Utility Belt: How Utilities are Stepping Up

Cooperation is not exactly a strong suit of financial services firms. In an industry that works hard to protect valuable information, collaboration very rarely happens—or at least, is very rarely successful. But in the past few years, more partnerships between firms have sprung up—particularly around common services like utilities—as the industry grapples with new regulations and increasing costs.

From the Depository Trust and Clearing Corp.’s (DTCC’s) and Euroclear’s Margin Transit Utility and Omgeo to FIS Derivatives Utility, the SmartStream Reference Data Utility and the various know-your-customer (KYC) services like Swift’s KYC project and IHS Markit and Genpact’s joint venture, KYC.com, utilities—in various forms—are becoming more of a force in the industry.

Two more are in the process of shifting to a utility model, as well: the Plato Partnership, which puts together analysis and market data, and Project Neptune, now called Neptune Networks, which provides bond market data from the sell side to the buy side.

Utilities have seen growth in recent years, but for every success story, there is a litany of failed projects, or stalled ones, cluttering the landscape and serving as cautionary tales to would-be mutualization enthusiasts.

Industry to Third Party
What defines a utility is a question that can have many different answers. Generally, utility projects in the gospel sense are not-for-profit entities offering a service to the financial industry as a whole. Vendors that provide a common service while seeking profit may also claim the title of utility as a way of marketing themselves. They are not typically utility projects but may fall under the looser utility banner.

Confused yet? The Association for Financial Markets in Europe (AFME) defined utilities in its March 2018 report, Industry Utilities: A Perspective for Capital Markets, as made up of three core characteristics: they create and provision a network, apply a standardized approach, and demonstrate economies of scale of a commoditized service.

In the past, these have traditionally been managed through multi-bank, or industry-led, initiatives. These were not always successful, owing to the previous points about financial institutions often being inherently secretive. As such, Mik Bjorkenstam, global technology post-trade and operational transformation program director at Barclays, sees utility models moving to vendor-owned constructs.

“We are seeing a trend of third-party vendors filling the needs not met by industry-owned utilities. The goal is to leverage vendors for core services that do not provide a competitive advantage,” he says. “The challenge is to ensure that the ‘cost to achieve’ is appropriately considered in the business case.”

But not all utilities see great success or acceptance in the industry. Over the years, several attempts to build utilities failed mainly because there was not enough support around the project.

Failed Projects
Project Colin, a utility billed as a margin hub and led by a consortium of banks that included Goldman Sachs, ended in 2015 with parts of it being folded into a joint venture between TriOptima and vendor AcadiaSoft. The whole project was intended to ease the burden of margining rules for non-cleared derivatives. Participating banks were supposed to plug into a central hub, but consortium members realized some vendors already had similar plans, and some members were already even investors in those projects. The plug was pulled shortly thereafter.

Soltra Edge, another project that abandoned plans of becoming a utility, wanted to create a platform to share cyber threats. It was a partnership between the Financial Services Information Sharing and Analysis Center (FS-ISAC) and the DTCC in 2014. Two years later, the platform was sold to cybersecurity firm NC4.

It’s not surprising that some ventures fail, seeing as utilities face many hurdles. Financial institutions may not be fully committed to join the utility either as an investor or as a user. Complex business models, lack of existing standards and the burden of legacy platforms can play a part in the hardship utilities see. External factors can also have an impact on utilities, particularly a high volume of regulatory change, market fragmentation or third-party risk.

However, regulatory change and the need to trim costs have combined to make utilities a popular concept among banks again. Financial companies have had to grapple with rising costs and tighter returns, so building in-house solutions of their own, for relatively common processes, becomes expensive. With a greater need for information, data and even services, structures that mutualize non-commercial—or at least, non-commercially differentiating—activities in favor of concentrating on those that have a larger benefit become more attractive.

David Ostojitsch, director, technology and operations at AFME, says that much of the drive to move to a utility model comes from increased regulatory pressure in the past decade.

“I think growth in the number of utilities is really related to the amount of regulation in the past 10 years, post-crisis,” Ostojitsch says. “There’s so much information that is required that the industry is looking for a structure that benefits them as a whole.”

He points to the example of KYC as a required activity that could benefit from an industry service like a utility.

“KYC is a really good example because it’s the one that’s talked about the most,” Ostojitsch continues. “It’s generally understood that a KYC utility for a jurisdiction or multiple jurisdictions has wide benefits. A lot of different banks have done their due diligence on KYC and realized that the ideal should be something that is beneficial to many different industry participants. I think that’s why people keep trying to build utilities, like KYC utilities, because ultimately what a utility provides is so great for the industry.”

Activities such as reconciliation, client onboarding and data sharing must be done by all financial institutions but not all have the capacity to build their own solutions or prefer not to engage a single vendor. Bank sources say that they would rather not invest a lot of money to solve those issues individually but would prefer to pool resources together instead, unless they’ve already developed their own platform to address challenges.

Grant Wilson, CEO of Neptune Networks, says end-users, both on the sell side and the buy side, are looking at costs involved with employing a single vendor for some services and are more interested in working on shared services, even if these are not going to end up being utilities.

“There’s a greater interest in investing in shared infrastructure and reducing costs across the board and obviously a utility structure is the best model to achieve that,” Wilson says. “I think the real driver is that market participants, both buy side and sell side, are looking at the vendor landscape and the costs of doing their business and seeing that there are a lot of heavy costs in what in reality should just be pass-through.”

Wilson adds the fact that most end-users get to have some control over what is shared on utilities also makes the business model attractive.

Understandably, some utilities—especially, perhaps, those run by vendors—need to gather steam before gaining critical mass among clients. The FIS Derivatives Utilities signed its first client, Barclays, in 2015 and the second, Credit Suisse, in 2016. In January this year, it welcomed its first non-bank client in Wedbush Futures.

DTCC-Euroclear GlobalCollateral executive chairman Mark Jennis says more people are looking to utilities to solve their issues but for the business model to really be successful, some patience is required.

“The interest in utilities has definitely become more critical, given some of the cost challenges, the capital challenges and the like. I think we’re starting to see that people are looking at utilities to solve some of that—but it takes time,” Jennis says. “But once it starts to coalesce with the community then you get solutions that are just far better than individuals going at it separately.”

Jennis adds that getting people to join utilities is “a lot of dialogue, for sure. It’s a lot of listening, a lot of hearing about pain points, and a lot of figuring out, strategically and together, where we want to get to.” He says working with potential clients also involves identifying what the utility will not be able to solve for banks so they are upfront about the capabilities of the service offering.

These days, the financial services industry has shown greater interest in working together as seen with regulatory projects like the move to a two-day settlement cycle from three days, establishing a sense of community in the process. But one of the greatest contributors in bringing institutions together has been the emergence of technologies like distributed-ledger technology (DLT), and the growing popularity of open-source tools.

Playing Nice
Indeed, many of the primary use cases that have been identified for DLT—examples include reference data management, clearing and settlement of trades, managing post-trade events and organizing KYC processes—are those that tend to be the primary targets of utilities. The idea is to use technology like DLT to create a golden copy, or a master record, of information—either of client data as used in KYC programs or transactions for more efficient post-trade reconciliation and settlement—that all parties with access to the ledger can use.

Ian Downes, managing director, CIB post-trade business development for BBVA, says new technologies should not be seen as a death knell to utilities and may even propel the model forward.

“It’s a question we’ve been thinking about: Can the utilities model be further extended using emerging technologies? We see that new technologies can assist with the rollout of utilities,” Downes says. “New technologies help define a new standard approach, which then can help to push along the utility development.”

Several people, including some utilities, see these emerging technologies as something that can help utilities achieve their goal. DTCC CEO Mike Bodson, who has long been an advocate of DLT, told attendees last month at the Futures Industry Association (FIA) annual conference in Boca Raton, Florida, that DLT will push the company to transform into something different.

“From where we sit, we were created because you need a golden copy of trade records. We’re going to disappear. I keep telling everyone who comes to work for me, where we are now is not where we’re going to be in 10 to 15 years,” Bodson said during the conference’s keynote panel, adding that the likely future role of the utility would be to manage the network that DLT provides.

But it is not just technology that could impact utilities. The dependency on banks working together on activities like clearing has given rise to the importance of collateral management utilities, a good sign for projects like GlobalCollateral. And in a late plot twist, increasing cyber threats have prompted banks and security experts to call on each other in public forums to offer information on cyberattacks that may afflict others, something that Soltra was trying to accomplish, but failed to get quite right.

With financial firms within the industry getting more comfortable with playing nice with each other, it’s clear that more collaborative projects will crop up, especially because the need for services with such wide-reaching benefits is not expected to fade anytime soon.

Neptune’s Wilson says he believes utilities are flourishing now because the current market environment makes them more attractive than other options.

“If we go back to the heyday of 2006 or 2007, then for-profit will be the model of choice because it’s really down to market structure and what the purpose of the service is,” Wilson says. “But right now there are so many different things where utilities can come in and so many different pieces of technology they can use, because it’s about the shared costs, infrastructure and collaboration that makes utilities the more appealing model in this environment.”

Correction (3/28/18): This story has been updated to correct the launch of Soltra Edge, which was in 2014, and to add that it was sold to NC4 in 2016.