Onerous reporting requirements through to the availability of new technologies and open-access frameworks are among the developments galvanising the debate around industry standards.
The concept of strengthening market efficiencies by establishing industry standards that facilitate greater harmonisation and interoperability is by no means a new one. However, resource-intensive regulations such as the EU’s Securities Financing Transactions Regulation (SFTR) and the Central Securities Depositories Regulation (CSDR) are placing renewed impetus on the need for greater acceleration of these efforts. SFTR, for example, will require counterparties to securities financing transactions (SFTs) to report details of the SFT to an approved trade repository, generally on a T+1 basis. The two-sided reporting obligation, which will be phased in from April 2020, requires 153 data fields to be populated.
“That requirement is driving firms to consider how best to get standardised data into the report, which highlights the fact that there are gaps in data required to report,” notes Todd Crowther, head of client innovation at Pirum Systems. “Additionally, there are a number of other data points that the industry is looking to standardise but that have not been fully realised yet, such as standard settlement instructions, collateral schedules, and data for know-your-client (KYC) requirements. So SFTR will help drive standardisation in some areas but not across other areas, which presents challenges to on-boarding, trade capture and processing, settlement and lifecycle management.”
While data standardisation could help ease the burden on individual firms grappling with upcoming regulation, a more homogenous cross-industry approach to data sets is also key. “Particularly in the equity lending space with SFTR and CSDR, firms are going to need to be talking the same language when speaking with one another,” says Tim Meredith, executive director, platform sales at J.P. Morgan. “In that sense, regulation is an enabler in terms of bringing the market together to force the issue of standardisation. It is then down to the market to agree that a collective investment is a beneficial longterm strategy, and regulation may also be the catalyst for that.”
Graham Gooden, EMEA head of agency collateral management at J.P. Morgan, points to the uncleared margin rules (UMR) as an example of regulations acting as a lever for the market to collectively innovate and develop industry standards in the derivatives space. He says: “For phases one to four of UMR, triparty has been the solution of choice but phase five brings in the buy-side, many of whom will use a custodian under a third-party model. Historically, the way many control accounts have been managed by a custodian has been through fax; however, with phase five drawing closer, the industry has come together around SWIFT standards for instructions that custodians are buying into and that let dealers instruct in an automated fashion. Regulation may have driven that at the start, but the industry has subsequently innovated to meet that need.”
Developing a common blueprint
The derivatives market also provides frameworks which could be leveraged to address the pressures facing the securities lending industry, namely the common domain model (CDM). In March 2019, the International Swaps and Derivatives Association (ISDA) published the ISDA CDM 2.0, which provides a standard representation of more than 20 lifecycle events for interest rate and credit derivatives products, as well as an initial representation for equity swap products. It is essentially a common blueprint that enables all market participants to deploy a machine-executable data model into their own systems and products.
“The ISDA CDM is the first industry solution across the financial services sector to tackle the lack of a standard convention in how trade events and processes are represented,” says Kelly Mathieson, head of enterprise solutions at Digital Asset, a provider of distributed ledger technology. “Having a single, common representation of derivatives and their trade events will enhance consistency, facilitate interoperability across firms and their platforms, support transactions, and provide a foundation on which new technologies can be applied.”
In April 2019, ISDA and Digital Asset announced the availability of an open-source reference code library that will allow developers to more easily implement the ISDA CDM and construct lifecycle events with machine-executable code using Digital Asset’s smart contract language – DAML. There is potential for the CDM to expand the scope of products it covers, for example, securities for collateral exchange and financing transactions. The International Securities Lending Association (ISLA) has also noted that it is exploring how technologies and frameworks such as CDM and digital contracts might be developed for the benefit of the securities lending community.
Mathieson sees further opportunities for CDM frameworks and DAML within SFTs and collateral management, from providing a real-time record and immutable timestamp of what collateral allocation decisions have been made by whom and when, and making that information available to the appropriate market participants throughout the lifecycle of a transaction, through to streamlining compliance with regulatory requirements by enabling permissioned authorities to observe relevant aspects of a transaction in real time. “Some of these opportunities have measurable business cases underneath them around operating risk, compliance, and the ability to reduce the unnecessary liquidity that is currently injected just to handle the sequential flow of transactions,” she adds.
Standardisation and innovation: an uneasy alliance?
One issue that is frequently raised when the push for standardisation and harmonisation comes to the fore, however, is its compatibility with market innovation and competition. Yet rather than stifling innovation, standardisation of core processes could in fact free up firms’ time and resources for the development of new products, services, and other aspects of their business that can offer a competitive edge. “Standardisation of the plain vanilla parts of the value chain or nuts-and-bolts process can still allow room for innovation as a business differentiator,” points out Meredith.
As Mathieson notes: “The ISDA CDM is focused on non-differentiating operating flows. It is an additive scenario whereby it lays the foundation for emerging technologies because if you have a standardised process then you can express that process in machine-executable code format. We don’t even know yet what the limits of that innovation could be.”
Standardised processes could also lead to more rapid development and adoption of new systems and services, states Matt Wolfe, vice president of strategic planning and development at OCC. “If you have to adapt to a number of individual processes then it becomes much more difficult to launch new services than if you could just launch that service on one standardised process.”
He continues: “Harmonisation and standardisation breed innovation – you can see that not just within the industry but much more broadly, for example the creation of standards such as HTTP (HyperText Transfer Protocol), which was the foundation of the internet, and all of the subsequent innovation that has resulted from that.”
When there is a level playing field, market participants, institutions and solution providers alike will be highly encouraged to seek out ways to build upon their competitive advantages, points out Alvin Oh, global trading product owner at EquiLend. “There are certainly cutting-edge technologies out there - for example, blockchain and distributed ledger technology (DLT), machine learning and artificial intelligence - that can play a part in how collateral is being managed. Much like the advent of trading algorithms, firms willing to invest in these technologies can benefit from the efficiency, transparency and risk mitigation that technology brings about.”
Breaking down silos
At an enterprise-wide level, harmonisation between business functions with a bearing on collateral can offer benefits such as cost efficiencies and open up revenue-generating opportunities. “If each business silo has its own approach to managing and optimising collateral, then as a firm you are not making the most of that collateral’s full potential,” says Bimal Kadikar, chief executive officer at Transcend.
Some firms have already begun to take steps to address this, yet they are not only taking different paths to break down internal silos, but are also on varying stages along those paths. Roy Zimmerhansl, practice lead at Pierpoint Financial Consulting, says: “Sell-side firms have been on a collateral journey for the past decade. I find it interesting that there has yet to be a clear structure that has emerged for the sell-side. At the beginning of the decade, there was much talk about the creation of a senior level “Collateral Czar” at each firm who would be charged with optimising the firm’s collateral horizontally across all businesses. While this has been a model for some firms, giving them a cost advantage, often collateral remains vertically aligned to businesses.”
Establishing a central collateral management agency is critical in breaking down silos, stresses EquiLend’s Oh: “With this business group focused entirely on collateral, it can best optimise usage firm wide. Another benefit of creating a centralised hub for collateral information is that it will also allow the various business lines to have the best data points in their day-to-day business operations involving collateral. This is one of the reasons why we have built EquiLend Spire, because we recognise the challenge these businesses face to centralise their view, control and optimisation of assets.” Just as regulatory change can serve as a trigger for new approaches at an industry-wide level, they can also drive change within enterprises.
Zimmerhansl says: “Typically, when a new regulation is forced on the industry, firms respond with an implementation plan that will satisfy the new requirements. Forward-thinking firms can use regulations as a springboard to rethink and reevaluate their approach and make changes that optimise their approach, and I think that UMR has provided that opportunity.”
However, firms’ capacity to rethink and enhance their collateral strategies is often constrained by competing business priorities. “The demand to innovate can push boundaries, but we need to collectively watch the balance between bespoke solutions and harmonising to solve a common issue and achieve a common goal. Despite the fact that harmonisation can cost in the short term, it can not only save money in the long term but also create value in terms of new opportunities. So, when you consider the bigger picture, it makes sense for firms to invest in this if they have the capacity to do so,” says Gooden.
Meredith adds: “A lot of capacity is being taken up with SFTR and CSDR, but given market activity levels are relatively low this year and organisations are coming under increasing pressure to prove they are doing something about potential efficiency gains, the time is now to pause, take stock, and leverage harmonisation.”
Many industry participants will likely be utilising different heritage systems to manage collateral across their equities, fixed income, and derivatives desks, for example. “All of these have a collateral need to speak to one another, so as a first step, firms need clean data to be able to see all of their positions and know how best to mobilise collateral and bring down those silos,” says Meredith. “It is more difficult to connect with others if you are not as joined up as you could be internally.”
Technology and software providers have developed various solutions to help bridge these systems. For example, Transcend’s Kadikar says: “Our goal is to provide an overlay that allows firms to plug the gaps they have within their existing collateral ecosystem, enabling firms to have comprehensive visibility into internal and external systems at an enterprise level.”
Advances in automation solutions have also been harnessed by the industry to bring together diverging data inputs to deliver standardised data outputs via standardised processes. Robert Frost, head of product development at Pirum Systems, offers the following example: “As a well-established automation and connectivity processing hub, we have standardised the process of clients connecting to all four major triparty agents and the submission of required values (RQVs) for both initial margin and securities lending, knowing that all of the firms connected to our platform will not have the same systems or data models.”
As Pirum’s Crowther notes: “Digitising data and making that data available to use are the foundation to achieve harmonisation and standardisation which could enable better automation and interoperability across the industry and thus reduce cost and increase efficiencies.”
The digitisation of data sets has gone some way to alleviating historical pain points, such as determining collateral eligibility. “We have digitised our collateral schedules, and made them available in machine readable formats,” says J.P. Morgan’s Gooden. “The next phase is making schedules available for clients to make changes electronically. If you look further down the track, eligibility could be transmitted through an application programming interface (API), and then other providers could take those APIs and create other services.”
Gooden suggests that this digitised model could allow for new innovative and interlinked solutions, in a similar manner to the way GPS apps, activity tracking apps, and smart wristbands feed into each other to provide consumers with information about the route and distance they have run and their heart rate when doing so. “Our industry isn’t quite there yet, but by having data in a digital format, other services can be built on top of it and be fed back into our own services.”
Harmonisation is not easy, remarks Oh, but it is crucial to simplify access for new entrants to join and add new liquidity pools to the market. He says: “This cannot be achieved without streamlined and centralised technology, from trading to messaging to settlement. Understanding pre- and post-trade are key to making a trading decision even before a transaction is done.”
This article features in the Collateral in 2020 Guide. Download the full guide here.