Global Custodian Securities@Sibos 2019 - Page 6

[ S E C U R I T I E S M A R K E T S T R U C T U R E ] T echnological innovation has reshaped many elements of ev- eryday life over the past decade, be it in retail, transportation, travel, communications or per- sonal finance. Despite the massive strides achieved elsewhere, securities markets have yet to make similar progress, and are instead continuing to operate much as they always have done. There are a num- ber of reasons why the industry has found it difficult to implement and execute change, although some market infrastruc- tures – including leading stock exchanges and central securities depositories (CSDs) – are taking proactive steps to uphold and future-proof their businesses. Chastening returns Market volatility has made it harder for investors to generate returns, with a number of empirical studies showing that active asset managers are falling short of their benchmarks. These negative head- winds are having a trickle-down effect on securities markets leading to falling margins elsewhere. Securities services – which comprises custody and asset servicing, fund administration, corporate trust and prime brokerage – have seen revenues grow by only 3% since 2010, according to McKinsey, margins that cannot be sustained for long. User costs are also exacerbated by the existing operational framework enshrined in securities markets, which is inefficient and intermediated by a range of different infrastructures and participants, all of whom provide their own incremental services to support the buying, selling and safekeeping of financial instruments on behalf of end-clients. Many interme- diaries are themselves considered by regulators to be systemically important, subjecting them to capital requirements and enhanced supervision, adding to their costs. While regulation is absolutely integral to the integrity and security of capital markets, its application is also sometimes disjointed and fragmented. Even within the European Union (EU), rules such as the European Market Infrastructure Regulation (EMIR) and the Central Secu- rities Depository Regulation (CSDR) are not entirely standardised across different jurisdictions, nor are they homogenised with legislation in third countries. This 6 Securities@Sibos January 2019 naturally creates barriers for institutions when they are venturing into or trading in new markets. All of these obstructions are creating a fertile ground for disruption in securi- ties markets. Market users are certainly optimistic about disruption, according to a study by SIX, where it found 63% of respondents identified robotic process automation (RPA) and artificial intelli- gence (AI) as the technologies most likely to deliver the greatest value. This was followed by distributed ledger technology (DLT) with 57% and application pro- gramming interfaces (APIs), which polled in at 37%. All of these new technologies are being explored by forward-thinking stock exchanges. No closer to the lightbulb moment Admittedly, an assemblage of FinTechs have repeatedly staked their claim as being disruptors in waiting, but the impact of these organisations on the broader industry has been trifling. While a minority of successful FinTechs such as Digital Asset Holdings have entered into commercial arrangements with market incumbents like the Australian Securi- ties Exchange (ASX) and Hong Kong Exchange and Clearing (HKEX), many have liquidated, as they were unable to monetise their products or struggled to attract reliable funding sources. Disruptive technologies could of course bring a number of efficiencies to tra- ditional market practices, but even the established providers are fast realising that innovation is not a straightforward enterprise. Despite a number of stock exchanges pursuing proof of concepts (POCs) testing the applicability of various disruptive technologies over the last few years, the fundamental processes under- pinning securities markets have remained intact. To date, nobody has come up with a technology prototype or breakthrough application which has the potential to remaster securities markets. Tokenised assets in securities markets Digital assets are, however, an innova- tion which could prove transformative for the industry, and a number of stock exchanges are taking decisive action. These instruments have unique proper- ties but generally comprise crypto-cur- rencies (Bitcoin, Ripple XRP, Ethereum), initial coin offerings (ICOs) and tokenised securities, namely instruments whereby ownership of a tangible asset (equity, bond, real estate, exchange-traded fund) is held in token form on a blockchain. Market participants are fairly bull- ish about the opportunities available through trading digital assets such as crypto-currencies. A study by SIX, for example, found that 50% of respondents believed digital assets would be the in- novation which brings the greatest value to securities markets moving forward. Conscious of the potential that these new instruments may offer, SIX is taking a lead in providing a secure platform for market participants to transact in digital assets – with SIX Digital Exchange. By designing an infrastructure giving users security, safety and transparency, SIX intends to bridge the gap between the digital world and traditional financial services. The benefits of tokenised assets In theory, tokenised assets could con- fer a number of benefits on securities market participants, including easier price discovery, cheaper access to illiquid instruments and enhanced liquidity for end-users. Collateral management is one area in particular where tokenised assets could play a major role. Under regulations such as EMIR and Dodd-Frank in the US, over-the-counter (OTC) derivative users must post initial and variation margin to central counterparty clearing hous- es (CCPs) to offset the risks associated with each transaction. Simultaneously, bilateral OTC contracts must also be fully margined by each trading counterparty as part of the recommendations laid out by the International Organisation of Securi- ties Commissions (IOSCO). This margin needs to be of excellent quality, with cash or high-grade government bonds usually being the preferred options. This sort of eligible collateral is in finite supply because of the various capital requirements presently imposed on major institutions under Basel III’s Liquidity Coverage Ratio (LCR), a rule-change which has forced banks to move away from overnight repo markets in favour of longer duration financing. OTC market users are therefore finding it difficult to access suitable collateral to post as mar-