T+1 | CSDR
If a group of individuals were asked whether standards are important, you would hope the answer is a resounding ‘yes!’, as one might think that as the benefits outweigh any logical argument otherwise. However, if that were the case, why is it that they remain elusive despite the constant and costly reminder that we need them?
The barriers for not yet having adopted integrated and unified standards across our markets could be put under four headings.
First is the fragmentation of the different systems, jurisdictions, and various organisations’ inability to change – we have created a wild array of processes, even though we ultimately need the same outcome. Second is complexity. We have all sat in meetings I am sure, where sometimes there are as many different approaches as there are people in the room. Then multiply that by the decades it has taken for our industry to develop all the current platforms, and the problem is further compounded. Third is simply the cost. Developing and maintaining standards is viewed by some to be an expensive undertaking, especially for small organisations. That leads to the justification not sufficient when we have the annual budget planning sessions. Fourth, and perhaps more important above all, is cooperation. A simple example that comes to mind is a discussion that I was involved in a few years ago regarding the direction of a trade – both sides disagreeing on who was the lender, and who the borrower in the exchange. Fast forward to today, and we are still not aligned on booking practices and when a trade starts and ends. We could add other drivers to this such as competition, where a lack of standards is seen by some as a commercial opportunity, and that further thrives through underinvestment or a short-term investment plan.
All the aforementioned have been raised in conversations, events, and meetings that I have attended over the first half of this year. The vast majority of those would suggest we are also well aware of the current lack of standards, and yet don’t seem to have taken the necessary actions or universally changed behaviours yet.
So, why do we need standards – why are they important? And most importantly, why do we need them now more than ever?
Standards are quite simply data points from static to dynamic commercial values, the procedures by which we use that data, and so a common application related to the functions and events of a financial market. We need these standards to ensure fairness, transparency, create efficiency, promote competition, reduce systemic risk and perhaps most importantly to lower the cost of operating.
The adoption of standards has created an amusing paradigm where, as we all believe standards are a good thing, multiple standards exist for the same activity. ISLA is no exception, as Best Practices are a core mandate for trade associations, with ours being reviewed almost two years ago and again this year in our Best Practice Working Group. Similar or adjacent markets have their standards and practices too, as do the trade associations that support them – something we also monitor closely and align to where possible. Then there is the array of organisations across the regulatory community, such as IOSCO and the FSB, through to the jurisdictional entities such as the ECB and the other European central banks and supervisors, and finally the global spanning standards organisations such as ISITC or SMPG; all have their own standards!
So, when I proposed a review of ISLA Best Practices, and aligning them with other sources, we identified 20+ practices, standards, codes and rules, without including applicable ISO standards or the increasing book of transparency requirements.
Being optimistic, the hope might be that there is a good deal of commonality in all the above and, if you had an effective AI device, you could perhaps weave them together to create a unified standard. Having said that, we can all agree that it’s not quite good enough yet and we need better and more efficient ways to adopt standards both at a micro procedural as well as data level. This is one of the primary reasons why ISLA joined forces with ICMA and ISDA to create the Common Domain Model (CDM) – one common place to encode best practice, as something like the use of collateral, despite a few nuances, is essentially the same process across lending, repo, derivatives and other market types.
So moving to the question of why now? Has something happened? If not, and perhaps asking a different question – do we think everything is running as smoothly as it could or perhaps should? The answer to that is quite simply no.
We are still discussing settlement efficiency, despite writing thousands of pages about the well- identified reasons for transaction failure. We also note CSDR related fines at high levels, and the disagreements about why they are so. A major contributor to that is static data, something by definition that doesn’t move but still manages to be wrong, not accessible, or is incorrectly used.
Further to the ‘why now’ element, is that the entire discussion has recently had gasoline poured over it in the form of T+1. If you miraculously missed this topic, it is the reduction of the settlement cycle from T+2, a trade negotiated today that settles in two business days later, to T+1. The impacts of moving to T+1 are well discussed, and a simple internet search would provide a lifetimes reading. As it relates to financial markets and specifically securities lending, there are manual processes and workarounds that have been happily working for decades. If you turn up the volume however, those old manual procedures create bottlenecks, as there simply isn’t the time to complete them. Consider for instance, someone who has spent the past 30 years retyping the same trades in one system from another. Suddenly, the in-tray needs to be completed 70% faster as there are less days available. In the past, we have might have undertaken a cost/benefit analysis to ascertain whether the process could be automated via simple code, but the two systems have very different data schemas, its too expensive, or there is no budget nor priority. Building that process would also mean testing, debugging, change controls, dependencies, and then the inevitable phase two when it’s realised there’s a bug or a nuance was missed.
That is one of the benefits to firms in adopting the standard data and lifecycle structures within the CDM, which exists in an open-source environment and is ready to use. Using this approach, you move closer to platforms that are essentially plug and play. Another benefit is that the standard will support regulatory reporting, the same as the proof of concept regulators have been testing (ESMA Machine Readable & Executable Regulation or BOE Digital Regulatory Reporting).
Returning to the T+1 topic, North America will move T+1 in 2024. European markets, recognising multiple impacts, are watching very closely and we will all want to learn about the outcome of testing due to start this year. Both the UK and EU now have Accelerated Settlement taskforces that will produce reports in the very near term; the UK a draft hopefully this year and a final report next year, whilst the EU will publish a report in 2024 under the mandate provided by the CSDR Refit. In the proposed text, ESMA will be required to report within one year of the final text appearing in the Official Journal.
Without too much imagination, we can plot the likelihood of moving to T+1 in two more jurisdictions. We also know that financial markets are going to become more complex with ESG, Digital, Crypto, etc. competing for space and time. Therefore, the most efficient way to get through this next stage is to for market participants to adopt standards directly into their procedures and technology stack.
If you aren’t focussed on these topics today and are still working on the assumption that adding bodies to a challenge is the way to fix things, I do hope you realise that the old approach has run its course and time to react is running out. The best place to find out what that really means for you is to join ISLA Working Groups and be part of the conversation.
Adrian Dale
