The known unknowns
10 December 2019
As the decade draws to a close, the securities lending industry arguably has more questions than answers about what the future will bring. David Lewis of FIS takes stock of what’s ahead
Image: Shutterstock
Financial markets love certainty. Certainty brings stability, predictable growth, political balance and public harmony. It can even dispel the threat of war and civil uprising. If certainty is capable of bringing all these positive outcomes, at least in theory, is it possible that the opposite is also true? If that is the case, as the second decade of the third millennia counts out its final days, we may well be in for quite a ride.
Between us and the end of the decade (who could believe the Millennium Bug drama will soon be 20 years old?) lies the UK election; arguably one of the most pivotal in living history. Its outcome may shape the political landscape across the UK and Europe for many years to come, and that outcome is probably the least certain one ever. Brexit will undoubtedly affect the securities finance industry to a greater or lesser extent, and some organisations have already taken action setting up new entities, either physically or just legally, to ensure representation in the UK as well as mainland Europe. This has been an active part of our work here at FIS as we help our clients prepare for what may come, but some market participants remain on the sidelines waiting for some certainty before making a move.
The securities finance industry, outside of political issues affecting the wider market and community, faces a very high level of uncertainty going into the new year. The Securities Financing Transactions Regulation (SFTR) has been looming ever larger on the horizon as the April 2020 go-live date draws nearer (which is curiously on a weekend), but it is one of the few certain things about it. Much remains unknown as the market awaits the release of the level three documentation which will detail the reporting requirements. For those going live in the first phase, that will leave them a period of around or under four months to complete the reporting developments. This is no small ask: it will require analysis of the requirements, design and build of the actual reporting outputs, or at least the amendment of reports constructed so far, connectivity testing and go live. In the middle of this will be the Christmas break and technology year-end freezes. As far as certainty goes, it will be in short supply, save for the fact that many are facing a very busy holiday season.
Few expect the launch of the legislation to be delayed so it seems that April will indeed herald in a level of regulatory transparency that the securities finance market has never experienced. The rollout of other large-scale reporting requirements, such as the European Market Infrastructure Regulation (EMIR), would also suggest that post April will be no holiday either.
Not too far in the future, in September 2020, Central Securities Depositories Regulation (CSDR) will also go live. As far as the regulation itself goes, it has certainty written all over and indeed through it. Certainty is, in fact, its core purpose as it aims to enshrine the process of fails management into a strict set of rules with punitive fines attached. What is uncertain is the effect this regulation will have on the market. Already some firms are indicating it may be the final straw with regards to their voluntary involvement with the securities lending market, citing the risk of large fines outweighing the revenues that they earn. This will have the knock-on effect of withdrawing some liquidity from the market and, contrary to the aims of the legislation, potentially decreasing settlement certainty as lenders remove their supply. The European Securities and Markets Authority has acknowledged a delay in implementing the regulation is likely, casting further uncertainty around the settlement certainty regulation.
Turning back to politics, 2020 will also bring us the US elections. Much like the UK, the outcome could bring about a seismic change in direction for the world’s largest economy, with the effects felt around the globe. On one hand, there may be a continuation of the regulatory bonfire that has been burning for the past three years, bringing looser control of both the financial markets as well as the industry at large. Alternatively, a sharp change in direction will bring taxes to the wealthy, the big corporations and significant amounts of legislation and regulation to reign in the banks and corporations. Coupled with Brexit and our own elections, the UK faces significant uncertainty over the coming months, and potentially years to come.
The rise of environmental, social and governance (ESG) influences will also increasingly affect the securities finance markets as beneficial owners behaviour and investment strategies change. Differing asset mixes, potentially greater involvement in voting obligations and less involvement in dividend trading will all affect the way the market operates. In potential conflict with this is the fiduciary need to lend funds’ assets to earn much-needed revenues, particularly as many funds drop their management fees to zero.
How is our industry expected to cope with all these changes? Data and technology will certainly be two key elements in any organisation’s survival strategy. Being seen to deliver best-execution to satisfy the requirements of the second Markers in Financial Instruments Directive will require sophisticated intra-day data to correctly rate trades and actively mark-to-market. The need to deliver accurate and timely reporting to the relevant regulators under SFTR will require a sophisticated technology lift, ensuring accurate and on-time deliveries of significant quantities of data. All the while, new collateral and governance schedules from beneficial owners applying their new ESG policies will change the dynamics of the lendable pool. New entrants to the market will be disrupting the traditional transaction chain, bringing additional routes to market and extra liquidity, but while demand remains low, automation through advanced technology will be required to keep the returns at an acceptable level.
2020 is the start of a new decade and a whole new era for the securities finance market. The challenges the market will face will demand that you have a strong technology partner to make the most out of the changes to come. Are you ready for those changes? If that’s a yes, can you be certain of that?
Between us and the end of the decade (who could believe the Millennium Bug drama will soon be 20 years old?) lies the UK election; arguably one of the most pivotal in living history. Its outcome may shape the political landscape across the UK and Europe for many years to come, and that outcome is probably the least certain one ever. Brexit will undoubtedly affect the securities finance industry to a greater or lesser extent, and some organisations have already taken action setting up new entities, either physically or just legally, to ensure representation in the UK as well as mainland Europe. This has been an active part of our work here at FIS as we help our clients prepare for what may come, but some market participants remain on the sidelines waiting for some certainty before making a move.
The securities finance industry, outside of political issues affecting the wider market and community, faces a very high level of uncertainty going into the new year. The Securities Financing Transactions Regulation (SFTR) has been looming ever larger on the horizon as the April 2020 go-live date draws nearer (which is curiously on a weekend), but it is one of the few certain things about it. Much remains unknown as the market awaits the release of the level three documentation which will detail the reporting requirements. For those going live in the first phase, that will leave them a period of around or under four months to complete the reporting developments. This is no small ask: it will require analysis of the requirements, design and build of the actual reporting outputs, or at least the amendment of reports constructed so far, connectivity testing and go live. In the middle of this will be the Christmas break and technology year-end freezes. As far as certainty goes, it will be in short supply, save for the fact that many are facing a very busy holiday season.
Few expect the launch of the legislation to be delayed so it seems that April will indeed herald in a level of regulatory transparency that the securities finance market has never experienced. The rollout of other large-scale reporting requirements, such as the European Market Infrastructure Regulation (EMIR), would also suggest that post April will be no holiday either.
Not too far in the future, in September 2020, Central Securities Depositories Regulation (CSDR) will also go live. As far as the regulation itself goes, it has certainty written all over and indeed through it. Certainty is, in fact, its core purpose as it aims to enshrine the process of fails management into a strict set of rules with punitive fines attached. What is uncertain is the effect this regulation will have on the market. Already some firms are indicating it may be the final straw with regards to their voluntary involvement with the securities lending market, citing the risk of large fines outweighing the revenues that they earn. This will have the knock-on effect of withdrawing some liquidity from the market and, contrary to the aims of the legislation, potentially decreasing settlement certainty as lenders remove their supply. The European Securities and Markets Authority has acknowledged a delay in implementing the regulation is likely, casting further uncertainty around the settlement certainty regulation.
Turning back to politics, 2020 will also bring us the US elections. Much like the UK, the outcome could bring about a seismic change in direction for the world’s largest economy, with the effects felt around the globe. On one hand, there may be a continuation of the regulatory bonfire that has been burning for the past three years, bringing looser control of both the financial markets as well as the industry at large. Alternatively, a sharp change in direction will bring taxes to the wealthy, the big corporations and significant amounts of legislation and regulation to reign in the banks and corporations. Coupled with Brexit and our own elections, the UK faces significant uncertainty over the coming months, and potentially years to come.
The rise of environmental, social and governance (ESG) influences will also increasingly affect the securities finance markets as beneficial owners behaviour and investment strategies change. Differing asset mixes, potentially greater involvement in voting obligations and less involvement in dividend trading will all affect the way the market operates. In potential conflict with this is the fiduciary need to lend funds’ assets to earn much-needed revenues, particularly as many funds drop their management fees to zero.
How is our industry expected to cope with all these changes? Data and technology will certainly be two key elements in any organisation’s survival strategy. Being seen to deliver best-execution to satisfy the requirements of the second Markers in Financial Instruments Directive will require sophisticated intra-day data to correctly rate trades and actively mark-to-market. The need to deliver accurate and timely reporting to the relevant regulators under SFTR will require a sophisticated technology lift, ensuring accurate and on-time deliveries of significant quantities of data. All the while, new collateral and governance schedules from beneficial owners applying their new ESG policies will change the dynamics of the lendable pool. New entrants to the market will be disrupting the traditional transaction chain, bringing additional routes to market and extra liquidity, but while demand remains low, automation through advanced technology will be required to keep the returns at an acceptable level.
2020 is the start of a new decade and a whole new era for the securities finance market. The challenges the market will face will demand that you have a strong technology partner to make the most out of the changes to come. Are you ready for those changes? If that’s a yes, can you be certain of that?
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