A New Black Swan

So the latest Black Swan was spotted in the last few days in the UK when the outcome of the Brexit vote took everyone by surprise. While many are still trying to make sense of the whole situation and figure out what it means for the future, the only thing that is certain at this moment is there will be a lot of uncertainty in the coming weeks, months and possibly years.

In question is the constitutional and political arrangement of the United Kingdom and broader EU, but how is it going to impact the financial services industry? The future of the “bank passport” that allowed financial institutions to do business easily across Europe will be a topic of much interest. Restrictions in ease of doing business might result in them moving out of the UK, and some have already started the process. This would not only result in shifting (if not loss) of banking jobs, but could also balkanize the markets. Technology requirements, for example hosting of data centers within national jurisdictions, could similarly balkanize operations. This would also impact adoption of centralized operations, like cloud services, and slow down the growth of start-up culture and innovation. Balkanized operations and restricted market access would deter or slow down smaller players in designing and launching innovative solutions, and help larger incumbents.

Then there is the question of pan-European regulations and initiatives like Target2 Securities. T2S entailed firms with significant European presence to restructure their operations across Europe. While UK never decided to join the T2S project, firms with European operations were so far busy designing their optimal operational mix within continental Europe. If the UK vote now requires further restructuring that may force them to rethink their current plans and impose additional resource constraints. Also of interest would be the LSE-DB merger; even though both parties have said the deal is not threatened by the vote, politicians might have other ideas.

The political negotiations in the coming weeks would therefore be closely watched as market participants look to navigate their way through the latest developments. All in all the level of complexity and uncertainty in the system has suddenly grown manifold. All blame the Black Swan.

To Brexit and beyond!

So the Brexit has finally happened. The equity, forex and bond markets are still reeling from the news, the volatility probably caused as much by the fact that Brexit was unexpected as of yesterday night in the UK as by the event itself.
While the overall impact will reveal itself over the next several years, in the next few months the capital markets would have to deal with issues such as the future of the LSE-DB merger. Does it make sense anymore, and if yes, how do the two parties proceed? One would expect that now there would be political pressure to ensure that trading and jobs do not move away from either London or Frankfurt. Keeping all stakeholders happy would be a more complicated affair, although it could still be done.
EU wide market infrastructure regulations such as T2S and MiFID II would also now be seen in a new light. London was seen as the financial capital of Europe. The EU would now have to proceed with these significant changes at a time when the UK is preparing to exit, and is weighing its options in terms of how best to deal with the rest of Europe. It could take a middle ground as Switzerland has taken, or position itself even further away with more legal and policy independence but less overlap with the European capital markets.
In an earlier blog that considered the possibility of Brexit, I stated that technologically this might be the best time for an event such as the Brexit. Technology is more advanced and we are better connected than ever before across nations and continents. However, undoubtedly there will still be significant impact from an economic, financial and demographic point of view. As always, there will be winners and losers. As a neutral, one hopes that the people in the UK are able to achieve the goals they had envisioned in making this decision.

The European post-trade landscape: regional integration initiatives paving the way for industry consolidation

The biggest changes in the global post-trade industry are taking place in Europe. The Eurosystem’s attempts to create a single market and associated market infrastructure are transforming for the European post-trade industry. Eurosystem’s Target2 Securities (T2S) project and the CSD Regulations (CSDR), along with numerous other regulations, are reshaping the European CSD (Central Securities Depositories) landscape. As settlement gets outsourced to the T2S platform, CSDs will lose a key revenue stream and will have to find new revenue by developing new offerings. Asset servicing capabilities will be a natural choice for many CSDs, but that may not be a winning proposition because they will face stiff competition from custodians, who have been offering these services for a long time. T2S will allow CSDs to expand their market coverage by becoming investor CSDs and offer domestic clients holdings of foreign securities. Efficient management of collateral has become of utmost importance, and T2S’s single liquidity pool allows CSDs to develop new collateral management solutions for their clients. EMIR requirements requiring holding of initial margin for derivative trades with a licensed securities settlement system enhance their opportunity, and most CSDs are developing collateral management solutions in response. Many CSDs are developing similar solutions to stay competitive in the post-T2S world, and there may be oversupply in the market along with duplication of efforts and investments. It is expected that the industry will go through consolidation. It is unlikely that CSDs will go out of business, at least in the short term, but their role will shrink significantly. In a new report we discuss these and several other key issues relating to the European post-trade market participants, including (I)CSDs and CCPs.

Post-trade and the clouds over Europe

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.

New SWIFT-Celent reports released on adoption of T2S

SWIFT and Celent have been closely following developments related to the implementation of the Euro system’s Target2 Securities (T2S) initiative and how market participants are gearing up in preparation for the same. As part of that we published a report titled ‘The European Post-Trade Ecosystem under T2S: Dealing with Complexity’ in March, 2013. Last week two new reports were published looking at the progress made in the last 12 months and what are still some of the open questions. The first of these two reports focuses on development pertaining to the settlement function under T2S, while the second one looks at firm strategies and arrangements for asset servicing and securities payments. These new reports, based on detailed interviews with major participants in the European post-trade environment, find that though there has been progress, the strategies of many players remain unclear. We also identify new offerings in post-trade services that are likely to emerge in the post T2S world and the drivers behind them. The press release of these reports’ launch can be found here.

Rising Market Concentration in the Post-Trade Industry

Several drivers will impact the evolution of the post trade industry. Different drivers act in different directions, however, if there is one common theme that is the concentration of players in the post trade ecosystem is likely to go up over the next 5-7 years and post-trade processing will increasingly become a scale business. This trend will be particularly seen in Europe, especially among market infrastructure and custody service providers. The growing concentration will be driven primarily by adoption of T2S and implementation of CSD regulations. Dark pool regulations will take volumes back to the lit market, helping incumbent exchanges gain more share. Custody service providers will also see rising concentration. T2S will be the prime driver for this in Europe. Local custodians could find consolidation among CSDs detrimental to their role. We expect significant consolidation among local sub custodians, and the market will ultimately be left with a few regional players and some niche players in local markets. Driven by these changes, some global custodians could decide to create their own CSD. Implementation of certain regulations like Basel III, Volcker, and Liikanen proposals could reduce concentration among investment managers and broker-dealers. However, opposing forces such as adoption of best execution and reporting tools, Big Data capabilities, and improved netting capabilities will help large broker-dealers gain market share. In a market that is becoming extremely competitive, harmonized, and industrialized, it is important that participants review and reconsider their current business model. Firms are responding to these challenges in a variety of ways. In the short term broker-dealers are considering headcount reduction, asset disposals, and portfolio run-downs to stay competitive, while in the medium to long run efforts to reduce duplication between geographies and products through centralization and offshoring are gaining traction. CSDs are looking to use common infrastructure allowing for interoperability and to build connections to local CSDs to manage non-local assets for clients. In Europe some custodians and non-euro CSDs may partner with euro CSDs to gain access to T2S. Some custodians will look to buy/build CSDs to gain access to T2S in Europe; however, their number is likely to be limited. Investment in technology to adopt to the post T2S world is a consideration for many players. Celent has learned that some banks are taking this opportunity to upgrade or replace their complete technology infrastructure by taking a firm-wide strategic approach. Provision of efficient collateral management services will also become important. These developments will mean market participants will have plenty to think about. Smaller players will need to consider strategies for survival, while larger players will need to explore opportunities to gain market share in a business that is increasingly becoming one based on scale. We discuss these and many more trends in a recent report titled ‘Future of the Post-Trade Industry, Part II: Rising Market Concentration’.