Asset servicers in the US are being forced to adopt new technologies on an accelerated basis amid the rise of new digital entrants like Robinhood providing free trading to retail investors on gamified platforms in the US
It was an unusual start to the year for the US asset servicing industry when Robinhood had to restrict trading in stocks including Gamestop because of the volatility caused by retail traders.
Traders were determined to squeeze hedge funds that have short positions in the companies.
While the stock price of GameStop stock increased, Robinhood, along with other brokers in the market, had to put up money with the Depository Trust & Clearing Corporation (DTCC) to back those trades during the two days it took for them to settle.
Since then there has been a surge of debate around the settlement structure in the US, and also in other countries too.
The settlement date for stocks used to be T+5 or five business days after the transaction date before moving to T+3. While every country has its own settlement cycle, a number of countries operate on T+2 or two business days after the transaction date.
DTCC has called for a move to a T+1 settlement infrastructure whereas others, such as Robinhood’s CEO Vladimir Tenev, have gone that one step further and have called for real time settlement, T+0.
Back in February, Tenev said he was pushing for the settlement infrastructure to be modernised. He noted that the events that occurred were not uniquely a Robinhood issue but an industry issue where many broker dealers and trading platforms prevented their customers from opening positions in these stocks.
Tenev suggested that solving the problem for the system will require “systemic change” and fixing of the “antiquated settlement structure”.
That same month DTCC launched a two-year industry roadmap to shorten the settlement cycle for US equities to one business day (T+1) with the aim of completing this vision by 2023.
The corporation has since collaborated with the Securities Industry and Financial Markets Association (SIFMA), and the Investment Company Institute (ICI) to help accelerate the move of the US securities settlement cycle to T+1.
The move towards an accelerated settlement structure has been criticised by a number of industry participants who say that moving to T+0 will be costly and will remove the invaluable benefits of netting.
Same day settlement is a huge stretch target that would require immediate settlement of all transactions, no netting, no end of day processing and no overnight cycle. The current settlement cycle model allows large amounts of trading to take place. For example, you can trade as much as you like in a particular stock — buys and sells — with the relative certainty that your net position is ok at the end of the day, or at the end of T+1 or T+2.
Moving to T+1 has caused some concerns too. According to experts, while T+1 makes sense domestically within the US, it may present challenges for non-US investors, not least of which is foreign exchange (FX) because T+1 doesn’t leave much room for a delayed order of confirmation.
Another expert has highlighted that T+1 isn’t free and carries risks of its own despite the aim to reduce risk in the market.
Aside from this, the start of the year also kicked off with the inauguration of the US’ new president Joe Biden.
With the new administration, experts expect regulatory engagement to increase and there are already early signs of this in asset classes such as crypto.
“We are sure the Elon Musk/SNL and bitcoin volatility will not go unnoticed. We also see the focus on environmental, social and governance (ESG) take a front seat. However it is still early days, there is a lot that the administration will have to get through before it gets to US custody,” observes Uday Singh, head of Broadridge Consulting Services.
It is against this backdrop that the US’ asset servicing industry is operating against right now.
Uday Singh, head of Broadridge Consulting Services, puts it like this: “With the rise of new digital entrants like Robinhood who are providing free trading to retail investors on gamified platforms, the asset servicers behind these companies need to move to a new cost paradigm.”
“This is forcing them to adopt new technologies on an accelerated basis as well as eliminate the dirty secret of manual processing that has lived on for so many years.”
Acceleration to technology transformation
Experts say technology is going to play a major role in enabling the US to boost its asset servicing industry and bring greater access to the US capital markets and eliminate manual processing.
“The US asset servicing industry has had the luxury of not having to reinvent itself in decades. However disruption is coming – just as payments, currency, and retail investing have been disrupted, so will the middle and back offices,” says Singh.
According to Singh, technology will drive this disruption, especially distributed ledger technology and artificial intelligence (AI). Asset servicing is one of the primary sectors where these technologies can really move the needle, and the main driver behind using technology for business improvement is digital transformation.
George Ralph, global managing director, RFA, suggests that this captures a number of different areas as digital transformation are essentially the “process of reviewing business operations with the view of automating to improve efficiency”.
The two main focuses from a technology standpoint driving business change are data management and collaboration.
Experts believe that a comprehensive data management strategy promotes better business and deal flow, and in the new working environment data has had to be handled in a different way to before.
“Moving towards a centralised data strategy, where each pool of your data is effectively poured into a central location, allows that data to then be extracted via a central dashboard negating the need for lots of spreadsheets, apps and platforms,” comments Ralph.
This is said to be a far more effective way of keeping sensitive data safe as you are working within a controlled environment where users can have different levels of authority for data use.
Additionally, Ralph highlights “You are also able to monitor your network, using AI and behavioural analysis tools, to keep your users and data safe but also track any anomalies in data usage from your team, helping you avert any issues in terms of data abuse”.
Most firms now have platforms in place that offer collaboration tools, like Microsoft Teams and Sharepoint, as part of their package. This marks a significant move forward in business IT functions and also a secure way to communicate.
The next iteration of these tools will come as firms understand just what level of ability these apps have: voice and message recording, secure file transfer, live file working and so on.
“So, now the dust has started to settle around our day to day business set up and function, training on the tools now already in wide use will take collaboration to the next stage of business function,” adds Ralph.
Scream if you wanna go faster
Enhanced technology will have to be deployed to move to T+1. Experts say the technology for this is already there, the problem is that it is costly and a lot of processes will need to be reviewed.
Indeed, the move to T+1 is a double-edged sword and industry participants are divided on whether this move is appropriate.
DTCC, SIFMA, and the ICI believe moving from T+2 to T+1 will benefit investors and market participant firms by reducing systemic and operational risks.
In a May 2021 whitepaper, SIONIC highlighted that legacy mainframe-based infrastructures, green screens, manual workarounds and duplicative processing are still very much alive in the back offices of some of the largest global banks and in many small regional fully disclosed brokerage firms.
Broadridge’s Singh views the move to T+1 as a great opportunity for the industry to reduce risk in the marketplace.
“However this is not without significant one-time cost and ongoing revenue erosion for some players. Boards must ensure that they understand the financial impact of T+1 to their balance sheets and profits and losses early. Many seem like they have not quantified the financial implications yet,” adds Singh.
One opportunity, according to Singh, is counterparty risk reduction and associated capital that will be freed up at the depositories, but there is also an impact on funding, collateral management, and trade break resolution.
Regarding challenges, some industry experts have identified that changes to the existing settlement convention will require tremendous industry-wide testing. Additionally, there are a lot of other things going on in the industry that need to be balanced with this.
“The biggest challenge is time, we will have to rethink processes --- timelines in some will have to crash by as much as 100 per cent. Firms that have made investments in real time capabilities driving operational efficiencies will be better positioned. There will be winners and laggards!” Singh exclaims.
Meanwhile, the US Securities and Exchange Commission (SEC) is working to make changes to mitigate the risks of similar future events such as Gamestop.
During the House Financial Services Committee on 6 May on the GameStop saga, Gary Gensler, chairman of the SEC, argued that while entities such as GameStop, Melvin Capital, Reddit, and Robinhood have garnered a significant amount of attention, the policy issues raised by this winter’s volatility go beyond those companies.
Gensler stated: “One thing that I’ve come to believe is that technology can bring greater access to our capital markets. Our central question is this: When new technologies come along and change the face of finance, how do we continue to achieve our core public policy goals and ensure that markets work for everyday investors?”.
Weighing in on how the SEC will broach the subject going forward, Singh muses: “This is a tough one. The SEC will have to figure out how to balance the integrity of the free market with investor protection. The sad truth of the markets is that someone is always left holding the bag. We will wait and see what the SEC can do…I do not envy their challenge on this topic!”
