Modernising the post-trade for greater capital efficiency and reduced risk
Moore’s Law observes that the number of transistors on a microchip doubles every two years, while its cost is halved over the same period. It has provided exponential growth in processing power for the past few decades, allowing many applications to improve performance by upgrading the hardware without fundamental architectural changes. 1
In the decades since Intel co-founder Gordon E. Moore first made this observation in 1965, consumer technology has continued to rapidly innovate, while the technology powering capital markets has lagged behind. Although recent physical limitations have caused improvements related to Moore’s law to taper off, advancements in distributed systems have continued the march of innovation. Much of the capital markets, on the other hand, have not taken advantage of such technological advancements and still operate in the past.
The €17 billion European post-trade industry plays a vital role in the securities markets, but it still relies on mainframe technology from the 1980s.2 The result is fragmented systems and interfaces that leave market participants struggling to react to market changes and to meet the needs of data-hungry investors and regulators.
The mainframes that have supported global capital markets for decades were built to answer specific questions at a specific point in time. Over the years, modern technology has been layered on top of the antiquated infrastructure, only providing a temporary solution. Similar to building a new house on top of an old foundation, sooner or later the base will give way, and the whole structure will crumble.
Put simply, the silos have calcified over time to the point where it’s easier for humans to talk to each other rather than find a way for the technologies to communicate. This tech debt creates broken processes that form the operational inefficiency that plagues firms today.
Investors, like all consumers, have become accustomed to on-demand service. They expect to be able to react quickly to market events and are looking to expand into alternative asset classes like crypto. Post-trade operations are challenged to keep up with these demands and provide the granularity, data visualization, and user experience that investors and regulators need.
From cost center to competitive advantage
For many firms, back-office processes are out of sight and out of mind—until something goes wrong. When factoring for borrowed stock, interest costs, balance sheet impact, and penalties, the cost of trade failure is substantial. A global trade failure rate of just 2% is estimated to result in costs and losses up to US$3 billion.3
In Europe, settlement failures have remained particularly high since the pandemic, fueled by market volatility and ongoing pressure on a smaller number of operations staff.4 Though the latest data shows a promising improvement in equities fail rates, fails remain a significant concern for both regulators and institutions.5
Adding to the pressure is the new Settlement Discipline Regime (SDR), which enforces penalties for failed trades in an effort to improve settlement discipline. Penalties range from 0.5-1 bps and apply to securities that are traded on an European Economic Area (EEA) exchange or cleared in an EEA central counterparty clearing house. Under these rules, central securities depositories impose the penalties on the counterparty responsible for the failed trade.6
As other regions—including the US, Canada, and India—announce their intention to shorten the settlement cycle, the Association for Financial Markets in Europe has launched a task force to explore whether Europe is right to follow the move to T+1.7 Decreasing the number of days between execution and settlement will reduce counterparty, market, and credit risk across the settlement cycle, but the bulk of the cost introduced by the move to T+1 will be borne by broker-dealers, clearing firms, and prime brokers. Some firms may not be aware of the breadth of implications of T+1 internally and on their buy-side clients.
The antiquated technology that dominates the industry today will bring the mainframe batch cycle times in the compressed settlement cycle into question. Moreover, workflows will need to be reconsidered to reduce settlement failures and allow the move to T+1.
The solution is to minimize manual intervention in favor of automation and cloud-based solutions. Modernizing the post-trade tech stack is estimated to reduce costs by 20-30% in key areas like reference data management, reconciliations, clearing and settlement, middle office, regulatory reporting, and overall application footprint.8
To operate at peak efficiency, banks and brokers must reduce the manual processes that increase risk of error and operate in silos in favor of technology that empowers users to make smarter decisions and to identify potential risks throughout the trading process.
Modern problems require modern solutions
The ripples of adoption are emerging across the industry—for example, in 2022 the London Stock Exchange (LSEG) partnered with Microsoft to architect LSEG’s data infrastructure using the Microsoft Cloud, and to jointly develop new products and services for data and analytics.9 The deal will explore the development of digital market infrastructure based on cloud technology, with a goal to transform how market participants interact with capital markets across a broad range of asset classes.
Simplifying the technology behind trading and post-trade functions can transform it from a cost centre to a competitive advantage. But for many firms, upgrading would require rewriting many systems with significant technical debt, with massive resourcing and planning costs—a daunting project with low chances of success.
Modern, high-performance computing coexists with COBOL, and microservices with mainframes. But as the value of data continues to rise, those who invest in the technology and capabilities to keep up with fast-paced, intraday market changes will come out on top.
It’s time to update the infrastructure powering capital markets. A single source of truth platform has the potential to optimize operations across teams, asset classes and geographies, reducing cost, complexity and risk. In turn, this makes it easier for emerging managers, professional traders, and institutions to access capital markets.
To keep up with the accelerating pace of modernization, firms will need to invest in technology to meet the needs of investors and regulators.
Those who do will be part of building the modern, scalable future of capital markets—improving access, speed, and service for all participants.
This article originally appeared in AIMA - The Alternative Investment Management Association.
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