Operational resilience – no room for mistakes
Financial market infrastructures (FMIs), i.e. Stock Exchanges, Central Securities Depositories (CSDs), and Central Counterparty Clearing Houses (CCPs) are all vital components which support the integrity and smooth running of financial markets.
The ability for FMIs to operate in all sorts of Black Swan scenarios and provide a seamless service throughout is non-negotiable.
“As an FMI, we have to be stable, reliable and available during all sorts of crises, whether it is a war or volatility in financial markets. We invest huge sums of money into our infrastructure so that we can maintain operational stability, when our clients need us the most” noted Jos Dijsselhof, CEO at SIX.
This is not just unique to Switzerland.
In India, for example, there is a mechanism at the country’s two biggest Stock Exchanges whereby they can access each other’s risk management systems if one of them suffers an outage, according to a speaker. Similarly, the same speaker said there are contingency measures in place in India to give retail investors direct access to a Stock Exchange, in the event of a major, systemically important broker running into difficulty.
Other areas of focus for FMIs include cyber-security.
“Our investments into cyber-security have increased dramatically over the last 5-10 years. We gladly dedicate time and efforts to demonstrate the relevance of cyber-security to our people and increase awareness towards cyber risks - and we do this because we see a net benefit“ continued Dijsselhof.
This added emphasis on cyber hygiene comes as the threat from cyber criminals is increasing in frequency, intensity and sophistication. In its latest Systemic Risk Barometer study, the Depository Trust & Clearing Corporation (DTCC) identified cyber-crime as being the fourth biggest risk facing financial markets today, putting it just behind geopolitical tensions, inflation and political uncertainty.
FMIs are also having to up the ante on operational resilience in preparation of the EU’s Digital Operational Resilience Act (DORA), a piece of regulation that will take effect from January 2025, and which is designed to strengthen the resilience of financial institutions against ICT threats.
Digitalisation – No turning back….
Digitalisation is gaining traction, with financial institutions increasingly integrating disruptive technologies, such as Artificial Intelligence (AI) and distributed ledger technology (DLT), into their operating models and product suites.
Digitalisation is essential if FMIs are to deliver a quality service to customers whilst also retaining and attracting top talent, according to Dijsselhof.
Some panellists at Sibos highlighted they are using AI to comb through vast data sets to develop useful analytics for clients, i.e. insights into the reasons for settlement fails, or as a tool to prevent fraud.
SIX is also doubling down on its AI efforts. “We had a series of interesting conversations with customers who use our display services. These clients wanted a solution that made it easier for them to compare two different stocks simultaneously. Following these discussions, our technology teams developed an AI tool that made it more straightforward for users to compare stocks in display services” said Dijsselhof.
SIX has an impressive track record on innovation, having launched its Digital Exchange, SDX, an FMI aimed at supporting the issuance, trading, settlement and custody of digital assets, back in 2021. Embracing disruptive technology is vital, continued Dijsselhof, if the financial services industry is to compete with the big technology companies for the best people.
Post-trade in Harmony – the Odyssey continues
Harmonisation across Europe’s capital markets continues to be patchy, according to speakers at Sibos Beijing.
At an FMI level, however, positive progress is happening, with Javier Hernani, Head of Securities Services at SIX, stressing that CSDs are always looking for new and innovative ways to facilitate efficiencies for end users.
“At SIX, we have three CSDs, two in Switzerland, one being DLT-based, and one in Spain. We have developed our strategy so that clients can use us to access either the EU via an account at Iberclear in Spain, Switzerland through SIX, or digital securities with SDX. However, the industry does need to get together to turn the current CSD-CSD linkages in Europe into something that is more of a highway, so people can access either the EU or European Central Bank (ECB) money more easily via an account at any of the EU CSDs” he said.
This comes not long after Former ECB President Mario Draghi published his eagerly awaited report on Europe’s competitiveness, which among other things, recommended that there should be greater consolidation of EU CSDs and CCPs.
However, more work needs to be done. There are a number of post-trade activities in need of urgent harmonisation, the Sibos audience was told.
Several panellists noted that account openings and client onboarding processes are rarely homogenised. This often results in custodians and CSDs asking clients for broadly similar information, i.e. KYC documentation, but in different formats and structures. Although there have been industry attempts to create a centralised utility to support client KYC, this has yet to materialise.
Corporate actions and proxy voting are other areas, where standardisation – especially of the underlying data – is required.
“On corporate actions and proxy voting, intermediaries will typically receive data from multiple sources, which is often non-standardised, and this can have a material impact further down the investment chain, leading to risk and errors creeping in. Data standardisation needs improvement here" said Hernani.
Although there have been repeated calls for some sort of EU-wide tax harmonisation, Hernani cautioned against such a move, pointing out that tax should be determined at a member state level. Instead, he suggested that the processes for claiming back withholding taxes ought to be standardised.
T+1 gets real in Europe
Although there were a few operational snags during the migration process, the consensus in many circles is that T+1’s implementation in North America was a successful one.
However, there is growing disquiet in other quarters about North America’s T+1 track record.
Although the DTCC , the Securities Industry and Financial Markets Association (SIFMA) and the Investment Company Institute (ICI) put out a joint notice highlighting that affirmation rates are up, trade fails are holding strong , and margining requirements are down, the costs of making the necessary operational changes ahead of T+1 were high and devoured a lot of internal resources.
Some Sibos speakers said the headline figures about T+1’s cost savings might be slightly misleading given how many operations people were sidelined dealing with all of the preparations for shorter settlements.
So, what does this mean for Europe?
Unlike some of the major North American markets, Hernani said the EU is far more complex, mainly because it is home to 27 member states , multiple currencies, and dozens of FMIs. In contrast, the US has just one CSD, i.e. the DTCC, which made the T+1 rollout much easier.
If the transition to T+1 across Europe – including the UK and Switzerland – is to happen seamlessly, then there needs to be industry-wide cooperation and engagement. Furthermore, Hernani advised that regulators in Europe not only implement T+1 in unison, but do so as quickly as possible.