The Network Forum: Securities Services All-Rounders Step up to Face Seven Emerging Themes

June 28, 2022
  • Investor Services
The Network Forum Annual Meeting took place in person, for the first time since the pandemic, at London’s famous cricketing venue, The Oval, to assess new opportunities and risks and how to navigate seven major industry developments. Janet Du Chenne and Sinead McIntosh report.

Key Takeaways:

  1. Since the pandemic, the custody business has shifted from “just in time to just in case”: it’s now about managing uncertainty, improvising among teams for a seamless service and being agile in adapting to industry themes
  2. Flexible working and hiring and retaining talent have seen the biggest corporate mindset shift to date, with evidence strongly advocating a post-Covid hybrid work set-up
  3. Geopolitical uncertainty could spur further rationalization of operating centers in the scale vs specialization debate, as well as more selectivity on which technologies to implement
  4. “New” technologies, such as DLT, have evolved with use cases across specific securities processes. However, it will be 10 years before they cover the entire value chain. Banks will be embedded in that ecosystem
  5. As the U.S. prepares for T+1, the move towards shorter settlement cycles remains far from a reality for other markets, such as Europe
  6. Industry participants have generally not experienced any notable settlement efficiency improvement since CSDR went live earlier this year. There is continued focus on implementation harmonization across the EU 
  7. Industry changes are forging closer bonds between network management and product for client solutions that address evolutions in infrastructure connectivity and data analysis

If the pandemic demonstrated custody’s resilience in facilitating client activity despite lockdowns and remote working, disruptive forces are expanding their reach beyond the backbone. Geopolitical risks arising from the Ukraine war and double-digit inflation are adding to service providers’ agendas, which were previously focused on entering new markets, adapting to regulatory and technology change and timely securities settlement. With the recent turmoil, the emphasis has shifted from “just in time to just in case”. The Network Forum (TNF) gathered service providers at London’s Oval cricket ground to assess how they’re becoming all-rounders in response to continuous change and uncertainty.

“The business is now about managing insecurities with geopolitical risks, cyber risks, as well as questioning the safety and longevity of certain new technologies,” observed one custodian service provider. In addition, as the world grapples with post-pandemic disruption, the overhang of regulatory and technology change, ESG, crypto and the future of work are other themes that must be considered. Keeping up with these developments will bare costs for providers and will force decisions on where they need to be agile, while improvising amid turmoil to deliver a seamless service that clients now expect.

From just in time to just in case: Industry practitioners at The Network Forum discuss their evolution from ensuring resilience and timely securities settlement to managing new risks

Photo credit copyright: TNF

Many providers continue to embrace further innovation and efficiencies in post trade, including the emergence of client portals for self-servicing and data to support the democratization of assets,as well as utility solutions. However, the jury is still out on industry readiness for certain developments and will require providers to evolve their roles beyond traditional safekeepers of client assets. Let’s take a look at the seven themes that are driving this evolution.

1.  Keeping Up to Date with the Changes While Remaining Resilient

A panel of securities services providers shared their experiences of the operational changes effected since the pandemic but noted other developments over the last five years have made things even more complex. In an audience poll, regulation was cited as the biggest change. 

Audience Poll:

What is the biggest change in our industry over the past five years?
Impact to operating models 19%
New technology e.g., DLT 22%
Price pressure 15%
Regulation 46%
Source: TNF

In addition, sustainability, rationalization, and digitalization have impacted operating models. There were questions as to whether operational centers of excellence are the right thing to focus on, much discussion on the implementation of digital technologies, as well as concerns around the impact of geopolitical risk on energy supplies. The Ukraine war could impact traditional approaches to outsourcing with some restructuring of regional operating centers. 

Some custody networks have experienced shocks from these developments and providers have chosen to exit certain markets. “Price compression and the cost of technology have forced clients and providers to choose between scale and specialization,” said one provider. “We have to find ways to optimize our technology base, work with partners and different types of experts. At the end of the day there’s commonalties regionally but specificities enable providers to thrive.”

Prevailing price pressures should force continued rationalization in the custody space, the audience heard. Despite this, the quest for innovation continues and providers and market infrastructures are being selective about which new technologies to implement.

They are assessing the investment of time, process efficiency, asset protection and client outcomes when experimenting with digital. Delegates heard that the industry has already made significant strides towards digitizing securities processing and further client benefits could be derived from the liquidity pools and instant settlement arising from central bank digital currencies (CBDCs).

One panel session also highlighted that in addition to focusing on operating models, there’s an opportunity to forge a sustainable path via collaboration. “We’ll see a rising sense of stewardship among investors and providers have an opportunity to drive a link between issuers and investors via meaningful communication.” “It’s difficult to make a change without the whole community with you”, cited one panelist. “The whole ecosystem needs to be on board.”

2.  The Future of Work

A panel of industry participants shared how the pivot to remote working since the pandemic has emphasized attracting and retaining talent through flexible working, upskilling and training in the new normal.

For many organizations, this has been the biggest mindset shift to date. An audience poll revealed that flexible working practices (18%) and career pathways and training (36%) were the most important considerations. A panelist from a Europe-based securities services provider shared how they had switched to hybrid working in 2021. To foster collaboration, the firm encourages time in the office during the week. However, they confirmed that “there is ample evidence advocating the post-Covid hybrid work set-up, proven by the bumper years of return we saw even with employees working fully remotely.”

Another bank shared that it had introduced hybrid working before the pandemic and to further promote flexibility, it permits employees to work from countries which are not their principal domiciles.

Many banks have used similar approaches to flexible working based on a performance-oriented approach. “This affords people with a certain freedom and acknowledges you fully trust them and the way they manage their private life,” said one panelist.

Training was cited as another key enabler of attracting and retaining talent. Banks shared how they are providing online platforms focusing on important industry themes such as sustainability and innovation, while upskilling employees in specific areas such as economic inclusion. 

3.  When Will DLT and New Technologies Prove Their Worth?

In assessing which technologies to implement in financial services, a panel of custodians shone a spotlight on DLT. 

They noted DLT’s evolution via system experimentations, POCs, and customer use cases for settlement process efficiencies. However, it will be a while before the technology takes over the entire securities settlement lifecycle. To get there, use cases should be driven by the operating challenges the industry is trying to solve and minimizing costs, remarked one panelist. “I would give it 5-10 years for full implementation realistically because we need to think about engagement in the overall ecosystem.” The audience seemed to concur, with a poll revealing 29% believe the technology needs another 10 years to prove its full potential.

Audience poll:

In how many years will DLT take over issuance, settlement safekeeping and asset servicing across financial services?
3 years 12%
5 years 24%
10 years 29%
Never 36%

Source: TNF

Various DLT applications have come to the fore more recently that carry specific benefits. These include experiments with CBDCs for creating liquidity and facilitating instant settlement, as well as the tokenization of traditional assets. A DLT developer shared how working with a crypto currency developer, they have produced tokens for regulated models like CBDCs and assets such as bond, shares and loans.

However, the migration of existing assets into the tokenized world will happen at different speeds, and it will take more than 10 years for pure atomic settlement,2 the audience heard. For now, the industry shouldn’t apply these technologies to what already works. For example, tokenization is not going to bring a lot of value to a liquid asset, which is already STP, but it could for an illiquid asset. 

“You have to take something that you know doesn’t work the way it should from an efficiency point of view and apply that technology in a disruptive way that actually creates transparency, liquidity, collapses capital and collateral requirements and makes it more fungible,” said one panelist.

“If the technology doesn’t produce liquidity, or take down your return on RWA, it won’t get the investment to get that adoption. It should focus on one area and be applied in a way that addresses capital concerns relating to assets off balance sheet. That’s in private markets assets such as private equity and securitizations.” 

To unlock the value of these technologies, the industry should partner to bring together banking and technology expertise with use cases, said one panelist. “We’re trying to address industry pain points such as tax and reconciliation. If we can apply the technology to those central processes to support the goals of reducing capital costs and increase liquidity it will keep us useful.”

DLT interoperability projects have also focused on specific settlement efficiencies. Partnerships include those between the Depository Trust & Clearing Corporation (DTCC) and Hong Kong Exchanges and Clearing,3 while the Singapore Stock Exchange (SGX) is developing a DLT-based system enabling companies to dual list on Nasdaq and on SGX.

The panel also addressed alliances and co-creation between fintechs and financial services firms to build out DLT technologies to streamline clearing and settlement processes. “There will be success stories, but we should shift investment towards projects and the winners who we decide will bring value – it will be a small cohort of them,” concluded one of the panelists.

4.  Regulated Banks Will be Key to Crypto Adoption

Another panel looked at the merging of traditional assets and securities onto the new digital rails and the role of sub-custodians in a crypto world. While acknowledging that crypto has shrunk to a third of the size it once was in May 2022,4 audiences heard how regulation and safety and soundness of traditional providers could facilitate its adoption. 

Trust and intermediation will see banks becoming more embedded in the new ecosystem, the TNF attendees heard, and banks will have a regulated role in this space.

“I don’t see all of our traditional functions (collateral, repo etc.) just being governed by code,” said one panelist. “The point is that it’s a learning journey for custodians to manage those assets, which is critically different to managing traditional assets. We’re talking about a whole new banking infrastructure, as well as managing and controlling private keys and controlling the assets. Crypto is here to stay and banks should embed themselves in that ecosystem.”

5.  Harmonizing CSDR

More than four months after the introduction of the settlement discipline regime under the Central Securities Depository Regulation (CSDR), one TNF panel reviewed progress to date. The implementation of cash penalties for failed settlements, highlighted in BBH’s Living with CSDR, has been a complex undertaking.

In an audience poll, 65% of TNF delegates said that settlement rates have remained about the same since the penalty regime was implemented in February 2022. This contrasts with recent commentary from some regulators, including that of Robert Ophele, Chairman of French financial market regulator AMF. He observed that “a large part of the challenges has been overcome.” Speaking at the recent World Forum of CSDs conference, Ophele cited a 96% (by value) or 97% (by volume) settlement efficiency rate in France since CSDR.4 

It is hoped that penalties will be effective in driving down settlement fails in order to foreclose the possibility that public authorities may revert to mandatory buy-in a solution.5

In the short term, the focus will be on the harmonization of CSDR implementation: improving penalties processing, consistency of reporting and the timeliness of medium-term partials6 to increase efficiencies. It’s about improving the process and cut off times and working together to get settlement efficiency up, said one panelist. “We’ll be seeing some of the innovation projects and we’ll see data management as one of the helpful tools to ensure the processes are automated.”

Another panelist shared the focus will also be on moving to the next generation analytics via dashboards that show clients where things are going wrong in the settlement chain.

Audience poll: 

Where should the focus be in the next 2-3 years?
Advocacy to change/simplify CSDR
Work on harmonization of the implementation across the EU
Bring in new technology

Source: TNF

6.  Shorter Settlement Cycles – Ready or Not?

Regulation such as CSDR is key to harmonizing certain aspects of the settlement cycle, which some markets have been trying to shorten. The U.S. has hit the accelerator on the move to T+1 and its plans to get there in 2024 allow firms time to assess the changes they need to undertake. There is still work to do on corporate actions and securities lending to return securities to the original lender in a shorter settlement cycle. However, more than half of TNF delegates voted that the aim should be for a T+0 settlement cycle.

Audience poll:

Should the industry ultimately aim for a T+0 settlement cycle for traditional securities?
Yes 53%
No 37%
Undecided 11%

Source: TNF

As the U.S. focuses to move to T+1, a similar effort remains far from a reality in Europe. Given Europe is not a homogenous market, similar moves to shorten the settlement cycle here and across emerging markets would be shrouded with complexities and difficulties, a CSDR panel said, with one expert asking, “are we trying to solve one problem by creating a bigger one?”

Despite the benefits of increased efficiencies, reduced risk, and improved use of capital – especially in periods of high volatility – the panel highlighted concerns around corporate actions, cross-border actions, and foreign exchange, particularly for asset managers who may need to instruct their custodians but operate in different time zones to them. This makes achieving shorter settlement cycles difficult. Intense collaboration is needed to get rid of anything that needs manual intervention. Europe is not ready to move to T+1 with CSDR having just arrived, but it should not be ruled out by the end of the decade, concluded one panelist.

7. Network Management 2.0 – Forging Closer Bonds with Product

Themes such as shorter settlement cycles and new technologies are driving the evolution of the network management function. From entering new markets to conducting onsite due diligence visits to agent banks, a panel moderated by BBH’s Head of Network Management, Mike Drake, noted this role is increasingly converging with product management to navigate operational change for clients.

There’s generally a closer alignment of this role with the product team to work on client solutions for the challenges highlighted in this article. A symbiosis and alignment of those functions can now be seen, whereas 10 years ago network managers were more tactical in delivering them, observed Drake. 

BBH’s Mike Drake and fellow network managers share how the function is more interwoven with product to deliver client solutions

Photo credit copyright: TNF

In fact, based on this panel discussion, 77% of the audience polled thought product and network would be closer aligned in the next two years, indicating that many TNF attendees thought that the alignment of Network and Product was the right organizational structure.

Drake asked fellow industry network managers about the key drivers moving the roles of network management and product closer together. Client solutions trump other factors, according to the TNF audience, but digital assets/technology initiatives are becoming more impactful.

Audience poll:

What factors have or will bring network management and product closer together?
Changes in provider landscape (RFPs, sub custodian exits, etc.) 19%
Client solutions 43%
Digital assets/technology initiatives 26%
Response to market events 14%

Source: TNF

One panelist highlighted market practice changes, citing Hong Kong Connect, as a an example where Network Management and Product were closely aligned. “To build that service, Network Management worked closely with Product and Service Delivery teams, ensuring that agent bank servicing capabilities were clearly aligned with market practice and our defined service level requirements.”

The panel also addressed an evolution in the network function itself. Practitioners are getting a tidal wave of data and the objective is taking it in, establishing relational data connectivity, interpreting the data and taking action as needed. This could include new risk management practices, client communication and product considerations.

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1 The democratization of assets refers to facilitating investors access to a broader range of assets, including private equity and real estate, via digitalization and new technologies
2Atomic settlement is the instant exchange of two assets that are linked, such that the transfer of one occurs only upon transfer of the other one
3 Hong Kong Exchanges and Clearing’s proposed HKEX Synapse is a blockchain-based platform that is integrated with DTCC’s Institutional Trade Processing suite of services to enable global investors to automate and expedite the trade confirmation and settlement process
6 The European Securities and Markets Authority has published on June 2, 2022, a final report that presents a proposal to modify the regulatory technical standards of the Settlement Discipline Regime to formally suspend the provisions of the buy-in regime established in CSDR for three years.
7 Partial settlement is the functionality to settle only parts of the quantity/cash amount specified in a settlement instruction

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