Reflections of 2022
2022 has been a year of considerable contrasts where we have seen the global economy driven increasingly by events, rather than economic fundamentals. To an extent this is nothing new, with UK Prime Minister Harold Macmillan having once said, “Events, dear boy, events”, when asked what was most likely to knock governments off course in the 1960s.
We entered 2022 with a heightened level of optimism that the worst of the COVID pandemic was behind us, given the roll out of vaccinations. Whilst new variants prevailed during the year, for most it then manifested as something milder in terms of symptoms. It taught us both economically and socially about the fragility of global supply chains and how, if disrupted, they can impact significantly on aspects of daily life. As the world was beginning to emerge from its COVID-led hibernation, unforeseen events grabbed the world’s attention on 24 February, as Russia invaded Ukraine. In the aftermath of the invasion, we saw a spike in global energy prices led by concerns around the stability in the supply of gas, mainly to Europe by Russia. Reflecting on these two quite separate events, one might conclude that there has become an over-reliance on both cheap goods as well as energy from some of the world’s most dominant nations, and that in times of stress, this can have far-reaching consequences.
Problems with global supply chains together with spiralling energy costs have inevitably led to inflationary pressures in most developed economies; this is likely to shape government fiscal and monetary policies for the foreseeable future. The marked periods of intense volatility within energy markets have inevitably permeated almost all other elements of the economy.
Securities lending markets have benefited from both rising interest rates, where real yield is visible again, and through volatility which continues to deliver lending and financing opportunities. Whilst on the one hand, I applaud a buoyant and profitable securities financing marketplace, on the other I can see how increased volatility and stress can expose some of the frailties that exist in our post trade and settlement infrastructures. The recent problems with LDI investment funds in the UK, amongst other things, highlighted how important safe and efficient margining of derivative and securities finance transactions positions is.
As a collateralised market, securities lending and financing can already see the importance of timely and efficient collateral mobilisation. In this regard, the ability to tokenize assets and use them as collateral is a clear and real alternative that also has implications for our markets.
In March, we saw the implementation of the settlement discipline regime under CSDR in the form of fines for failing trades. Initially, we saw some improvement in settlement rates, however more recent data would suggest that settlement rates have fallen again across all asset classes. Notwithstanding the efforts of all actors in the value chain to address the situation, the fact that this problem feels endemic will cause concern amongst the regulatory community, notably as they consider whether to exclude SFTs and securities lending from the mandatory buy-in process.
At our Annual Post Trade Conference in November, I remarked how much of the discussion around fails seemed to centre on familiar issues such as SSIs and the return leg of the transaction. Traditional thinking can only take us so far however, especially if we find ourselves moving to a T+1 settlement environment. Any work on establishing best practice standards as well as better and more efficient KYC processes and procedures, will help but also respond to the questions posed by the regulatory community in a post-Archegos world.
However, the real game changer to my mind, would be a significant move towards the wholesale adoption of digital technologies, ranging from the tokenization of assets through to the creation of smart contracts. In a world where the cost of deploying capital is increasingly more expensive and its requirement precise, the ability to pinpoint when within a given trading day liquidity is needed will be crucial.
In November, Goldman Sachs (GS) launched its digital asset tokenization platform, GS DAP, with the issuance of a €100 million ($104m) digital bonds for the European Investment Bank on the private GS blockchain. The 2-year syndicated bond issuance was settled instantly in a delivery versus payment transaction. This was a glimpse into our collective futures, which I don’t believe is so distant.
ISLA therefore continues to follow these developments and where appropriate, respond through revised best practice, or in the form of new and novel legal frameworks that will support these developing markets.
As I reflect upon 2022, there are two further areas that provide potential cause for concern as we look beyond this year.
The first is the increasingly strong headwinds that we see around the Basel III/IV prudential regime. Changes to the minimum output floors when calculating counterparty exposure, together with harsher treatment for unrated counterparts when facing prudentially regulated entities presents our markets with several real challenges. ISLA is working with its members through the relevant working groups to demonstrate how these changes could have significant implications for market efficiency as well as underlying liquidity. Whilst we understand the motivation behind the latest changes to the regime, I do feel that as currently drafted they do overly penalise short-dated collateralised SFT markets, which in themselves are the life blood of the capital markets.
Finally, I wanted to highlight that as we head towards 2023, we see the re-emergence of the UK regulatory authorities as a truly independent force. Much has been said about the post-Brexit era and as we come to the end of 2022, we are seeing several key interventions from the FCA and PRA in the form of consultations and policy discussion papers. Whilst I would hope that any divergence from the previous European regime is more pragmatic rather than political, there is no doubt already that we are seeing a different position on several key issues in the UK. That raises important questions for associations such as ISLA, as we look to ensure that we can fully support both members in the UK and across Europe. Similarly, I recognise that many of you reading this will be facing that split regulatory regime environment. Perhaps familiar challenges for those who already run global businesses, and where the UK becomes simply another important regulatory player.
As we look to 2023, and in closing, I would like to wish you, your colleagues, friends, and families well for the festive season and new year.
Andrew Dyson
