Ahead of Sibos, it is worth considering some of the key issues that are debated in the more private forums of the securities services world. Will they be aired at Sibos? Or are they too toxic? And, more importantly, if they are raised, will we get some insights into how to resolve them?
The design and purpose of the securities markets infrastructure is becoming critical, for billions of dollars of user fees are being poured into that, primarily nation-state based, universe of duplicative developments. We are now at a stage where we have to question the role, nature and design of that infrastructure, for industry utilities have become one of the fastest-growing sources of demand for investment dollars in the business. We once had exchanges and central securities depositories (CSDs) dominating the space; now we also have a proliferation of central counterparty clearing houses (CCPs), the emergence of data repositories or the bifurcation of settlement and asset servicing as in Europe. And effective infrastructure monopolies are moving into the for-profit space. There is a risk, given the ratios applied to some recent expansion plans, that there will be a dissipation of their newfound wealth rather than the creation of more value.
The profitability of the securities services business is a further major issue. Declining fee levels, reduced settlement activity and the absence of the all-healing bull market has put pressure on supplier margins. And questions need to be asked about the saving graces identified to overcome this trend. Are the new products the panacea that many believe? Is collateral management or regulatory reporting a savior? Will harmonization bear fruit? Are economies of scale a unique selling advantage of the mighty? Are we really seeing the demise of the single-market provider after an apparent fatal decline stretching now over some 20 years?
We need to examine the real risk of the business. After all the bulk of current losses appear to relate to regulatory or legal reinterpretation of liability, followed by penalties levied due to rash strategies for redeployment of client monies or alleged obfuscatory foreign exchange dealings. In addition, there is the cost of the legal uncertainty about title in cases of default, with rehypothecation and segregation of client monies being issues of note. And finally, there is the traditional $10 million loss pit of corporate actions. But who has lost money on sub-custodian default? And how has nobody lost on intraday cash exposures?
And why do we still struggle with standards? How on earth can have we come to a situation where the banal area of securities numbering remains a challenge? What does that mean for the even more complex world of legal entity identifiers? And how on earth will we ensure a common understanding of the convoluted world of ISO 20022 when many still struggle with its aging antecedents? And, in any event, have we really solved the soon to come of age issue of FIX, SWIFT and other claimants overlap in standards design?
The advantage of a blog is that, like SIBOS panel sessions, the one-line phrase is most remembered. So let me try to give some short answers to the points I have raised. If nothing else, hopefully they will give SIBOS attendees ammunition for questions to the great and the good on those lofty stages.
We have made major strides in exchange consolidation, and it has definitely not come to its term, despite the adverse reaction of competition authorities or vested national interests. The age of consolidation for CSDs appears to have come to a halt, with the impairment costs, seen in the ICSD world, being a salutary lesson for the proponents of optimistic DCF valuations. But the CSD world is overpopulated, especially, as in much of Europe, as CSDs are being emasculated by their loss of settlement flow management to T2S. CSDs are prime examples of duplicative technology and business propositions, and they must consolidate.
CCPs are experiencing a parallel trend to the multilateral trading facilities (MTFs) of a decade or so ago, and, as for the MTFs, we are likely to see the emergence of just a small number of successful players in this space over time. And, inevitably, CCP capital structures will need strengthening, for they are material concentrators of risk, and many of their alleged checks and balances look frail in any simulation of an extreme crisis.
The concept of the data repository is best enshrined in the Depository Trust & Clearing Corporation (DTCC), but there is a high risk of fragmentation in this space. That would bring a proliferation of market standards, with the potential for data repository output to be kept for post-trauma risk attribution rather than, as needed, to be used by regulators and infrastructure managers as a dynamic tool to prevent future crises as a result of market excess.
The profitability of the commercial sector is not going to improve. The reality is that fee attrition has been, for the last decade, on a faster slope than the traditional compensating trends of market appreciation, industry consolidation and new capital formation. This is likely to continue and can only lead to further consolidation, including, undoubtedly, a continued move away from local players and also the departure of the weaker, lower-quality providers who fail to invest. Conversely, changing technologies, and the potential to rent infrastructure as a result of the emergence of true facilities providers in the cloud, will ease the road ahead for the mid-range firms. And, perhaps worryingly for major firms, there has to be a risk of greater regulation, as they are seen as de facto CSDs in their core SMAC competence and systemically market critical in their asset finance and collateral management roles.
Business risk is increasing in the commercial sector, and we have to ask if there will be a demand for more capital to be assigned to this area of activity. Traditional capital allocation models fail to produce demand for high capital support due to the relatively low level of historic losses in the industry. But changes, such as the redistribution of risk under AIFMD and the proposed UCITS V, will put a focus on the increased potential for losses, however remote these are said to be. After all, with tens of trillions of dollars of assets out there, even the odd basis point of risk capital would transform managements views of the fee value and the alleged low-risk nature of the business.
And surely, at Sibos, we need to talk standards. Theoretically they should all work perfectly. But it is difficult to get a universally consistent view on many of the standards, whilst securities and account identifiers remain a law unto the competing service providers aiming to create barriers to exit for their own product ranges. ISO 20022 for Dummies defines the standard as the common one for the financial industry; yet it is more about coexistence of multiple standards and a worthy attempt at interoperability. Unfortunately, though, it has not made the lives of users any smoother.
If we told a new entrant to our world that they were entering an industry with multiple technical standards, a fragmented and duplicative global utility infrastructure and falling profit margins at a time of greater risk absorption by the commercial sector, would they really see us as a dynamic career option? Action is needed. Wouldnt it be wonderful if the path to reality could start in Sibos Osaka 2012?
John Gubert