The recent discussion of the possible pressure on the Indian government to list the leading Indian bourses can be considered in many ways including as a clash of civilizational management cultures. With a history of foreign rule, Asian countries that became independent relatively recently are generally suspicious of foreign interference and see control of the large domestic institutions such as exchanges (often termed national jewels) as vital. This is an important reason for the monopolistic or duopolistic vertical exchange market structure in these countries. It makes it easier for the government and the capital market regulator to control the activity of the exchange. Ironically, in the west, after the financial crisis, the need for control and stronger regulation has become an important focus of the respective governments and leading financial regulators, for obvious reasons. Listing the Indian exchanges would make their performance not only transparent, usually a desirable trait, but also more amenable to market forces and pressures from both the domestic and the international investment community, which can sometimes run counter to the respective national interests of the exchanges in which the countries are based. The Indian government and the capital market regulator SEBI would have to take a call on whether they see listings as the best way of making these exchanges transparent. The firms that have invested in the exchanges by taking minority stakes should be in a position to sell these stakes at any point in time, and hence an IPO is not the only way for them to realize their gains on past investments. If the exchanges are indeed listed, it has to be in order to make them more efficient, transparent and globally competitive. Of the two exchanges, probably the BSE which has tried to list in the past would be the most favorable to the process since this might put it in a better competitive position vis-a-vis the leading competitor in the NSE. The NSE would probably not want to disturb the status quo, or do it in a very controlled fashion if at all. But these are internal market dynamics the regulator would not bother much about, and it would mainly focus on issues such as systemic risk management in a post-listing scenario. The final decision, while not a ‘make or break’ one some vested interests are making it to be, would still be of interest to the casual observer of India’s journey as an important emerging global capital market.
The Eurosystem’s Target2 Securities (T2S) initiative aimed to drive integration, harmonization and reduce cost of settlement, particularly for cross border transactions, has finally gone live. Several European CSDs planned to join T2S in 4 separate phases, the first phase being scheduled for June 2015. Four of the five CSDs (Greece, Malta, Romania, and Switzerland) that were planned to go live on T2s in the first phase did join as planned. However, Italy’s Monte Titoli, that was perhaps most closely watched, delayed its implementation and is now expected to launch in August, 2015.
T2S has been in planning for almost a decade now, and it was anticipated that a project of such large scale may face some technical difficulties, and its roll out may not be as smooth as planned. Last year Celent conducted a research to understand the strategies different market participants were looking to follow to adapt to the post T2S world. In that research we found that except for some players, particularly large regional custodians, most others were following a wait and watch approach and was looking for more information about the system’s eventual roll out.
Their reasons were several, but the precise issue of technical hic-ups was one that we heard from several participants. While the exact reasons behind Monte Titoli’s decision to delay its implementation are not known (and it could well be due to circumstances specific to Monte Titoli rather than a general T2S challenge), this heightens the focus on participants scheduled to join in the next phases. How Monte Titoli and others in next phases gear up to their T2S plans will be closely watched by participants who are still evaluating their options as to how to operate in Europe – i.e., if to become a directly connected party, consolidate sub-custody network and so on. From that perspective, some of our key findings that market participants are still waiting for more clarity and understanding still hold good for many institutions even though a year has passed and T2S is officially live now.
You may find our research findings published in 2 separate reports here: one on settlement, the other on asset servicing.
Europe has been dealing lately with all the issues around the Greek debt and the possibility of a “Grexit”. While the final decision on the matter would have its significant repercussions, the uncertainty that has come with the problem in the last few months is also expected to have its own associated costs. It could also impact the long-term competitiveness of the region vis-à-vis its competitors in the US and Asia-Pacific.
When we focus specifically on the capital market issues. there are several significant regulatory changes happening in the European capital markets at this point in time. EMIR, Mifid II, Basel III, T2S and CSDR are all regulations at various stages of implementation. From a post-trade point of view, several of these regulations are expected to have significant impact, especially when we talk about T2S and CSDR. However, the continuing concern over regulatory implementation in Europe is that the delay and uncertainty over when the regulations come into effect could prove costly for the region overall. An example is the delay by European Securities and Markets Authority (ESMA) in providing the draft technical standards. Similarly, the recent decision by Monte Titoli to delay joining the T2S, at least for a few months has proven to be a setback for the project, considering it was easily the largest CSD to participate in the first phase and would have been instrumental in measuring the effectiveness and success of the implementation.
There is a lot of ground that the regulators and industry are trying to cover in an economy that is still suffering from the after-shocks of the financial crisis. While trying to do everything in a hurry isn’t the answer, it is important to ensure that the deadlines are kept as much as possible, otherwise on-going delays will directly impact European market’s competitiveness.
There has been an interesting article in the Financial Times by John Authers on the ‘bondification” of the equity markets, namely the tendency for fund managers to invest in good dividends, low debt and high return on equity. Some of the causes of this phenomenon include the low interest rate regime in many of the mature markets such as the US and the tendency for high risk aversion after the financial crisis. Authers also quotes a move away from traditional finance theory as comparing returns with the risk-free rate does not always work given the issues in defining what a risk-free rate is in the current fixed income market landscape. He also mentions issues fund managers have with risk diversification since it did not seem to work in the financial crisis for commodities or emerging market equities.
The author concludes by saying that the bondification of risk might not necessarily be desirable in the long run. I agree broadly with the conclusions of the author but would also like to point out some relevant issues in this context. The first is that the low interest rate environment will not stay forever, hence the market is going to move away from the tendency for bondification and this would benefit both fixed income and equity markets. The fixed income markets would see more activity and the equity markets would be able to get out of the constraints that bondification places on it, including investment into mainly blue chip stocks which would be popular anyway and away from less established or riskier stocks of smaller firms.
The second issue is regarding the falling relevance of the investment models, namely the use of the risk-free rate and falling tendency for risk diversification. Just because there was a financial crisis does not mean that financial theory or models become less relevant. The issue was less with the models and more with the practice and issues in the economic, business and political environment. The use of a risk-free rate might still be of relevance, it might just have to be calculated more carefully and using a set of return indicators instead of certain benchmark bonds. Similarly, risk diversification is still as relevant as it was before the crisis. With the lessons from the crisis, our approach can become more sophisticated and complex, but we cannot stop using diversification just because it might have failed in the financial crisis, which was (hopefully) a once in a lifetime phenomenon. It should work as long as there is no crisis of similar proportions.
The Saudi Arabian equity market, the Tadawul, has recently begun the process of easing access for foreign investors. A late entrant on the global equity scene, the market itself is not something to be scoffed at, being larger than the likes of the Mexican, Russian, and Indonesian equity markets in terms of market capitalization. And this is without the Saudi oil firms, which are state-owned. However, there are some significant restrictions on foreign investment such as limits on the minimum asset size a firm should have, the percentage a foreign investor can own in any one stock, and the T+0 settlement period which is a challenge for any foreign investor.
The opening up has been a gradual process. Some investors such as HSBC have shown their hand by moving early, but most leading global investors seem to be taking a wait and see approach. Also, some foreign institutional investors are in the process of completing their application for the Qualified Foreign Investor license. So while it will be some time before the Tadawul becomes as important as some of its other emerging market counterparts in the international context, it seems to fit the bill of the last frontier for global investors among the large emerging markets. A possible bright spot for an asset class that has been under the weather of late..
How can wealth managers capture the next wave of clients in light of a shift in the core client base, dynamic client expectations, stringent regulations, and emerging technology? Celent clients can catch the replay to the latest Celent WM webinar here: http://celent.com/node/33745
This webinar is based on the following reports:
Finance Meets Fashion: Wearables in Wealth Management
Effectively Serving the Mass Affluent
Beyond Budgeting: The New Generation of Personal Finance Tools
NextGen Investors: Targeting the Millennial Generation
Nasdaq has recently one become of the first leading capital market firms to consider the use of Blockchain and Bitcoin technology. It plans to use the technology in its private markets platform to begin with, with the possibility of using it in its clearing houses and CSDs at a later date. In some ways, this is the most significant commitment any large financial market firm has made to adopting Blockchain. Even more interesting is the manner in which Nasdaq has gone about the process. It has made one of its VPs an evangelist of the platform, with a strategic mandate. This is an interesting example of a tech-savvy firm utilizing an innovative approach to encourage and advocate for what it sees as the next big wave of change in the financial markets.
However, the open architecture of Blockchain technology and the difficulty in controlling the kind of transactions that could happen through it make it complex to use, and there are some resultant security concerns as well, which is why large banks are normally reluctant to adopt such a technology. So the industry would have to put checks in place before there can be widespread adoption of Blockchain in capital markets. There are already some existing provisions with Blockchain to address these requirements, and we can expect more effort in this regard as time goes on.
With the rise of the robo-advisor, the possibility of a similar advance with regard to research is enticing. Robo-advisors help investors make choices based on their personal investing preferences. Associated Press already uses automated robot journalists to produce some of its articles. Similar robot analysts could undertake analysis for varied fields such as finance, marketing etc. using APIs to obtain news and information from platforms such as Thomson Reuters and Bloomberg and other similar providers. Where subjective information is required, mechanisms similar to SurveyMonkey could be deployed to undertake surveys by these robot analysts, which could then use advanced software systems to analyze the information so obtained. A lot of academic research could also be conducted by machines in this fashion. Universities already employ supercomputers in research and such machines could arguably even produce finished papers that could add value.
Indeed the use of machines can be envisioned to go beyond such work. CEOs could be machines or robots instead of human beings. Furthermore, it won’t be surprising in such a context, with laws permitting, if people elect supercomputers to represent them democratically. Instead of a scary Skynet, we could have a number of robot representatives that could each represent a different constituency and act in accordance with the specific choices and constraints put in place by the electorate. Any controversial decisions could be vetted by the head of the party the computer represents, who could be a human, or even by a neutral ombudsperson. None of this is probably something that hasn’t been thought of or discussed in one form or another elsewhere. I was just wondering how long we have before it affects us even more than it already is. Just some thoughts on a slow Sunday.
There has been an ongoing dialogue for some time now between the European capital markets regulator European Securities and Markets Authority (ESMA) and the Commodity Futures Trading Commission (CFTC) of the US regarding the requirements for clearing of OTC derivatives. In the opinion of market participants, the lack of agreement, over issues such as margin requirements and the period for which a transaction can be considered to be at risk, is highly detrimental to the efficient functioning of the global capital markets. The evidence has also shown that increasingly there are two separate pools of liquidity operating in the US and European markets respectively, a sub-optimal and undesirable state of affairs. However, from the point of view of the trading participants, the important thing to keep in mind for the future is that the two regulators are in ongoing discussions and the contentious issues are specific and not pervasive. There is also a great deal of respect and understanding that has been displayed by both regulators for the other’s point of view, all of which bodes well for overcoming their differences. An agreement would allow for greater liquidity and higher levels of market efficiency, and should also provide a much needed boost to global derivatives trading.
The recent letter by several firms to the European Commission regarding the upcoming changes in the MiFID II regulations for the commodities markets raises some important issues. Few industry participants or observers would dispute the point that commercial users of commodities should not be treated on par with firms that speculate in the derivatives markets. A firm that uses a commodity as a raw material often needs to trade in commodity derivatives for hedging purposes. If the current exemptions for such a firm are removed, then its cost of operation would go up accordingly, and the end-users would also end up paying more. However, when these firms trade commodity derivatives for speculative purposes, the same argument does not apply. Hence, there is no similar rationale for exemption from MiFID II regulations that affect financial firms trading in the commodity markets. In this case, the argument that commercial users of commodities or commodity trading firms have required no support from the government in the past and hence would not need the same in the future does not hold. Just because something has not happened in the past does not mean it will not happen in the future. The main aim of the regulator should be to reduce systemic risk, wherever it might lie. As long as the regulators are able to take such a nuanced approach, the industry participants should have nothing to complain about. Otherwise, they have reason to feel aggrieved.