Bourse is heavily expanding in ultra low latency connections, targeting latencies under 3.3 milliseconds for Frankfurt-Amsterdam, under 4.5 milliseconds for Frankfurt-Paris, under 40 milliseconds for Frankfurt-New York, and under 49 milliseconds for Frankfurt-Chicago ...
... and so it goes on.
Just two years ago, many exchanges thought that seconds were fine. Today it’s milliseconds. Tomorrow it’s microseconds. And then what?Is it to achieve the ever elusive cross-asset class trading system? The one where a paired equities trade can be combined with an FX hedge across a global arbitrage? Nah, we’ve already got that.Is it to innovate new instruments, even when the last set of instruments – Structured Investment Vehicles, Credit Default Swaps and Collateralised Debt Orders – screwed up the world’s economies? Nah, we’ve already got that too.Is it to bring on board new exchanges and focus on emerging markets?Nah, we’ve already got emerging markets, cross-asset class structure exchange products.So what is the next wave of major change in trading systems and markets, and how will governments manage to derisk the next wave of innovation?Well, if the move does become one where real-time execution is combined with real-time settlement and real-time risk management, as I’ve stated before, then the challenge for broker-dealers will be to bring added value to clients through arbitraging across venues and instruments.But hey, that’s what they do now isn’t it?Of course.It’s what broker-dealers and market-markers have done for all time and will be what they do for the future. You see, the challenge is to keep up with the innovations of a Goldman Sachs and it is the reason why Goldmans made $100 million profits for every day of trading last year.Now there’s a fine border line between making markets and moving markets, and that’s the line Goldman walk.It will be interesting to see how Goldman and company make markets in the future, between the Obama tax and the new regulatory regime.But the key will be to continue to innovate with technology ... and they are and will be.That is why we are moving towards an almost seamless order flow through execution through settlement system, thanks to smart order routing combined with execution management systems.That’s one of this year’s big buzzes in trading tech, especially as Asia has followed Europe and America’s approach with Japan clearing the way for new Alternative Trading Systems and venues.So perhaps the big buzz will really be about arbitraging across venues and instruments using global smart order routing, combined with real-time execution and settlement in microseconds.
Hmmm ... sounds risky to me.
Will governments be up to the job of regulating all of these new innovations?
Fascinating meetings with the Russian exchanges RTS and SPIMEX. After my reference to military intelligence yesterday, you may wonder whether SPIMEX is something to do with finding out who started the swine flu pandemic but no, it’s the St. Petersburg International Mercantile Exchange.
The two exchanges have very different start points and focal points, with RTS (the Russian Trading System) starting as a privately-owned exchange back in 1995 whilst SPIMEX is an initiative of the government to create a working commodities exchange.I had been aware of RTS for a while as, during the MiFID investigations, their name came up many times as a working, highly automated exchange. Originally launched using NASDAQ’s trading platform, they soon developed their own products and services, covering algorithmic trading for equities, forex, future and options and more.Today, the exchange is one of the best performing, with the RTS Index tripling in value during 2009 to an index high of 1,451 at yesterday’s close, compared to a market low back in February of under 500, although this is still well below the high of 2,487 in May 2008.What is the reason for such volatility?Oil.Chris Weafer, Chief Strategist at Uralsib Bank, puts it in context: “We've recovered very strongly this year mainly because of the recovery in the oil price. Plus, the recovery and optimism in the rest of the world has allowed for the Russian ruble to stabilize." Or is it because RTS is a keen innovator offering analysis across every trader’s portfolio and position in real-time, as the RTS people I spoke with yesterday said. RTS now offers highly automated trading across 1,400 stocks, with 90% of the trades using automated systems and 10% Over-the-Counter (OTC). It is also one of the top 40 Global derivatives exchanges and trading is getting far more complicated, with around 15 trades per transaction on average today compared with 10 trades per transaction just two years ago.Similarly talking with the SPIMEX guys, there is a clear vision that they are trying to avoid being another failed commodities exchange (around 60 have been launched since 1990).Why did the previous exchanges fail?Because no-one trusted them by the sound of it.According to a SPIMEX advisor, it was because of a poor understanding of risk, a word rarely used because Russians do not allow risk to occur. This is why most exchange and exchanges are based upon ‘fundamentals’ – "if I can see it, touch it and trade it, then that’s ok. If you are looking for me to pay now for something that might pay back in the future, no way."This is why most Russian banks do not provide trade finance, and why oil is an issue.For example, oil producers currently do not co-operate because they do not trust each other, according to one of the guys at SPIMEX.Most oil producers are local monopolies with no competitive mechanisms. As a result, when oil prices rose in 2007-2008, Russians were paying more for their oil than America and Europe, even though Russia has more oil reserves and production than most.So SPIMEX was launched in September 2008 to overcome this, with the Russian anti-monopoly committee creating the right environment to trade on exchange by fining several of the oil producers for anti-competitive practices.But the real common feature of both SPIMEX and RTS is real-time risk management.Both exchanges proudly talk about their focus upon real-time analysis of traders’ positions.In the case of SPIMEX, they offer real-time settlement and straight through processing, so there is no risk for trading.In the case of RTS, they offer real-time positioning of every trader and every trader’s clients portfolios, not just in real-time for their own trades but also for the knock-on effect of their dealings in derivatives down the line. I asked RTS about their risk management, and they made clear that for each transaction, the risk is calculated for the trader’s portfolio, including all orders to be filled, in real-time. There are then two clearing sessions during the day. One at 14:00, which takes three minutes to process, and the second is at end of day, and takes fifteen minutes.If a margin call is made, the broker must cover their position within two hours or, if at end of day, before the start of the next day’s trading.This discussion got interesting, as RTS and SPIMEX appear to be developing systems that ensure no trader can leverage risk to the levels where the market implodes, and they do this in real-time.It is the nature of new trading systems and operations that they design things to work in the ideal way, as the outline above is what Europe and USA are trying to develop.For example, the FSA’s £2 billion technology change program for real-time liquidity reporting is pretty much what RTS has today.No wonder the gentleman from RTS turned to me towards the end of our chat and asked, straight-faced, “what has the Markets in Financial Instruments Directive (MiFID) done for democracy”.He probed me about best execution and what it means: “is it just all about price, speed and cost (and likelihood of settlement)?”I then realised what he was getting at.Where, in all the developments of MiFID and its best execution, transparency and competitiveness objectives, was the mention of risk?Where is the focus on real-time risk reporting?Hmmmm ... it’s obvious that RTS, and the Russian aspirations to build the next major Russian-Asian commodities exchange, is something to watch.Meanwhile, the major thought that struck me in this dialogue, was that we have two opposites.In Europe and America, we have an over-leveraged, casino capitalism culture of trading that is now being re-engineered to restrain excessive risk without responsibility.In Russia, we have a risk avoidance trading environment through real time controls, which needs to increase liquidity and leverage in order to fuel the flow of commerce.If Russia does not achieve this, then its commodities ambitions cannot be achieved.So maybe there is a happy medium here between the Russian approach to risk controls of trading, and the Anglo-Saxon approach of using financial instruments to create liquidity.Now there would be a thought ...
At the Deutsche Bourse Open Day for IT, I chaired a panel comprising senior figures from Eurex, the International Securities Exchange and IBM.
The focus of the panel was the future of trading technologies, and was a wide ranging discussion covering everything from dark pools to high frequency trading (HFT).
Questions were abounding, such as:
Question:Is HFT good or bad for liquidity as it gives large players an unfair advantage over small to mid size players and allows market abuses such as flash orders and front running?Answer:As long as everyone has equal access to the markets, then it is no issue. The fact that some traders cannot afford the technologies to deal in flash orders is not an unequal market perspective; it’s just that some are better at doing this and can afford the systems to do it. There is no barrier to entry however.(BTW, I totally disagree with that view)Question:At these speeds, is it technically impossible to do compliance? For example, Barclays Capital are just one illustration of the markets becoming more difficult to manage when they are fined for not even being able to get the timing right on a trade execution. Answer:
Yes, this is more difficult but time stamping trades is an essential core competence of any trading house. The issue lies with low latency and how a broker deals with order flow. If you cannot time stamp effectively when an order is received, filled and executed throughout the trade flow then you are not delivering on that core competence.
This happened recently with TD Securities who were accused of front running trades, and yet how do you prove you weren’t front running when everything takes place in a microsecond? TD Securities fought off a recent investigation to prove they were not front running by being able to demonstrate timings through their order flow, and so yes, keeping time is a basic requirement today.
Question:What about the whole aspect of the changing regulatory regime with the new rules being developed by the G20, the de Larosiere report, the confirmation that there will be a MiFID II, etc. In fact, MiFID II, according to a speech by Charlie McCreevy in Dublin recently*, will incorporate OTC Derivatives in its next iteration. What does all of this mean for trade execution and technologies?Answer:
The markets are ready for more regulation although it is interesting that most regulation creates unintended consequences. For example, the law of intended consequences is demonstrated by MiFID where the aim of the regulation was to have more transparency and openness and what did we get? More opaqueness, price fragmentation and a growing off-exchange trading environment using technology to create dark pools. This is the key to the technology used in the trading environment- to create arbitrage, risk and profitability for the client.
Meanwhile, everything will move towards real-time reporting. For example, Eurex is already able to provide real-time clearing at trade execution. Firms will move towards this model for real-time trade reporting and real-time risk and liquidity management.
Question:What about Social media & Twitter? Don’t these tools support insider trading? Do we end up with all traders being searched for personal communication devices before they enter the trade floor?Answer:No, you don’t need to go to that extent. Facebook and Twitter are electronic communication tools however, so they need to be brought under the controls and disciplines of compliance regulations or be blocked and, if a trader is found in contravention of such in-house policies, then it’s a disciplinary dressing down and possibly termination of employment. But you can do things about these areas. For example, research into this area (download report) clearly shows that the US regulatory rules apply just as much to tweets as they do to email. And there are tools you can implement to monitor such activities and store and forward such information, which is the right approach to take.Question:How do you see the development of Cloud Computing in the trading markets?Answer:In the US, we have seven major exchanges and I can see the world developing into one where those seven exchanges all place their servers in a massive server farm, co-located with market makers and brokers, so that the systems can deal in real-time. That’s where we are almost at today and certainly will be moving in that direction more and more over time.The answers above were my own take on the discussions by the way, and not quotes from the panellists, but you get the idea of the flow.We finished with a vision of the future of trading which I will sum up as being a world where each continent has a massive data centre of co-located servers representing the main trading venues of each economy.The European data centres will naturally locate in London, Paris and Frankfurt; America’s will be in New York, Chicago and possibly San Francisco; Latin America’s in San Paolo and Buenos Aires; Asia’s in Mumbai, Tokyo, Shanghai, Hong Kong and Australia; and Africa and the Middle East will be based in Johannesburg and Dubai (or Bahrain or Qatar dependent upon how the region’s financial centres compete for dominance).Fourteen massive data centres with mirroring and backup for each other.Effectively a massive cloud of trade execution.And yes, that’s where we move towards – a secure global cloud computing environment, all linked by dark fibre between fourteen massive data centres.The data centres house the world’s exchanges and their broker dealers.They can transact in microseconds within exchange and, thanks to terabit lines, can send a trade execution around the world in under a millisecond.Lightning dealings in order flows through smart order systems that allow billions of offers and bids to be matched in a millisecond.All of this liquidity flow being watched under a traffic light system of liquidity risk and market monitoring, such that market abuses are visualised and captured during the trade flow in real-time.The G20 agreements on co-located data centre environments dealt with that one after the financial crisis of 2013, when the dark fibre smart order routers allowed Goldman Sachs to front run ...
Aw shucks, now I’m just getting cynical again aren’t I?
* In his speech to the EU Public Affairs Ireland Conference on 18th September 2009, Charlie McCreevy, European Commissioner for Internal Market and Services, stated:
“There appears to have been a significant migration of share trading transactions from the more regulated MIFID venues to the unregulated over the counter broker dealer venues where substantial unregulated dark pools of liquidity have built up. This gives rise to questions as to whether there are unfair commercial advantages for the operators of these venues and whether the trend undermines price discovery, market integrity and efficiency for the market as a whole. The MIFID review will address this issue.”
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In the securities settlement markets, we’ve spent years trying to break down barriers to clearing and settlement ... and most of those barriers are still there.
We wonder what to do about it?And regulation seems the only answer.Or is it?
As we look at innovations in payments (retail, commercial covered in last two posts), this week is the final thoughts on this as we study payments in the trading room and investment markets.
There are clearly some things afoot which will change things.
The first is that everything is real-time or supra real-time.Sure, we talk about fast and scalable systems, but in the trading arena we’re talking not just fast but super fast.What’s super fast?Well, a human blink of an eye takes about 200 milliseconds or a fifth of one second.
Today’s trading systems trade in under 200 microseconds.
There are 1,000 microseconds in a millisecond, so we can trade 1,000 times faster than the blink of an eye.
That's super fast.
This is the world of latency, which I’ve blogged about often.But latency really does bring in a new focus on real-time.For example, I spent last week at a fascinating open day for Deutsche Bourse’s IT and intend to write a detailed update through this week on what came out of that day.
To start with, here’s a chart (double click to enlarge):
This was presented by Colt Telecom and shows linkages between London, Frankfurt and Chicago, with latency of 50 milliseconds or thereabouts. In other words, four messages can move between Frankfurt and Chicago in the time it took you to blink.
Here’s another picture:
This shows how all the exchanges are linked via high speed dark fibre 1 gigabit per second (1G) and up to 10G. The view is that, by 2011, these lines will be moving data at 6.4 terrabits per second (t/s).
6.4 t/s!This means we will be moving from a world where it takes about 0.5 seconds to send a message right around the world once (two blinks), to one where that global transaction of data could move around the world in a complete cycle in under one millisecond (blink and you miss it).This is the real-time world.
Now think about liquidity, risk, clearing and settlement and imagine a world where, as you trade.
Your complete picture of liquidity positions are transparent to all traders internally.
Your liquidity risk exposures, market and credit risk exposures and more are visible to all counterparties in real-time. Your trade reporting and pricing is visible to all regulatory and supervisory authorities in real-time. And real-time clearing takes place as part of trade execution.This world is not a future vision but a reality.Eurex, for example, thanks to being tightly coupled with a clearing system (Eurex Clearing), are already offering real-time clearing.
Meanwhile, we have regulators moving further and further towards information reporting duties that go far beyond today’s methods.
That is why real-time trade and risk reporting will be a reality in the near-term.
End of day just doesn’t cut it. Intra-day doesn’t manage it.Real-time everything.That’s the future of investment markets.Real-time visibility and transparency for all counterparties to manage risk.Mmmm ... now it gets interesting.
It’s great being in another timezone as, after my 11-hour flight, I felt really tired so an early dinner and then bed by 10 o’clock ...
... waking up at 1:30 a.m.for a nice five hours of watching movies whilst trying to get back to sleep.
I get to my first meeting and say, “y’know, I’ve been awake since half-one and need coffee”. I then find that everyone else from Europe and America is the same way and up since one or two this morning.
This may be a bleary-eyed SIBOS therefore and I get to my first session, which focuses upon clearing and settlement, to find the audience asks no questions ... yep, they need coffee.
The session opens with a statement from the SWIFT hosts that this is a record-breaking SIBOS with over 5,300 people registered which is more than SIBOS in Sydney three years ago.
So much for a market that has meant to have imploded.
In fact, as I go around the exhibit hall, I see that many of the booths are bigger, brighter and better than ever ... including those of Citi (“we’ve spent a billion dollars on infrastructure in 2009”) and Royal Bank of Scotland (“making it happen”).
Anyways, back to the first session which was a keynote from Michael Bodson, Executive Managing Director of the DTCC.
The DTCC is the large US Central Counterparty Clearing systems (CCP) with the aim of moving into being the largest clearing system globally, as demonstrated by their OTC Derivatives information warehouse which, according to Michael, now tracks $450 trillion worth of credit derivatives in 35 countries.
He emphasised that this is key: a single data repository, a single warehouse, a single hub. The idea of multiple hubs for each region, which is being mooted by the EU as they do not want to rely on a single US-based hub, is clearly wrong in his view.
This is because right now, it is clear to all parties how to register a risk because it is on a single database. If there were multiple hubs, then which risk gets registered on which hub for which counterparty becomes confused.
Or that’s the DTCC’s view.
On a wider note, he did say that post-trade has suddenly become a hot topic because we stared into the abyss last year and survived thanks to collective resilience of the infrastructures.
He outlined that the DTCC handled $500 billion in open Lehman Brothers trades during the six weeks after their collapse on September 15th 2008. In fact, during one day, they liquidated $300 billion in open positions.
These are shocking numbers and the fact that the infrastructures worked and were resilient was the key.
This is why the clearing and settlement plumbing of the world’s financial markets has gone from being “about as exciting as goat’s cheese” to being sexy.
Clearing and settlement has moved from being post-trade back office boredom to being critical to everyone’s management of risk and exposure in these global markets of liquidity.
Interestingly, the DTCC had actually run a simulation of a major top ten investment bank failure based upon Lehman Brothers as the case in point, as a training exercise just weeks before their collapse.
A prescient moment.
Michael also referenced that regulators should have three areas of concern in the markets – an asset bubble, liquidity risk or major fraud. The fact that you had Lehman Brothers and Bernie Madoff within months of each other shows what a good job the regulators are doing.
Yeah, baby, yeah.
This presentation made for a good grounding for the panel that followed which was all about competition and value-add between global custodians, central securities depositories (CSDs) and central counterparty clearing systems (CCPs).
To be honest, there’s a challenge there in that you don’t really want competition between these groups if you are trying to manage risk effectively. The ideal risk manager you see, is a risk management of one, where all risk is centralised. That is the point of a CCP or CSD, to have it centralised.
As a result, you really have a natural monopoly when it comes to clearing and settlement. This was the grounding of the panel which comprised:
Philippe Metoudi of Clearstream representing Asia;
Monica Singer of Strate representing Africa;
Ted Rothschild pf JP Morgan representing America; and
Alan Cameron of BNP Paribas representing Europe;
chaired by yours truly.
It turned out to be a really good panel, debating the nature of ‘value-add’ and ‘competition’ in the post trade clearing markets.
As I chaired it, I didn't take many notes or quotes but am sure it will get a write-up somewhere and will link to this later. The one comment I did note was the one comment from the floor from a not-for-profit clearing infrastructure:
“CSDs get accused of being fat, dumb, lazy and bureaucratic as state-run enterprises and are then told that it is not right if they try to innovate, compete and reduce prices and costs. We can’t win.”
Yeah, baby, yeah.
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