Modernizing architecture can reduce long-term costs

There is a lot of talk in the financial services industry about modernization and automation, but the reality is that too many banks and broker-dealers still base much of their network of business-critical data and processes on a complex web of spreadsheets and manual interactions. This has mostly been sufficient, with banks making do with a patchwork approach to new business initiatives, data quality improvements, and ever-increasing regulatory requirements. 

But change is coming. The rate at which markets and their broader ecosystems are advancing—alongside the sheer volume and complexity of new regulations—will force the industry into a seismic rethink of the way they approach their fragmented architectures. 

Financial institutions are on the cusp of a profound change to the entire clearing, margining, and securities finance ecosystem. The US shift to T+1 narrows down the settlement preparation window to just a few hours in the most challenging scenarios. Uncleared Margin Rules (UMR) have triggered a global need to rebalance portfolios between centrally cleared and bilateral trading routes. 

The Fundamental Review of the Trading Book (FRTB) will materially change the capital that banks must hold against credit and market risk exposures. And the Securities Financing Transactions Regulation (SFTR) has already had a significant impact on trade reporting, collateral reuse arrangements, and disclosure obligations. 

The modernization of underlying infrastructure providers is also turning the screw, with banks and broker-dealers required to undertake substantial reforms to connect and interact with those providers, simply to maintain existing service levels. 

Collectively, these changes place a significant burden on the industry, rising exponentially with the number of systems, teams, and locations involved.

The cost of compliance

As we know, banks and brokers operate at the heart of the financial services ecosystem, sitting between the Street and the market, and servicing a vast array of customers across retail, corporate and institutional investors. 

As a starting point, all relevant systems and processes must be identified, assessed for their compliance, scalability, elasticity, and typically upgraded or enhanced in some way

That essential role necessitates an ever-more extensive range of checks and balances in the form of rules and regulations, which usually translate into very complex data consolidation challenges and computationally intensive calculations. The scale and pace of those requirements has increased significantly over time, in lockstep with the level of sophistication and rigor with which the industry is assessed. 

Responding to even a single new rule or regulation can be a huge undertaking. As a starting point, all relevant systems and processes must be identified, assessed for their compliance, scalability, elasticity, and typically upgraded or enhanced in some way. 

That requires teams of people—product experts, regulation experts, external consultants, engineers—to make it happen across every corner of a company’s operations. It represents a huge cost to the industry, and the operating model for responding—where every firm employs their own team of in-house experts—is increasingly inefficient.

But this isn’t a simple story about the inefficiencies inherent in regulatory compliance.

Competitive advantage

Transformative technologies—such as artificial intelligence/machine learning, tokenization, and cloud—have fired the starting gun for a generational shift across global capital markets. Interoperability, scalability, and system flexibility will be the key trends that define an organization’s ability to capture the significant growth opportunities that this transformation will bring. 

For example, collateral management, margining, and securities finance is emerging as a key battleground across the sell-side community, where high interest rates are making the cost of funding explode and putting the focus on balance sheet optimization. Today, there is a clear dividing line in the industry between those operating spreadsheets and siloed systems and those with centralized processes for automated collateral, real-time inventory management, risk integration and utility integration. 

The benefits of making that change are huge and will only increase. Those firms are far more effective at identifying business opportunities based on optimized risk analysis, and at the same time able to respond to a raft of regulations like the standardized approach for counterparty credit risk (SA-CCR), UMR, FRTB, and SFTR. 

This centralization also enables those firms to optimize their inventory—to lend, pledge, or repo—due to greater visibility into their data and organizational processes, all ultimately helping to drive greater risk-adjusted returns to gain an edge over their competitors. And as the industry evolves, they will benefit from rapid and regular updates, with the flexibility to incorporate new functionality at a better rate than their rivals. 

This overarching trend is driving a material change in the relationship between clients and their technology vendors. Banks and brokers are seeking long-term partnerships with vendors that not only have the right solutions to address immediate operational challenges, but bring a deep industry expertise, offering not only a detailed understanding of regulation they must adhere to, but insight into next wave of transformative technology to drive their growth story.

Gil Guillaumey is head of capital market solutions at Nasdaq.