From the desk of John Arnesen
Consulting lead, Pierpoint Financial Consulting
A couple of weeks ago I attended the 2020 Deutsche Börse GFF summit in Luxembourg and I thought I would highlight my impression of the conference and what I found interesting. To avoid the risk of misquoting someone, I will not refer to anyone by name.
First and foremost, this summit is incredibly well put together. The content, speakers and location at the European Convention Center makes it a compelling event and sets the bar for other industry conferences that will take place during 2020. With 840 registered delegates and 801 in attendance, it is one of the largest conferences of its type and I take my hat off to Deutsche Börse and Clearstream for the effort they made in preparation.
The conference kicked off with a keynote speech by a senior member from the Bundesbank. It was interesting to hear concerns expressed that CCPs are very UK-centric as most clearing is performed onshore in London. With 85% of euro-based activity cleared through LCH, obviously an alternative CCP network must be developed in the EU for its markets given that come January 2021, the EU and UK will have a very different relationship. It seems clear that CCPs are vital to forge the way forward for an integrated capital markets union. Concerns were expressed that there is too much regional disparity in the health of some banks with the less well capitalised struggling to service the funding needs of small businesses, particularly clever start-ups that will ultimately solve for some of the far-reaching issues the EU is facing. It was emphasised that the bloc needs far more digital solutions and to become a climate impact neutral trading area with some urgency.
Concluding remarks centred on the fragmented approach to pension funding across Europe and that there should be better products and access to the capital markets for pensioners in general. A challenge indeed.
Industry Leaders Panel
The Industry Leaders panel established a consensus that all funding has to fall under one business unit in order to optimise collateral and deal with upcoming regulatory reporting such as NSFR and expanding UMR requirements. I found it interesting that panellists saw no delineation between front and back office and that all have invested heavily in efficient middle- and back-office functions to minimise the cost of capital. One panellist described how they take a back-to-front approach to ensure solid processing flows and this is important after their experience with EMIR reporting and went on to say that post-trade management is key to a successful operation. No argument from me there.
It was debated how tolerant regulators will be towards poor SFTR matching rates and that to assume a lot of leeway might not be the best approach to take. Brexit has caused some bifurcation in that more business now flows through their European entities, causing some liquidity and funding issues. There was agreement that the cost of uncertainty with regard to Brexit negotiations will continue to weigh on the markets in 2020 and may result in far more conservative decisions. This is exacerbated by the yet-to-be contained spread of COVID-19, so we should expect more range trading.
All acknowledged that tri-party agents need to do more for ESG considerations. It is a certainty there will be more non-standard requirements and with greater governance around the requirement to exercise voting rights, the question arose as to whether this could be addressed by tokenisation. Now there is a challenge for some smart people but I would agree that unless we find a way to break the deadlock over voting, the market may become a Japanese-style recallable one which could be disruptive to say the least.
The need for standardisation was discussed and all agree it is of vital importance and the industry can learn from the derivatives market in its ambitions to develop a similar common domain model. However, the challenge to agree on a set of standards was not understated.
The subsequent ’Buy-side Panel’ warned about being careful with labels as too often some institutions are considered buy-side when in fact they are not and vice versa. It was argued for example that a hedge fund is a buy-side client but is typically not thought of as such. UMR was a hot topic of discussion with the consensus that it will change trading behaviour and was considered punitive to both buy- and sell-side firms and will clearly put pressure on firms to enter cleared trading including cleared repo. This has led some clearing members to consider the liquidity risks of clearinghouses because it’s their risk, not that of the pension fund clients they represent. Interestingly, on CSDR the panel believed that it would be prudent for ESMA to wait and see the effects of SFTR and the output before going live with CSDR in 2020 and that a delay would be beneficial to the regulator and the market. It appears ESMA felt the same way a week later announcing a delay to 1st February 2021!
Living with Derivatives Regulations
The discussion over UMR led nicely into the next panel, "Living with Derivatives Regulations: Cleared and Uncleared Margining". An interesting point about cash as initial margin (IM) was made in that it differs between the US and Europe. In the US, one can post a money market fund as IM as long as the fund does not conduct any repo activity. In Europe, it’s possible to post a UCITS despite the fact they all do repo. I hadn’t appreciated this nor that in posting cash, one needs to ensure your counterparty is able to accept it. Cash is also problematic for US money-market funds in that they are required to not take credit risk on a custodian. As cash creates this risk, one is motivated to turn it into something else. Essentially cash collateral is messy and likely expensive to post given the challenge of deployment.
The description of legal documentation for UMR sounded rather overwhelming with six- complex sets of documents to complete and the added consideration of a buy-side investor using external managers. If the use of derivates is permitted in the mandate, one has to monitor that activity. The panel reported that some asset managers are eliminating the use of derivatives altogether. That led to a discussion on the trade-off between bilateral and cleared trading. While the benefits of cleared trading make sense, some elements are alien to the buy-side. They may not be overly happy with the pledge structure and lack experience with it. UMR preparation has busted the myth that pledge works the same way as tri-party collateral. While the sell-side is very used to dealing with collateral and a pledge reduces their counterparty risk calculations via lower VaR, the buy-side lacks the relevant experience and will have to take a deep dive into its structure and merits, all of which takes time.
Next week I will review the remainder of the conference and why a headline in the FT that week, made me uncomfortable, for the first time, with some aspects of short selling.