Taking harmonisation to the next level
First published in the early 2000s, the Giovannini Report listed all of the barriers preventing the creation of an integrated clearing and settlement system in the EU. Nearly a quarter of a century on, EU harmonisation is still a work in progress , with some of the Giovannini Report’s recommendations still yet to be implemented.
However, we are seeing some positive developments.
Speaking at Sibos, Jesus Benito, Head Domestic Custody & TR Operations at SIX, said standardisation in Europe is being facilitated through industry initiatives, including ISO 20022 and Target2Securities (T2S). Regulations – such as the Central Securities Depositories Regulation (CSDR), the Shareholder Rights Directive 2 (SRD 2) and the incoming Single Collateral Management Rulebook for Europe (SCoRE) – are also playing a vital role in accelerating market integration, he added.
Although the industry has made in-roads on harmonisation, Benito conceded there is still more work to be done, especially around withholding taxes and portfolio transfers.
Shorter settlements remain a priority
Shorter settlements were covered extensively during this year’s Sibos.
In May 2024, the US, Canada and Mexico will transition their equity settlement cycles from T+2 to T+1, a move that Benito said will be more challenging than the previous migration from T+3 to T+2.
While adopting T+1 should help reduce settlement and market risk, free up collateral that would nominally be held at CCPs, and encourage industry-wide automation, it is likely to throw up some complications as well. With less time to carry out post-trade operations, the risk of failed trades could increase, in what might result in financial firms facing higher costs and penalties in certain markets, he continued.
“FX settles on T+2, but this could force financial institutions – especially those in Asian markets – to pre-fund their trades,” said Benito. Other activities which could face challenges following the transition to T+1, include securities lending, corporate actions and settlements of exchange traded funds (ETFs).
Regulators elsewhere are monitoring developments in North America, with experts anticipating European markets will eventually adopt T+1 as well.
Should this happen, Benito suggested that the EU, UK and Switzerland should introduce T+1 in unison and avoid some of the operational teething issues that might occur in North America - where Canadian securities will begin trading on T+1 one day before US securities. This has happened because the US is implementing the T+1 switchover during the Memorial Day weekend - a public holiday which is not celebrated in Canada.
Is CSDR having an impact?
Nonetheless, most experts believe the EU will not introduce T+1 , until the CSDR is fully bedded down.
One of the main objectives of the CSDR is to improve settlement discipline, by imposing cash penalties on the counterparties responsible for failed trades. Despite the regulators’ intentions, Benito said settlement discipline is not getting better in most EU markets, although noted Spain was an exception.
If settlement fail rates do not come down, it is possible that the penalty regime could be further tightened by EU regulators. Already, the CSDR Refit is talking about the possibility of introducing mandatory buy-ins if settlement fail rates do not trend downwards.
In response, Benito encouraged post-trade participants to automate more of their operational processes, as this should help reduce the number of fails in the system.
Digitalisation – avoiding the hyperbole
Ever since Chat GPT was released last year to much fanfare, experts have started giving more attention to this topic and poring over how Artificial Intelligence (AI) will transform our lives, both for better and for worse.
Post-trade is no exception here.
Marion Leslie, Head Financial Information and Member of the Executive Board at SIX, said there are a number of practical applications for AI in post-trade. “Financial institutions can embrace AI as a chance to improve their overall post-trade experience,” said Leslie. She also noted AI could be deployed to predict settlement fails, especially in the fixed income market, where fail rates tend to be higher.
While a handful of forward-thinking intermediary providers are leveraging machine learning to help them predict settlement fails, a report by the European Securities and Markets Authority (ESMA) found that most CSDs and CCPs are not currently using AI.
Although there are plenty of potential use cases for AI in post-trade, a lot of work needs to be done first before we can get to that point. “A regulated financial institution cannot run its business based on information from unknown and non-expert sources,” she said.
AI will only be effective if the data being fed into it is accurate.
“Trying to marry information together to predict settlement issues – such as trade fail rates – is challenging without structuring and normalising the data. There is also a need to retrieve and store examples of past events of what we are trying to predict in order to train machine learning algorithms. In the case of generative AI, this knowledge should be incorporated into the model. Only once this has happened can banks even begin to start thinking about where the future opportunities could lie using AI,” explained Leslie.
Tokenisation – going to the next level
Switzerland is rapidly cementing itself as a digital asset leader, a development which has been enabled by the country’s progressive regulations, according to David Newns, Head of SIX Digital Exchange (SDX).
This comes as the tokenisation market, along with the financial market infrastructures (FMIs) supporting it - continue to mature and develop.
In 2022, SIX became the first CSD to have direct access to SDX, which will make it easier for a wider pool of investors to access natively digital CHF denominated bonds. This operational link enables the dual listed digital bonds to be traded and settled attomically on SDX or T+2 on the traditional infrastructure, said Alexander Kech, Head Digital Assets, SDX.
Other notable milestones include SDX becoming the first Distributed ledger technology (DLT)-based FMI to adopt the Digital Token Identifier Foundation (DTIF)-managed ISO 24165 DTI standard, a unique identifier for digital ledgers , tokens and crypto-currencies, added Kech.
Regulators can utilise DTIs to oversee digital asset trades, ensure compliance with anti-money laundering and counter-terrorism financing requirements, and monitor risks associated with global Stablecoins and other digital assets. Additionally, ESMA has recommended the DTI as a risk management measure within the EU’s DLT Pilot program.
However, just as AI will not transform the market overnight, the same rings true for tokenisation.
This was echoed by Newns. “The digital asset revolution is not one that will happen overnight . But, revolutions do happen over long-term horizons in banking. It is a 10 year – if not longer – time horizon from the point we are talking about tokenisation to the point where we have large-scale implementation,” he noted.
One of the challenges facing tokenisation, however, is fragmentation. Kech said a number of FMIs and banks are each operating off different Blockchain infrastructures, which in turn is creating so-called ‘tokenisation islands.’
With tokens being traded in narrow silos, the market is struggling to gain liquidity. However, Kech said there is a role for Swift -as a multi-party neutral network – and FMIs - as multi-party neutral market infrastructures - to facilitate connectivity between these different tokenisation islands.
Only once there is interoperability will liquidity in the tokenisation market gather momentum, he said.