Continued pressure on margins during 2023 will bring additional scrutiny to the cost of executing business, predicts FIS’ David Lewis. For the industry, the question will be when, and how hard, to pull the levers that are in reach to improve efficiency and to reduce cost
There is only so much that you can control in any aspect of your business. As such, correctly identifying which levers can be pulled effectively is key to making the most of the opportunities your market can offer.
It could be argued that the securities finance and collateral market is largely beholden, and therefore reactive, to the forces that affect it, including global economics, politics and regulations. Simply put, interest rate movements, market volatility, and boom and bust cycles all affect the market and can drive demand up or down. To anyone who has spent time on the lender or supply side of the street, it is patently clear that you cannot generate demand to borrow securities. You can only take advantage of that demand by being the most economically attractive lender, which is not always about fee or rebate levels.
Looking back at 2022, at first glance, the headlines were not bad at all. For one thing, global revenues were around 7 per cent higher than those achieved in 2021. However, regional differences, most notably in average fee levels, meant that Asian and European markets declined overall by roughly 2 and 6 per cent respectively. The North American market, aided by its relative size, carried the global market forward, with average fee levels in both the equity and fixed income markets around 10 per cent higher than in 2021.
While headline revenue numbers and year-on-year values may have looked good, with global revenue breaching the $12 billion mark in 2022, perhaps more importantly last year saw a double figure percentage rise in transaction volumes, continuing a trend this column has identified in previous years. The implication is that margins will continue to be under pressure, bringing additional scrutiny to the cost of executing business.
Looking forward, 2023 will be all about efficiency. But what does that mean, and which levers should organisations be looking to pull?
Headcount and automation
Headcount is an obvious one, albeit uncomfortable or unpopular. The first quarter of each year is often the time that all types of organisations look at their human resources and analyse where reductions or relocations might make sense. Several major organisations have already announced plans to cut certain percentages of their staff, and the trend towards moving certain roles from expensive to lower-cost locations is set to continue, or even accelerate.
This particular lever can rarely be pulled in isolation, however. Human resources can only be removed if the tasks they perform are also removed, reassigned — assuming that other resources have the bandwidth — or automated.
Indeed, the automation of tasks, and specifically those that cannot be eliminated completely, is going to be a continuing trend through 2023. As a market largely at the mercy of the forces around it, the securities finance and collateral industry needs to focus further on pre- and post-trade costs of all types and flavours. Pre-trade has enjoyed significant focus over recent years, with advances in market data analytics, including our own FIS Securities Finance Market Data services, which feed intraday insights into automated trading and marking activities.
However, there is more to be done here as the cost of automation can sometimes move in the wrong direction, particularly if a lack of competition hampers progress. Forthcoming developments from FIS will be focusing hard on the concept of the most economic match, which brings together all the aspects of a trade match that impact the return on the activity, including collateral costs, RWA impact and counterparty profiles.
Counterparty profiles and activity history are just one aspect of what constitutes the most economic match. Factors such as settlement rates, contract and billing breaks, and standing settlement instruction (SSI) issues, can all affect the overall cost of a transaction. The world of post-trade is one in which many market participants are expected to focus their efforts and investment in 2023, making this a very important lever that can be pulled.
Digitisation of assets
Technological advancements are not limited to automating pre- and post-trade activity, of course. The very assets that are managed by beneficial owners and their custodians, lent to borrowers, and used as collateral, are also changing.
In particular, the digitisation of assets is rapidly emerging as an area in which efficiency gains can be felt quickly. While adopting distributed ledger technologies remains a conceptual challenge for some, the utilisation of tokenised assets may be an easier development to understand and adopt.
Tokenised securities offer multiple advantages over their simpler electronic record versions, much in the same way that digital records provided a huge leap forward over the paper or physical securities that preceded them. In particular, the ease of instant transfer of asset ownership, backed by the audit trail recording their movements, increases the traceability of assets across transaction and collateral chains, while also improving settlement certainty.
Harnessing tokenised securities
Using tokenised securities not only reduces post-trade costs, it also creates an opportunity to detach the delivery of collateral and borrowing of securities from traditional settlement cycles. The adoption of tokenised securities will enable the intraday delivery and recall of assets, creating the possibility of intraday repo and securities lending transactions. Shortening the length of a securities lending transaction may negatively impact the revenue that an asset can generate.
Lower revenue for lenders and beneficial owners translates into lower costs for the borrowers of the assets, of course. But that does not necessarily mean that the demand to borrow those securities will rise proportionately. In other words, it is more important than ever to focus on the overall cost of undertaking that transaction.
On another note, custodial costs for tokenised assets are predicted to be lower than their electronic record brethren. This may benefit the providers of custodial services that invest in servicing such securities. Indeed, several large custodians are publicly backing the development of tokenised securities across their businesses, and not just securities finance and collateral.
Benefits of this approach include improvements in storage security, corporate actions processing, and asset tracking, thereby leading to a reduction in risks, including fraud. While some resistance remains among investors and regulators, tokenised securities are an inevitable development in the securities finance markets as the industry looks for levers it can pull to increase efficiency and reduce costs.
As 2023 develops, the question is not whether to act, but when, and how hard, to pull the levers that are in reach.
