From the desk of Julian Eyre
Managing Director, Eyre and Co
[Note to readers: Julian Eyre delivers today guest blog post, focused on the digital transformation pathway. Eyre and Co have a collaboration with Pierpoint focused on the digital space, innovation and Common Domain Model with a focus on return on investment]
This blog will provide an alternative (subjective/contemporary?) view on actions and plans banks and financial market participants could consider when creating strategic value for their business. Historically any initiative described as ‘strategic’ conjures images of tens or hundreds of millions of dollars of cost - with little to no ROI in the next 10 years, with many projects ultimately failing because the business case was poorly designed, the plan poorly executed or the project too ambitious at the outset.
The more recent appetite for agile sprints, Kanban and scrums has driven the adoption of current project management techniques and many relatively short-term projects with a goal of ‘in year ROI’.
Great, now teams are delivering projects more likely to succeed and deliver a short-term business benefit. But it is also often the case that enterprise, strategic programmes have been rejected, deferred, or taken off the list because the business has no appetite for large wholesale change and transformation programmes.
Fast-changing IT trends including data lakes and microservices, cloud strategy and Robotic Process Automation, Machine Learning and Artificial Intelligence all attract business budget to drive efficiency, increase transparency, automate, and reengineering. In most cases, all of these solutions extend the legacy problems and place a veneer of benefit over the root problem.
And the IT departments have invoked the most recent technical wizardry to solve critical business challenges…without necessarily focusing on competitive advantage and simplification.
The business has been forced into thinking short term, potentially worried that longer-term budgets may not be available, the market may experience a downturn next year, and the project sponsor will be promoted once the quick short-term win is achieved.
The result? A series of tactical business and technology projects that solve tactical, short term business problems frequently do not address critical underlying issues. In many business areas, which evolved rapidly from Big Bang (1986, arguably the key deregulatory moment outside of the US), through to 2000 – attempts to scale using outdated processes and technology, vendor platforms offering limitless configuration and customisation and IT dominant proprietary systems. This landscape has been underpinned by varying data models and interpretations of business processes within the banks and between the banks.
For people and technology, the post-trade operating cost has become disproportionate to the complexity of the product lifecycle and mundane activity needed to achieve the function (allocations, confirmations, settlement, payments). While some standards have developed, mainly as connectivity tools, such as FIX and FpML, in many cases loosely defined structures ensure the ongoing requirement for reconciliations (processes, people and technology) across the transaction lifecycle, within banks and for any data items crossing outside the bank. The consequential exceptions management process is costly and inefficient. ‘Chapeau!’ to the emerging market community-level exceptions service providers. But the wholesale lack of definition of standards, the low adoption of the standards that do exist and the inherent flexibility of the ‘standards’ has contributed to a fundamentally inefficient market landscape, across and within product verticals.
Distributed Ledger Technology (DLT) or blockchain solutions could be viewed as an accelerator to an industry best practice model however they are not at a maturity stage in most cases, and the adoption of this technology will invariably require a change of operating model, or data and process transformation from a legacy platform to DLT through adaptors and APIs to execute. This approach further extends the complexity and cost of the core IT landscape.
In addition, there is a risk of DLT proliferation as there may emerge competing communities of DLT platforms comprising collaborative or competitive factions within the industry. Without interoperability, there is the opportunity for further complicated and costly outcomes where multiple solutions may be needed to participate in a market.
So, which digital innovation is gaining traction now? ISDA documented a Common Domain Model (CDM) for derivatives in 2017. Recognising the importance of a digital CDM template, they developed a codified version of CDM, and this is now iterating through 2.0 and gaining functional and operational depth.
Any bank or market participant considering the derivatives CDM would benefit from considering its extensibility, suitability and usability in adjacent markets. ISLA and ICMA are collaborating with ISDA and developing CDM extensions relevant to the Securities Lending and Repo markets, respectively.
So, some creative technology is developing to standardise and codify industry best practice - that sounds expensive…. Well, maybe not…. At the heart of the CDM approach is the principle of digital building blocks to model and codify trade data and processes, lifecycle events, cashflows and corresponding contractual and collateral processes. While the current securities finance and derivatives industries are not entirely aligned, there are common characteristics to both markets where elements of the CDM may be reusable, extensible and a suitable foundation for development. These building blocks can deliver tactical use cases (such as allocations, collateral etc) that will deliver simplified data and processes and corresponding lower costs for post-trade processing on an in-year ROI basis – positive, cost-efficient, incremental tactical benefits.
Assuming the CDM principle accelerates and gains traction and this approach is taken, any participant can be confident that their short-term projects will align with a more strategic longer-term digital transformation programme where benefits will be unlocked though extension of the CDM adoption in-bank and across their business counterparty community as more participants adopt the tactical use case solutions.
So, what is the cost? Depending on the banks’ appetite to architect a wider digital transformation one starting point is to perform a detailed process discovery across internal people and systems to understand the number of systems touch points, the number of APIs used, the data structure and attributes employed in each system, the data enrichment and human interaction needed to ensure the transaction lifecycle is unimpeded. The analysis can further assess enterprise ‘STP rates’ and review the cost of ongoing support and maintenance of the systems, the IT and vendor costs involved.
Emerging process mining software can help automate this discovery process.
Collaborating with industry communities and trade associations and a benchmark of internal processes against ‘best practice’ will support the exploration of divergence from current ‘standards’ models. Benchmarking bank processes will confirm the current cost-per-trade metrics.
Understanding the current all-in cost per trade, the numerous data and process models in use in the banks and the human resources needed to support this landscape will help define the high-level CDM business case. By aggregating this analysis, the full industry impact can be estimated. Anecdotally, for derivatives, globally, this has been estimated at $4bn+ per annum.
An alternative approach, supporting a more tactical incremental adoption model is to select a few key areas (allocations or collateral perhaps) where there is an appetite to accelerate innovation and test the emerging CDM model in collaboration with external aligned counterparties. Either way, a before and after assessment will be needed to validate the business benefit achieved through adoption.
These adoption options further challenge the CDM strategy as its possible each market vertical may develop a divergent use case model, limiting adopters and fragmenting CDM development and budgets.
Eyre and Co, in collaboration with Pierpoint, firmly believe in a collaborative, cross-product model where discrete roles and responsibilities are defined.
In theory - each Trade Association will own, manage, and provide governance for their industry standards and best practices which are codified into a single CDM repository. The model developed can then be consumed by opensource platform providers who develop the software necessary to digitise and implement the CDM designs. The final requirement is for an industry neutral, market owned utility or design and adoption council. The CDM DAC will be industry co-owned, funded and managed service to converge consensus on use cases, development, and adoption priorities of the CDM elements. The CDM DAC can include any party interested in participating and contributing to the success of this emerging digital imperative. We would be delighted to share our thinking – please get in touch.