BoE's Post-Trade Reform Efforts Will Need Full Industry Cooperation

If the road to hell is paved with good intentions, the road to post-trade reform is littered with worthy initiatives. Industry observers say the Bank of England’s report on the future of post trade, the latest attempt to bring efficiency to this non-standardized area of financial operations, accurately identifies areas of weakness, but it will need an inherently competitive industry to cooperate if it doesn’t sink like other efforts before it.

“It’s a very good initiative and a good start—but for the last 20 years there have been quite a few good initiatives,” says Godfried De Vidts, senior advisor to the European Repo and Collateral Council (ERCC) of the International Capital Market Association (ICMA).

The BoE’s report, which was issued earlier this month, is the work of a panel of post-trade market practitioners convened to explore how technology could be harnessed to deliver a more efficient and resilient post-trade ecosystem. The report lays out three “pinch points”—client onboarding, uncleared margin, and non-economic trade data—that are slowing transformation. The panel is to establish a task force to address these points further to find areas of back-office operations where there is a lack of data standards, poor quality and inaccurate data, and non-standard workflows.

Post trade is traditionally the unloved area of tech investment, with firms favoring client-facing, revenue-generating activities. There are real incentives for financial firms to cooperate on reform so as to bring forth industry-wide cost savings, but efforts toward efficiency and standardization have been trumped by more immediate profit and competition considerations.

David Field, head of prime services and securities finance at Delta Capita, a managed services provider, points to the erstwhile Project Colin, an attempt by collateral managers at about a dozen large swap dealers to set up a margining utility in 2014. The consortium planned to build a shared infrastructure, jointly owned and developed by the participating banks, that would allow their disparate in-house collateral management systems to plug into a central hub. But the principals behind the secretive project threw in the towel around the beginning of 2015.  

“Banks don’t really trust each other. The big bulge bracket Tier 1 investment bank kicks off an initiative to say, ‘Look we all have the same problem, we have invested a fair bit in our technology, we think it’s a decent platform. Why don’t you guys switch off what you are doing, and then we can all share costs?’ And all the other bulge brackets say, ‘You must be joking—you mean you can see our positions and payments? Yeah right!’ So a bank cannot lead this initiative,” Field says.

But public sector efforts haven’t had much more success in reforming post trade. In the early 2000s, the European Commission created a group of experts called the Giovannini Group, which published two reports in 2001 and 2003 that defined 15 barriers to efficient cross-border clearing and settlement of securities in the EU, and offered ways to remove them.

Some 20 years later, the European Post Trade Forum (EPTF), a group of experts set up by the EC in 2016 to review the post-trade environment, reported that most of the Giovannini barriers were still in place, and in fact there were new barriers in what was now a very different world.

“The European Union and the UK have been looking at post trade for at least 20 years, and instead of abolishing barriers to more efficient markets, in fact we have created more of them with additional regulation,” De Vidts says.

A lack of initiatives is not the problem, he adds. “The EPTF is only mentioned in a footnote [in the BoE report], but it has in fact done a lot of work already. All the main market infrastructures were represented, including central counterparties, investment banks, insurance companies and others. The work has been done; the problem is that it doesn’t get implemented in practice.” 

A regulatory expert, who asked to speak on background due to their work on other regulatory initiatives, says this implementation is complicated by firms’ protectiveness of their businesses, which has kept operations like clearing and settlement siloed by country. At the time of the Giovannini report in 2003, for example, Deutsche Börse subsidiary Clearstream had just been charged by the European Commission with abusing monopoly powers to restrict access to German securities settlement by its competitor Euroclear.

The task force appointed by the BoE’s market practitioner panel will have to be seen to represent all vested interests, and find a way to negotiate those interests when they clash directly. And the BoE itself needs to ensure that the initiative is wider than just Britain, or a UK-centric effort could just create another silo, the expert adds. 

The World Is Changing

Others say, however, that downward pressure on margins since the 2008 financial crisis, regulation, and developments in tech like cloud might give post-trade reform attempts a new lease on life.

“[Traditionally,] profit-and-loss (P&L) owned the business, and it was run by what you might call P&L barons, who didn’t need to communicate, and had profits to pay for all the manual effort to fix bad data,” Delta Capita’s Field says. “They just stuck up two fingers to anyone who wanted to invest profits into the firm, and they only cared about P&L. This is a world that is progressively breaking down.”

With declining headcount, he adds, there isn’t the same capacity to pay to fix bad data anymore, and the appetite for reform is bigger.

For the same reason, and with regulation forcing the push, there is also a great need for standardization in the industry. “There has been historical interest across the industry in standardization, not least because it accelerates commoditization. Commoditization is great for the client, because it introduces price transparency and an ability to compare standardized services. But it’s not so good for banks’ P&L. So whenever standards initiatives would pop up, they would get killed, politically,” Field says. 

Vendors Welcome Report

Other capital markets vendors also welcomed the report, saying the pinch points are areas they have already been speaking to clients about, and automating. While they clearly have a horse in this race, they argue that their solutions can integrate with firms’ current systems, saving customers having to rip out and replace their entire tech estates. They can also act as neutral third parties for cost mutualization efforts.

“One of the frustrations is buy versus build—there has always been that discussion,” says Daniel Carpenter, head of regulation at Meritsoft, which is owned by Cognizant and operates a platform for post-trade processing called Finbos. “Houses can build, but that requires knowledge, subject matter experts that can actually write the requirements, and development of the technology with resources already committed. And then [there’s] the subsequent management of that technology. The initial phases all mean delays in solution delivery and the associated knock-on effects this brings.”

The Covid-19 pandemic has shown firms that efficiency and resilience are not choices. Joakim Stromberg, product manager at CME’s TriOptima, says the collateral management and post-trade infrastructure services provider for over-the-counter (OTC) derivatives, and its reconciliations platform TriResolve, saw margin calls double in March compared to January and February. TriResolve reconciles 90% of all OTC trades.  

“Margin disputes tripled, even quadrupled in some places. Firms with manual processes can cope with them on an average day, but in extreme situations, you suffer from a lack of automation, and that shows up the weakest link in the chain of valuation changes. But the real challenge is in coping with all disputes where investigating and resolving disputes require more time and resources to process than a margin call,” Stromberg says.

“Uncleared derivatives will become more affected because this is where you have disputes in an uncleared world: where both sides of a trade have their own idea of the valuation of a trade,” he says.

With these incentives to push post-trade reform forward, reports like the BoE’s will always be helpful, Carpenter says, as it’s useful to have the backing of the BoE if you are in the back office and agitating for more money.

“If you are the head of operations going to ask for budget from above, you have this supporting document, and you can say, ‘This is what the industry is saying, this is what other firms are doing,’ and that facilitates access to appropriate funds and people,” Carpenter says.

Additionally, post-trade reform should happen incrementally, Stromberg says. “In modern IT, if you are agile, you make slight improvements every day. That is the approach that we come from, and that applies even to changes in this case. And I think that should be the next step from this report: I would like to see the outline of a plan, where is the low-hanging fruit, how can we address that first, and then establish that plan, so the industry doesn’t become demoralized by all the work that has to be done,” he says.