If we can order on Amazon for next day—and sometimes the same day—physical delivery, and if we can buy software and download it immediately after paying for it, why do we have to wait two days for our securities, which are transferred electronically to arrive in our account?
Granted, there are significant differences between an Amazon order and a securities transaction. However, in a much-lauded post-crisis ‘harmonised’ Europe, how far will current initiatives intended to improve efficiency take us? How will a regulation for central securities depositories (CSDs) ensure we settle on the intended settlement date? And, ultimately, what would it take for us to replicate the Amazon experience in post-trade?
Building the foundations
Creating an integrated low-risk and low-cost post-trade environment requires a high degree of standardisation and interoperability. The European Central Bank’s Target2-Securities (T2S) has played an important role in recent years in achieving this for cross-border securities settlement, propelling the market further towards harmonisation in the areas of corporate actions, a common settlement day, settlement finality and matching fields.
It has also galvanised progress in securities processing: the harmonised functionality for the 24 CSDs in T2S has, in principle, enabled domestic and cross-CSD settlement via a single T2S CSD (subject to CSD links being in place). The Eurosystem’s consolidation of Target2 (T2)—the real-time gross settlement (RTGS) system for the processing and settlement of payment orders in central bank money—with T2S planned for November 2021—has the potential to drive further process optimisation.
From a regulatory perspective, Central Securities Depositories Regulation (CSDR) and the EU Shareholder Rights Directive (SRD II) are hugely impactful to all securities participants, with a focus on investor protection, timeliness, speed and efficiency and, in the case of CSDR, uniformity and standardised market practice.
CSDR, and its demand for increased settlement efficiency, is certainly a step towards Amazonisation. With Amazon, a failure to deliver goods on the intended delivery date could be escalated to the retailer, followed by the cancellation and the purchase of goods from another seller. Correspondingly, under CSDR, the CSD will invoke penalties for the late settlement of securities and mandate a buy-in for securities not received by the buyer from four days after the intended settlement/delivery date. The buyer will then purchase securities from an alternative source.
Yet there remains work to be done. With respect to T2S, volumes remain low. Feedback in industry forums indicates that an average of just 600,000 instructions are processed per day, while ECB statistics also show that cross-CSD settlement volumes are below 1 percent. T2S only covers two currencies—the euro and the Danish Kroner.
While CSDR has brought positive changes, challenges remain. For example, some investors’ operational processes might not be fully automated and they might be reliant on e-mail or other manual/non-straight-through processing (STP) interfaces permitted by their securities services providers. This setup may hinder their own settlement efficiency and, by default, others in the settlement chain.
The impact of extra-territoriality is, as always, a key challenge for regulations such as CSDR and SRD II. There is a pressing need to educate foreign investors on new European rules and the risk they will face if they do not make meaningful changes.
What might an Amazonised securities post-trade industry look like?
The Amazon experience is based on a seemingly boundary-less product suite, efficient distribution, a user-friendly app, payment and delivery standard settlement instructions and a chatbot for customer queries. Multiple sellers independently contract with the platform’s single gateway to purchase goods and services; physical delivery is fulfilled through mechanisms such as Yodel, DHL and DPD; and services can also be accessed directly through a plug-and-play model. At first glance, it seems incomparable to the securities industry. However, the possibility of 24 national CSDs outsourcing their settlement business complete with all their national characteristics to a centralised system is worth considering. It is not unreasonable to anticipate a European CSD, sitting above the national CSDs eliminating the processing-related barriers. Think of this as the Amazon shell—a single gateway to which multiple sellers or issuers contract.
Issuers would then issue securities in to the European CSD shell, which could provide the utility function to guarantee the transfer of securities to their rightful owner and ensure that transactions are done quickly and efficiently. As a provider of connectivity to the platform and a provider of unbundled ancillary products and services, the custodian would provide client-centric solutions, allowing them to plug and play services such as custody, asset servicing, lending, borrowing and asset optimisation. Settlement may also still feature as a service.
Further possibilities are presented in the context of the data revolution: transparency, risk measurement and management, and benchmarking will uphold effective risk practices and the integrity of post-trade while settlement analytics could become a commodity in its own right and trigger client-centric services. These services could allow clients to seamlessly add solutions such as data analytics, liquidity, collateral management, inventory management and asset optimisation including lending and borrowing.
The journey ahead
To build on the regulatory agenda and the harmonisation initiatives to date, and in order to move towards this Amazonised world, there are five areas of focus for the industry to consider:
Finishing the task of harmonisation with T2S. Bringing additional volumes from European markets onto the T2S platform is pivotal, and would help to lower the T2S settlement fees while the uniformity of processing could also help to convince non-European investors to consolidate their assets in T2S markets. The introduction of new markets in T2S would also be a step towards European market integration.
A regulatory agenda for the new order. The continued need for transparency should not be underestimated, and there is work still to do here. The potential benefits of the legal entity identifier (LEI) have not been fully realised beyond the mandatory trading layer to other areas of the securities value chain. However, its prescription to the entire chain through to the CSD would benefit the buy-in provisions of CSDR and the beneficial owner transparency requirements of SRD II. When considering a regulatory agenda for the new era, a shift in focus from the traditional actors to the new entrants, or so-called “disruptors”, is needed in order to ensure a level playing field for all.
Political integration. Developing the ‘union’ in the European Union will play a significant role in achieving a harmonised European post-trade landscape. European elections carry the uncertainty that any new leadership might have new, differing, competing priorities. This could impact operating models, legal provisions and innovation.
Technological innovation. New technologies such as distributed ledger technology, AI and cloud-based services could improve the collection, management and distribution of information. This creates the potential to deliver new post-trade processes that are much more efficient and effective than the old.
Embracing competition and new roles. The European post-trade agenda should cater for more competition, not less, in all shapes and forms. Account structures have been harmonised through CSDR, EMIR and MiFID II and provide investor choice. Regulatory transparency has led to an unbundling of services providing investors with greater choice. Complementary pricing and products are on the securities servicer’s agenda to meet investors’ demands for cost transparency, usage and the unbundling of the product and service suite. In addition, legal and tax harmonisation would further facilitate investor choice so that investors can be indifferent to where the settlement and custody location should be. The entry of non-banks into the custody space would change the competitive landscape, further ‘de-layering’ post-trade.
While the industry is taking steps towards harmonisation and integration, there is a limit to how far these efforts can take us.
Without a standardised interface, and a standardised set of rules, laws and practices, it is very likely—for the foreseeable future at least—that the status quo will remain.
The industry should ask itself whether it should wait until it has fully paid for the T2S developments to reap the benefits of a then 20-year old platform. The clock is ticking, counting down until the disruptors obtain a true measure of what they need to do to service traditional assets with the new.
However, the task is so colossal that the new world will co-exist with the existing. Custodians will remain crucial but will evolve: additionally servicing crypto assets and becoming guardians of data providing a modular, client centric suite of products and services, diversifying with the new order through collaboration, and performing a variant to their existing role.
The industry can introduce new technology and participants. However, if the foundations are not in place and the barriers and threats not removed, the result will be a new version of
