From the desk of John Arnesen,
Consulting Lead, Pierpoint Financial
On November 4th 2021, Securities Finance Times held its 5th annual technology symposium virtually. Many of you attended, but I thought I might give my two cents worth of what caught my attention in the first and last panels of the day. Across several panels, there was a tremendous amount of information to digest, and it taught me a lesson. I listened to the first panel live and then went back to listen to it on replay some days later. The information I absorbed on the replay was very different from listening live. I could have sworn they were two different events! Perhaps the ability to stop the recording or the fact that I was listening with purpose, without reading email at the same time, made all the difference. I won't quote anyone individually at the risk of inaccuracy.
SFTR and Now
Guess what? It's not going swimmingly. Did anyone really expect any other outcome? I was amused by the reference to the occasion when ESMA first approached the industry to ask what data it could provide, and they were directed to the Agency Lender Disclosure (ALD) process. No wonder SFTR requires 155 fields if that is all we could come up with. There is a central weakness in the diversity of data held by individual firms. Had ESMA asked 100 firms to provide details of all securities finance transactions before SFTR, it would have received 100 different data submissions. SFTR, to a large extent, is a result of this fragmentation and lack of concise data for regulatory consumption.
I think SFTR was an inevitable outcome due to this. However, the panel was quick to point out that it goes far beyond the original mandate set out by the Financial Stability Board, and some of the 155 fields request data that no firm wants or uses outside of SFTR. It was telling to hear that a recent SFTR working group had 300 registered delegates, with a guesstimate of 100 plus dialled into the call. You would expect such numbers before the go-live date, but not necessarily more than a year afterwards, so clearly, universal issues are still affecting all participants. I hadn't appreciated that trades could match at the trade repository, but the details contained in the record could be wrong. This isn't helpful to the reporting authorities, and depending on the frequency and number of occasions this happens, it renders the data less meaningful. Perhaps, given it is only in its second year, these issues will smooth themselves out over time, but the panel didn't see a way to reduce the number of fields, as let's not forget SFTR is enshrined in European law. ESMA couldn't do this even if they wanted to and are allegedly sympathetic to the fields with repetitive difficulty. Should the market hope for some fields to become optional? Possibly, but don't hold your breath. A point well-made was that firms should consider using an external independent audit of their data. Relying on the submission of a delegated reporting entity doesn't let you off the hook with regulators. A minority of the panel believed that fines for poor data submission are closer than the market thinks. I don't hold this view as I don't believe ESMA or the FCA has the stomach for it, especially with the enormous costs and effort that reporting institutions have gone through. An equally excellent comment was that, in theory, SFTR should not have cost firms anything near what it has, and the reason it did is a lack of standardisation which is why the ISLA Common Domain Model (CDM) initiative is pushed so hard. And while the market continues to struggle with specific fields, how long will it be before ESG reporting becomes another set of complex data fields? Food for thought.
Digital Markets for Securities Finance
Sensibly, this panel kicked off with establishing what is meant by digital assets with a well-described brief history of the development of the internet. How it evolved from a static information experience to an interactive, connected consumer-based platform that has developed into a trusted presence for individuals and corporate entities. In other words, it is so established in daily life that it is part of the fabric of human interaction, and as it has matured, the subsequent natural development is to digitise activities or processes that will benefit users. I always think of the library experience. Imagine the ability to enter a virtual library where you look up the title online and read the book in a digital format? Think of the application for school children in parts of the world that can't easily access libraries or books?
So what does this have to do with securities finance is a good question, and the moderator asked each panellist to set out their stall in terms of what they mean by digital technology and why it's important.
The panel responded with DLT, using a Central Bank Digital Currency (CBDC), CDM and a single source of truth. Much has been written on most of these topics, and it's not wasted on me that the theme that runs through all of them is the need for standardised representation of records. As one panellist reminded us, if you are building a securities finance product from scratch today, you won't do it with the prevailing model. A couple of comments caught my attention. A CBDC is a likelihood given the number of central banks working on their own solutions, and they could have a practical risk reduction solution for the industry. Mark-to-market is an essential function of risk mitigation, but there is a delay of up to one day before the funds are received in cash transactions or even longer when over the weekend (when companies tend to fail). An instant settlement, 24/7, could eliminate this risk when using a token with a central bank's full faith and credit.
The other comment debated where regulators fit into the transition to a more digital experience. It would be somewhat foolhardy to develop DLTs that don't invite regulatory input into the development. It's noticeable that some fintech's get ahead of themselves developing products that they think bypass regulatory scrutiny only to find that they don't and appropriate licences are required. It happens in the payments business, so it would make sense for DLT solutions for securities finance to receive tacit approval in each step of their development. In a world where DLTs are used extensively, could regulators receive golden source records of transactions and possibly replace the likes of SFTR? Hope springs eternal. The moderator had asked the audience to vote on which pitch was most compelling for them, and the results were as follows;
CDM 40%
Singe Source of Truth 40%
CBDC 10%
DLT 10%
Not surprising results and an indication that all of the fragmentation, reconciliation and other frictional processes are at the forefront of participants minds.
This brought us to the next question asked of each panellist: What is the biggest issue facing the industry today. As mentioned, fragmentation came up, and in particular regulatory compliance from a variety of regulators. Could we ever see regulators collaborating on a set of common standards to streamline requirements? It's possible, and its absence is a cost absorbed by the business. Costs were cited as another big issue; the ability to connect to platforms with standard protocols and give the user the ability to switch easily may feature highly in the future. Cybersecurity was mentioned, which perhaps doesn't get enough airtime. As we enter a world of more connectivity and collaboration, our data will be shared with an increased number of third parties. Given the sensitivities around this issue, the due diligence required for approval may be intense, costly and lengthy. I hadn't considered this, and it's an excellent point. A lack of interoperability was named as having a hampering effect on digital transformation, and this has been an ever-present issue in the current market, but it will have to improve under more digital frameworks vastly.
Legacy systems and their drag on efficiency because they can't adapt or evolve undoubtedly resonated with the audience. The active, competitive industry of overlay solutions mirrors the reality of this situation.
When all issues were put to the audience for a vote, the results were;
Legacy systems 62%
Lack of interoperability 25%
Cybersecurity 13%
Taking both polls together, I come to this conclusion. Systems that may have been adequate ten or more years ago are now a cause of frustration, workarounds, manual intervention and inefficiency. SFTR preparation was a wake-up call to the need for standardisation, and while it is largely behind us, the effort and cost can't be repeated for some future requirement.
There is an interest in the future model of DLT platforms, but not before standardisation is achieved. It would therefore appear that the CDM for securities finance is the most pressing and urgent prevailing issue.