finsights

8/10/2019 FINsights

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8/10/2019 FINsights


Preface

From the Editors’ Desk

1. Strategic IT Cost Reduction - “Doing More with Less” 05

2. Investment Banking Transformation into a Bank 13

Holding Company

3. Post-merger Integration: Best Practices for Information 23

Technology Mergers and Integrations

4. Alternative Investments: Leveraging Event-based 29

Processing for Real-time Information

5. Securities Operations: Operating Model Best Practices 35

6. Maximizing the Impact of Business Transformation 41

7. The Next Generation Prime Broker 51

8. Processing Corporate Actions - A Continuing Challenge 57

9. Securities Processing: Evolution and Trends in 63Exception Management

10. Trends in Clearing and Settlement in Europe 69

11. Offering Managed Products - Challenges in the 75

Middle and Back Office

12. Handling Client Risk 81

13. Mitigating Rogue Trading Risks by Leveraging Your 87Investments in AML

14. Creating an Enterprise Risk View for the New Age 99

Investment Bank

Transformation in Securities Operations

Challenges and Trends in the Industry

Managing Risk

Contents

8/10/2019 FINsights


In the European Union, clearing and settlement infrastructure

providers are going through a phase of cooperation and consolidation.

The participant organizations are seeking ways to achieve unified

procedures and economies of scale to fuel process efficiency and

cost reductions. Consolidation in stock exchanges and the recent crisis

in the financial markets have further intensified pressure on clearing

houses and Central Securities Depositories (CSDs) to scale and gear

up to handle more than one market. In this article, we discuss our views

on the trends emerging in the clearing and settlement industry in

the European Union (EU), the challenges that lie ahead and the

technological advancements.

SECURITIES

OPERATIONS

Hari Shankar Gupta Praveen Daga

Trends in Clearing and Settlement

in Europe10

8/10/2019 FINsights


Exhibit 1 Trends - Earlier and Now

Electronic Trading

Sytem

Emergence of Central

Counterparty

‘Black Box’ Trading

Trends Earlier

Code of

Conduct &Interoperability

Emergence ofMTN’s ATF’spost MiFID

Consolidationof post trade

serviceproviders

Trends Now

Technology advancements facilitating electronic

order execution and complex trading strategies

adopted by the bulge bracket investment

banks have fuelled the transaction volumes

exponentially at the exchanges worldwide,over the last few years. This ever increasing

trading activity tries to exploit very fine price

differences that exist within segments,

exchanges and geographies. Thus, it becomes

imperative that the cost of executing each

transaction (including clearing and settlement

costs) and the capital commitment required is

not an obstacle to this growth.

For this to happen, the post-trade marketstructure has to undergo significant changes as

currently seen in Europe. The current wave of

change here is driven by the need to increase

processing efficiency and reduce the costs of

trade and settlement processing through

unified procedures. The European clearing

and settlement industry players are aiming to

get into the league of their US counterparts

where the clearing and settlement costs areamong the most competitive in the world.

The EU is playing a key role in the industry's

transition. The first wave, 'Markets in Financial

Instruments Directive' (MiFID), was

introduced in 2007 to reduce the cost of raising

capital and trading on the exchange side of the

business. The second wave, 'Code of Conduct',

focused on post-trade processes and aimed at

reducing the clearing and settlement cost for

domestic and cross-border transactions,

through interoperability and procedureunification among industry participants.

Exhibit 1 takes a look at the shift in trends that

the European clearing and settlement industry

has witnessed over the last few years:

1. From Consolidation to Cooperation

While the US remains far ahead in terms of

consolidation of the clearing and settlement

industry, currently, the momentum is clearly

in Europe. The European Commission (EC)

is trying to get the fragmented clearing and

settlement infrastructure players to cooperate

and collaborate. The aim is to persuade

exchanges and trading venues to share their

trading infrastructure with multiple clearing

and settlement providers, and to make

existing players open up to competition foran efficient and cost effective clearing and

settlement infrastructure.

Reflecting this trend, more and more trading

venues are opening up to allow multiple

clearing and settlement agencies to enter

their markets. The London Stock Exchange,

Key Trends

70

8/10/2019 FINsights


allowing Swiss central counterparty SIS

x-clear to join LCH.Clearnet as a competitive

provider of clearing services on its equity market,

is a step in this direction. We expect more

and more trading venues to follow suit eventually.2. Emergence of MTFs, ATN post MiFID

MiFID has led to the emergence of various

pan European Multilateral Trading Facilities

(MTFs) - such as Chi-X, Turquoise,

NASDAQ OMX and BATS Trading. These

MTFs now represent around 20% of the

market activity and are equivalent to primary

exchanges for certain stocks. Traditional

exchanges have not been too receptive to

MTFs, and there seems to be an attempt to

deny them access to clear and settle trades

through the existing clearing and settlement

infrastructure. This has led to emergence of

new-age CCPs - like the Fortis clearing facility

(now nationalized owing to solvency concerns

about its parent financial institution) and

DTCC's EuroCCP - as they have pan

European settlement linkages.

Certainly, the emergence of alternate trading

venues has increased the pace of front office

transformation, as traditional exchanges have

to enhance their services. However, the back

office needs to come up with Pan European

clearing and settlement solutions, to be able to

serve multiple markets and cope up

advancements in front office space.3. Interoperability through Code of Conduct

The Code of Conduct was adopted as a

voluntary measure in November 2006 in EU by

stock exchanges, Central Counterparties

(CCPs) and Central Securities Depository

(CSDs). The participants agreed to become

more open to competition and accepted

interoperability with multiple and/or

nonaligned exchanges. The Code of Conduct

provides that an exchange in the EU, cannot

give a CCP the exclusive right to clear its trades.

Similarly, a CCP has to agree to interoperate

with another CCP that wants to clear for the

same exchange. Likewise, a CSD has to give

CCPs and other CSDs access to its services.

The Code of Conduct also seeks price

transparency, discourages mandatorybundled services and puts more thrust on

harmonization and simplification of the

systems and procedures, throughout the

multiple clearing and settlement providers.

Synchronization of systems and procedures

thus becomes quintessential, while the

merger of service providers may not be

necessary, which also means that there is no

threat to the competition.

The key challenges impeding the achievement

of unification and cost reduction are reflected

in Exhibit 2.

1. Driving synergies out of unification

It is not easy to adopt a common platform

and procedure for clearing and settlement of

securities across all of Europe. Unification

will entail significant costs and time and

require close supervision and management of

multiple initiatives. Further, any unification

will have to accommodate local nuances in

the form of inconsistent fiscal, legal and

regulatory underpinnings, the current state of

market infrastructure, traded volumes and the

level of sophistication of the products traded.

Given these challenges, the industry should

endeavor to simultaneously invest in creating

new offerings, value added services and

innovation so that post-unification, the

industry bottom line is not affected.

2. Overcoming delivery risk, multiplicity

of regulations and complex duty structure

While the American model of clearing and

settlement has worked well in the US, the

implementation of such a model in Europe

remains a challenge. Unlike the US, the EU is

Key Challenges

71

8/10/2019 FINsights


trying to unify procedures across multiple

markets and multiple countries, given their

diverse regulations, procedures and customs.

The new model of post-trade processes may

present more risk types and the proposed open

architecture, which is touted to be the future of

European clearing and settlement industry,

must duly incorporate risk mitigation factors.Rationalization of duty and tax structure

should also be considered. This has potential

to become a big ticket item as any cut in tax

and duty structure will directly affect the

government’s revenue, which it may not easily

want to give away.

3. Multiple roles of CSDs

Apart from the core function of settlingtrades, CSDs also serve other purposes. In

many countries, they act as the link between

issuers and holders of securities, and also as

the platform for the banking system to

provide collateral to the central bank to

support liquidity.

The multiple roles of CSDs in the current

model will have to be carefully replicated in the

new model as the local market nuances need to

be catered to outside the unified structure.

This will, to some extent, increase the risk and

cost of operations.

Advancements on the Technology Front

1. Target2-Securities (T2S)

T2S is the name of the new pan European

central platform for the cross-border and

domestic settlement of Euro-denominated

securities against central bank money, run by

the Eurosystem. T2S, slated to go live in 2013,

will replace the settlement systems of nationaldepositories.

It will provide settlement services for debt

instruments, equities, investment funds and

warrants held through the participating CSDs'

accounts provided they are settled in Euro.

2. Link Up Markets

Earlier this year, seven European depositories,

accounting for nearly 50% of total securitiessettlement in Europe, became joint participants

in Link Up Markets. The Link Up Markets

model will offer the user a single point of entry

by leveraging the existing infrastructure

within participating CSDs, and will not build

a new multi-market settlement engine or

a multi-market CSD. Rather, it will create

a communication hub, facilitating efficient

cross-border post-trade processing. This

central hub will route instructions between

any two participating CSDs; it will validate,

convert or transform message formats;

and will enrich functions when required.

Exhibit 2Challenges - Earlier and Now

Reducing Risk and Improving

Efficiency

Automated andone stop multiproduct shop

Crossborder

trading toincreaseliquidity

Challenges Earlier

DeliveryRisk

MultipleRegulators and

DutyStructure

Driving synergies outof unification

Role of

CSD and the VerticalModel

Challenges Now

72

8/10/2019 FINsights


Further, Link Up Markets will be able to

provide services in a range of markets and

currencies as the central platform support

can be extended relatively easily within

Europe and beyond.

The clearing and settlement industry in

Europe has so far managed to overcome the

impact of the financial crisis. However, the

manner in which financial markets evolve,

post financial crisis, may lead to further

challenges as market players may demandcost effective and robust solutions.

In these times, it is imperative for post-trade

service providers to continue addressing

inefficiencies to wring out cost reductions and

to implement tighter risk management policies.

Exhibit 3 presents an overview of the costs

across the entire clearing and settlement valuechain in US and in different regions in Europe:

As shown in Exhibit 3, the post-trade

processing costs are at least twice as much as

that in US. Among the various components,

clearing costs are as much as 4 times and

settlement costs as much as 3 times in the

Impact of the Financial Meltdown on

Clearing and Settlement Infrastructure

Conclusion

UK, than those in the US. For Italy, this is

even higher at 9 and 11 times. The picture is

more acute when it comes to costs of cross-

border settlement within Europe, where a

transaction can add significantly to theoverall cost of the transaction.

The higher costs in Europe are due to lack of

interoperability of systems and procedures

among various settlement infrastructure

providers and the for-profit nature of most of

these providers, as opposed to the DTCC,

which is a user owned organization.

Certainly, there is room for bringing down

costs, but a lot depends on how far the

industry players and European Commission

are able to work aggressively and decisively

to remove interoperability hurdles.

1. Giovannini Group reports

(http://www.ecb.int).

2. Target2-Securities(http://www.ecb.int/pub/pdf/other/

t2sblueprint0703en.pdf)

3. www.linkupmarket.com

4. The Direct Costs of Clearing and

Settlement: An EU-US comparison, by

NERA Economic Consulting.

References

Source: 'The Direct Costs of Clearing and Settlement: An EU-US comparison', by NERA Economic Consulting.

Exhibit 3Per-trade Clearing and Settlement Costs across Value Chain (in Euro)

US

UK

Italy

Denmark

Germany

Switzerland

0.07

0.29

0.21

0.27 0.013

0.19 0.31

0.12

0.81

0.53

0.10 0.26

0.212

0.5

0.019 0.372-

- -

---

1.29

0.542

0.81

0.53

0.36

Recording Matching Clearing Netting Settlement Total Cost

73

8/10/2019 FINsights


Praveen is a Chartered Accountant and an Associate with the

Banking and Capital Markets Practice at Infosys Consulting.

He has over 5 years of experience in the Investment Banking

and Information Technology consulting. His area of expertise

covers structured project finance, treasury middle and back office

functions and database strategies for capital market intermediaries.

He has handled consulting assignments for several global investmentbanks and asset management companies in the areas of database

strategy, credit risk reporting automation and IT transformation

for derivatives middle and back office.

Praveen DagaAssociate

Infosys Consulting

Hari is a Chartered Accountant, Company Secretary and an Associate

with the Banking and Capital Markets Practice at Infosys Consulting.

He has over 6 years of experience in the capital markets industry.

His area of expertise covers regulatory compliance including policy

formulation and review, asset management, investment banking

and broker dealer operations. He has handled consulting

assignments for leading investment banks and asset management

companies in the areas of regulatory compliance, asset management

operations and liquidity reporting.

Hari Shankar GuptaAssociate

Infosys Consulting

About the Authors

8/10/2019 FINsights


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