Completing Europe’s custody puzzle
The evolving post-trade securities landscape in Europe can be viewed as a puzzle, of which regulatory and infrastructure changes are part. To complete the puzzle, market participants need to visualise the broader picture
2017 marks the year when most of the highly anticipated infrastructure and regulatory changes are now becoming a reality. The changes, some of which were conceived even before the financial crisis of 2008, are geared towards improving efficiency and reducing costs in the post trade securities landscape. Alongside this, we are seeing an acceleration of technological evolution within the wider financial industry that has the potential to reshape the landscape further.
Our challenge as an industry is that these changes are all happening in parallel with different time horizons. However, by deconstructing the evolving landscape into five core elements, or pieces of the puzzle, can we begin to see the full picture: markets; clients; providers; technology and, last, but far from least, how we interconnect these elements into a European Strategy.
The securities market in Europe faces several infrastructure and regulatory changes:
- The European Central Bank’s TARGET2-Securities (T2S) platform is well and truly alive with the majority of the volumes of participating markets on the platform. T2S is reshaping the securities value chain by providing a single platform for settlement and matching across 23 European central securities depositories (CSDs) within a harmonised settlement day in Central Bank money.
- Investor protection is a consistent theme within regulations such as the Alternative Investment Fund Manager Directive (AIFMD), Units in Collective Investment Trust Schemes V (UCITS V), the Markets in Financial Instruments Directive II (MiFID II) and the Central Securities Depository Regulation (CSDR)
- Risk reduction is another important theme, driven by MiFID II and the European Markets Infrastructure Regulation (EMIR)
- Collateral mobility and liquidity optimisation are becoming increasingly more important in meeting a broader range of compliance requirements with regards to regulations such as MiFID II and Basel II.
These regulatory and infrastructure changes require a review of existing business models in order to meet new obligations. These are also focusing attention on three broad themes related to risk reduction: asset safety, collateral and liquidity optimisation. As these are analysed, clients will be looking for value-added services to help them engage efficiently with the new business environment in which they find themselves. Each client’s individual solution is dependent on the priorities they need to address for themselves and their client in this new landscape
Service providers will meanwhile need to introduce efficiencies, not only in their new client offerings, but in addressing the cost pressures of reform on their own existing operations. They will need to review the components of their offering to address their clients’ specific challenges, along with value added services, as well as meeting their own cost efficiencies. Operationally, collateral management must meet a broader range of compliance requirements with regards to regulations. In a post T2S European environment, for some participants, the focus should be on reducing pressures on High Quality Liquid Assets (HQLA) through mobilisation of domestic assets into tri-party collateral programs. Finding an optimal service model to meet both regulatory demands and return cost efficiencies through a revised operating environment may require partnership and collaboration across different providers. As with many aspects, this is driven by volumes and a business case at the level of each client.
Instead of delivering individual solutions to help clients to meet singular challenges in the market such as T2S or an individual regulation, the question really becomes one of a wider context, what are the concrete benefits that this new landscape in Europe has brought to participants and how can they be aligned with the other developments that are shaping the market.
The twin promise of digitisation and distributed ledger technology not only points to opportunities for incumbent providers, but also the likelihood of competition for parts of their business from nimble technology firms. This will necessarily lead to a review of where exactly different intermediaries in the chain add value and what technology needs to be deployed to enhance that value.
The final piece
Completing the puzzle requires a modular approach. This enables us as an industry to deliver solutions using evolving technologies. Modular service models can bring both flexibility and efficiency to the daily challenges that clients face in adapting to market change.
Connectivity to a new settlement platform is just the start. In responding to these challenges in Western Europe, clients have changed their buying behaviour. In the case of the post T2S landscape, for example, they now buy on a regional basis, with a modular view of collaboration and partnerships with multiple providers to find unique solutions to multiple challenges.
Any financial institution doing business in European securities markets needs to satisfy itself that its operational needs and strategic objectives are being effectively met by its service relationships. Collaboration among service providers along the value chain is introducing the potential to reshape the value chain itself. It is no longer just about T2S solutions, but rather a broader European custody strategy and how they take advantage of a new European landscape in achieving broader strategic aims.
How do we achieve these broader aims?
A client’s own strategic priorities should be the starting point for any selection process as they may point to different possible paths to optimising benefits. A one- stop shop is not always going to be the only solution to the overall market problems faced by a client.
Clients need to identify their priorities before considering their choice of providers in a European context. By asking themselves the right questions about what is important to them and their clients in the changing European landscape, they will be able to find the right solutions to meet their needs. Answering them will not immediately lead to a single obvious service solution but it should at least narrow the appropriate options to a smaller number that can be considered in more detail.
Rather than wait and see how the landscape may settle, due to the amount of change happening in parallel, a perception of inertia in the face of active competition in Europe risks a loss of business. Late mover firms may, for example, find that an inability to maximise cash benefits and efficiencies will impact the cost model used to charge clients.
With many of the puzzle pieces in place, now is the time to act. Given the pace of technology innovation and disruption, waiting another five to ten years is not an option. Different models for asset safety, liquidity optimisation or collateral mobility are already live in the market. Now is the time to match individual needs with those models. Our latest whitepaper explores some of the model choices developed by the industry to help different stakeholders along the chain adapt to changing circumstance.