The Pace of Change
At the beginning of the month, I was invited to speak on the current digital landscape. The term ‘digital’ in this context was extremely broad, ranging from tokenisation and distributed ledger (DLT) to crypto currency, digital assets, and the infrastructure that joins these topics together.
More recently and in preparation to speak at the upcoming ISLA 14th Annual Post Trade Conference, I reflected on a paper that the Association published in 2019 called ’The Future of the Securities Lending Market | An Agenda for Change’. Since its publication, the world has not only seen the launch of Chat GPT, but a growing number of AI tools across many mainstream industries and processes, as well as our day-to-day and working lives, to improve efficiency and speed.
That pace of change however is not yet reflected in well-established pre and post trade financial markets if, for instance, we consider that legacy challenges of the past 30 years are yet to be successfully addressed. Topics like credit worthiness, stock loan recalls, KYC onboarding, interoperability and a longstanding challenge discussed in working groups and conferences for the past two decades, Agent Lender Disclosure (ALD).
For those that remember, the last trending technology discussion topic of blockchain faded away with the epitaph that it was a solution looking for a problem. Looking back, what seems amusing is that this conclusion could sound like a marooned individual, adrift on a raft in an endless sea, who is offered a speed boat, yet rejects it in favour of the raft they are on.
Distributed Ledgers and blockchain have been around in a workable form since 2008 and yet looking at why these are not quite yet mainstream brings us to why the pace of change hasn’t picked up as much as some would like: the complexity of migrating legacy systems, regulatory uncertainty, scalability, maturity and ultimately, cost.
Change is in the Driving Seat
Moving back into the non-digital realm, other changes are afoot that many believe will begin to drive adoption of new technologies.
First let’s consider Accelerated Settlement (T+1) in North America. Recent reports have highlighted that on the surface, the transition was successful, and settlement failures did not rapidly increase. Digging deeper however, we find that instead of a synchronised automation of moving parts, there was an increase in manual effort. That expensive use of resource has two obvious outcomes in that, firstly, future unforeseen volume increases could result in maximum capacity being reached sooner, resulting in a higher proportion of settlement efficiency. The other is that firms, seeing the increased cost and risk, invest in technology that speeds up perceived inefficient practices. This could explain the growth in discussion and published papers pointing to adoption of distributed ledgers.
In Europe, the European Securities and Market Authority (ESMA) are working on a report, due to be published by January 2025, that will set out how the EU will move to T+1. Similarly, the UK’s HMT recently published an interim report and consultation that will also result in a paper at the end of the year, outlining their T+1 go live ambitions.
A second change we should consider is Europe’s Capital Market’s Union (CMU) which includes the DLT Pilot Regime and highlights the importance of fostering a harmonised approach to the issuance of digital assets and tokenisation, to promote cross-border transactions. Adding Accelerated Settlement to the mix makes a strong case for accelerating the adoption of technology.
But How?
Considering all these moving parts, one key weakness stands out. With thousands of participants in the securities lending market communicating across the multiple platforms that are part of the infrastructure eco-system, how can we adopt any technology if we aren’t singing from the same hymn sheet? An eager reader might conclude that standards will solve for that conundrum, but is that ‘data’, ‘language’ or ‘trade lifecycle’ standards? In reality, it is all of the above and so we need a unifying standard to make the technology work in a simple and efficient way. The alternative is that markets build the ‘new’ using the complexity of the ‘old’, which is the cause of many of today’s challenges.
We find a similar challenge at ISLA as work progresses on the review and re-write of ISLA Best Practices. To address the standards’ overlap, we have set ourselves a rather daunting but necessary task of creating a gap analysis between our guidance and that of many of the other trade associations with common features (e.g. collateral) as well as standard setting bodies like ISITC, SMPG, ECB’s SCoRE, BCBS, IOSCO, FSB, etc. This reminds me both of a quote used by a colleague that “everyone likes a standard as long as it is theirs” and equally the story of the Tower of Babel, which as a building project apparently failed due to differences in language.
Closer to Home
So, if we know that the first step is standards and that they make technology work better, whose standards should be chosen and which ones? When our industry was working on the double-sided nature of the Securities Finance Transactions Regulations (SFTR), a question was asked in a trade association working group, “How can we agree on what the standard approach is to this regulation and where should the answer reside?” The industry unanimously agreed that it should reside with the trade association that represents that market. The benefit of this approach is that standards, best practices and even an association’s legal documentation is created by consensus of financial firms and service providers, with no overriding commercial drivers at play.
As it relates to securities lending (ISLA), repo (ICMA), and derivatives (ISDA), and for the reasons outlined above, those standard practices have therefore been encoded in a common standard, a Common Domain Model (CDM). The CDM addresses the complexity of our respective markets, by not only defining data points, but also the relationship between the data points, lifecycle events, as well as the underpinning legal agreement that governs the activity. To ensure it is open to all, the three associations have moved the standards to FINOS (Fintech Open Source Foundation), where it is now called the FINOS Common Domain Model.
CDM…’Yeah, but what is it?’
There are several good explainers as to what a CDM is. At one end of the spectrum, is that the CDM is a uniform representation of output using standardised functions. However, for something some may regard as complex, analogies work better – imagine that firms are the people, the phone is the infrastructure (replace with Cloud or DLT), and the CDM is the language and rules governing what is said. The phone analogy works so well on multiple levels as whatever common language you speak, both parties trust the output irrespective of phone make or model, or network provider. Phones have also gone through equivalent ‘search for standards’ moments which has led to the adoption of a single type of power cable, allowing for all phones to plug into any computer to backup, etc.
In terms of why firms should adopt our standards. Aside from the fact that the market asked for a single standard and a solution to interoperability, members of the various associations have also funded this solution through their membership. Recent events have also led many market participants to question the status quo. If, as expected, we see greater fragmentation in our markets we will see an increased risk of seeing liquidity marooned across platforms and venues. This will only underline the importance of developing and advocating for a single set of standards in the form of the CDM. Other more obvious considerations are the costs associated with regulatory reporting, the time/effort spent in reconciliation of non-standard outputs both to internal and external systems, and the lack of options when a platform is temporarily unavailable.
For more information on the CDM and relevant use cases, please visit ISLA’s Common Domain Model (CDM) resource page.
OK, so what next?
The answer to this question depends on the perspective of the reader, so here are some suggestions.
Borrowers & Lenders – Going forward, each development project small or large should ask whether the CDM can be used to future proof and standardise that investment. You might need it to communicate your data to another internal system, vendor, regulator, etc. It could also make a platform plug/play-able to other platforms, reduce future cost, or build a path for DLT projects.
Vendors & Service Providers – Many have already embraced the CDM with some developing entire platforms based on the CDM. Benefits include addressing interoperability which in turn lowers maintenance costs (data between other platforms) and reduces the change control treadmill of the past.
Regulators – The power of regulatory reporting to promote positive change should not be underestimated. Some headline regulatory reporting obligations have created standards in booking practices that in-turn have resonated with market efficiencies. One undeniable impact has been an increase in the cost to regulators in terms of legislating, gathering and processing the data, but also a huge cost to those that must report. The next evolutionary step should be reigniting the EU’s MRER and UK’s DRR proof-of-concept projects that shone a light on how these challenges could be addressed. Both the EU and UK projects, which were tested against the CDM, highlighted enormous savings and efficiencies which in turn would unlock vital market developments.
Many of these topics will be discussed at the upcoming ISLA 14th Annual Post Trade Conference in London on 6 November. Please do reach out to the ISLA team if you would like to find out more about the CDM or any of the topics I discuss above.
Adrian Dale
Head of Regulation & Markets, ISLA
