What are the most prominent risks in the market at the moment? What are clients concerned about?
Risk is a broad term, and you have to be careful to differentiate what we are specifically talking about—counterparty risks, operational risks or systemic risks? Each of these has different measures, and different aspects that need to be addressed.
Typically, however, we are seeing that our clients are focused on counterparty risk, and I find that surprising. With all the regulatory work that has been done, and the focus on central counterparties, I would actually be more concerned that systemic risk is increasing. Equally, with regards to the operational side of things, the scope for error is much larger there.
I’m not by any means belittling the importance of counterparty risk—it is critical, and the focus that the regulators have put on it is legitimate. However, when considering the most pressing issues, I would be more inclined to focus on operational risk and liquidity risk.
There is such a stringent requirement for high-quality collateral for almost everything our clients do. Several different regulations require a certain level of collateral, and if it’s not available when it’s required, we will see a liquidity crunch that could potentially generate the next crisis.
I see that as a systemic issue, but so far, that is the way that the regulators are going. We are struggling to find the best ways to optimise collateral, and to optimise liquidity, but it’s becoming increasingly difficult and it will eventually cause problems. To me, that’s a bigger risk than counterparty risk.
Why do you think your clients are more focused on the counterparty side of things?
Infrastructures such as SIX are regulated differently to banks, and therefore have a lower risk premium attached to them. The issue of segregating assets is very relevant to our clients, as they are also dealing with agent banks. However, we have had asset segregation at a sub-custody level for many years, and a client that is, for example, an investment bank, is already required to segregate its own proprietary assets from those it holds on behalf of clients.
So assets are generally safe. What is not safe is cash. But still, there are mechanisms to place cash tactically, or to convert it into securities, in order to make it as safe as possible. While you may inadvertently end up sitting on cash, and that cash is exposed if something was to happen to the bank overnight, all of this is against a background of relatively few failures. This doesn’t happen often.
We’re creating solutions for scenarios that are possible, but unlikely. In a crisis, you can’t know what is going to happen, so you have to plan for the worst and hope for the best. But, with clever cash management on the part of the clients and ourselves, we can mitigate those risks to quite a high level.
What I struggle to mitigate is the systemic risks arising from the concentration of liquidity. There are problems around this on the horizon, and they are only going to get worse.
Were the regulations put in place after the financial crisis over-zealous? Have they caused as much harm as good?
They’re focused on transparency, and that is fundamentally a good thing. Requiring collateralisation of transactions is also a good thing. However, it’s important to consider how the various regulations interact with each other and what the cumulative effect is. Regulations may be generally good in isolation, but when you put them together you often find concentrations that you hadn’t anticipated.
I just don’t believe that you can systemically automate crisis response. In the case of the last global financial crisis, elements of it were dealt with well, even without any regulation in place. That happened because market participants—competitors, clients and traders—picked up the phone over the weekend and matched transactions themselves. This ran between Europe and North America, and by Monday morning we were in relatively good shape.
There is a lot to be said for a common-sense approach and for professionals getting together to ensure stability. You can create codes and triggers and reports, but all that is going to do is automate a process that is not the right process for the problem. It’s not going to work.
You can’t automate the wealth of experience of people who have been in the market and dealt with these kinds of issues for the last 20 years. Sometimes you just need to get those people talking to each other, that’s what works, and the benefits of that apply to everyone.
Whatever the next global issue is, it will certainly be different to what we have planned for. We need a system that is flexible enough that when an unknown problem comes along we can figure out who the right people are to address it properly. We are fortunate that, in the post-trade industry, those people are there.
What other challenges is the industry facing with regards to regulation?
I think the biggest challenge we have as far as regulation goes is selective and individual interpretation of the implementation. In some cases, there are different jurisdictional interpretations, which increase costs and don’t necessarily reduce the likelihood of a major fail if there is another crisis.
Different national regulators will implement different timelines and accept different solutions to manage the same thing. That can’t be good. If the regulation applies on a pan-European level, there should be one level of collateral that’s acceptable and one timeline in place. Different implementation models create inconsistencies—the regulation itself isn’t the biggest problem, it’s the way in which it’s implemented.
Inconsistency creates huge costs for the industry, because each institution has to get a legal opinion on every market it works in.
Each institution has to gain access and force through its rights in the event of a counterparty failing in each particular country, which is difficult, because insolvency laws are different in each country.
If you’re going to put regulation in place, do it once and do it right. Consult with people who know what they’re talking about and can give a pragmatic view on things, and implement something that makes sense. That would make it cheaper, easier and safer for the industry as a whole.