Joining Up is Hard to Do (by John O’Hara, Taskize)
Competitors don’t cooperate easily and banks do it worse than most. But in every industry there are occasions when clubbing together becomes a necessity, with former foes uniting in a common cause.
Reforms to the OTC derivatives market certainly count as a common challenge for the vast majority of Europe’s banks and brokers, as well as their buy-side clients. The incoming rules for centrally- and bilaterally-cleared OTC derivatives – designed to increase transparency and reduce systemic risk – have far-reaching implications. Operationally, they demand a front-to-back-office overhaul of internal and externally-facing processes that have hitherto been unconnected, uncoordinated and very often carried out via manual, proprietary and non-standardised means.
In particular, OTC derivatives market participants will have to monitor and move cash and other collateral assets required for initial and variation margin much more quickly and frequently than previously. For centrally-cleared transactions, new relationships and processes are being developed to mobilise and deliver collateral from central securities depositories (CSDs) and custodians to clearing houses via clearing brokers. For bilaterally-cleared transactions, the changes are also significant, with variation margin exchanged between multiple counterparties according to strict rules on control and segregation.
The combined effect is to increase pressure on under-resourced back offices across the buy- and the sell-side. Many believe collateral transfers are well on their way to entering a T+0 if not real-time environment. To handle their increased number and frequency, multiple information and transaction flows between myriad counterparties must be freed up and accelerated.
Although the new rules are designed to encourage market participants to switch to the most systematically-robust instruments (centrally cleared, executed on electronic trading venues), many believe these do not meet their needs and are thus committed to making the OTC derivatives markets fit for the 21st century. To do this, consensus and collaboration is essential.
While it’s easy to agree on the need for automation and standardisation to facilitate continued and growing use of the OTC derivatives markets, it is far harder to work together with partners across the industry to achieve this result. As noted above, the history of collaboration in the financial markets is chequered at best; and few today can afford to bet on anything but a dead cert. Moreover, it’s not just enough to get a single set of competitors to agree – rival CSDs, custodians, clearing houses, brokers and asset managers (among others) need to buy into a common future vision for OTC derivatives. How, then, to come together effectively?
Existential crises can sharpen the mind, but the lessons of past failures and successes can also inform. In my experience, having the interested parties sit around the committee table, collectively staring at a blank sheet of paper, is not the best place to start. In many cases, the most successful utility-type initiatives are those that are nurtured by a core team of evangelists, working alongside organisations from across the industry to hone and refine the appropriate solution in line with feedback but, critically, maintaining the momentum behind a core idea, which itself must be targeted, specific and easy to deploy.
Incumbents and vested interests – both individuals and organisations – have obvious reasons to buy into new ideas to improve and invigorate a market; its success may well bolster their existing market position. But they must also satisfy their ‘hierarchy of needs’. Whilst you can’t make an omelette without breaking eggs, consensus-driven solutions cannot be threatening or risky. Ideally, they should reward and recognise inputs, guarantee intellectual property and not expose backers to new costs or risks. They should not demand significant investment of human or financial resources to the already over-stretched, but they should offer a path toward maintaining or ideally increasing revenues, addressing pain points directly.
Put like this, it’s easy to understand the failure of initiatives that are seen to be led by an acknowledged dominant player, or even a consortia of firms with multiple competing, conflicting priorities. It is often far easier for a small, unthreatening vanguard to push a project through the hard yards, albeit involving the rest of the industry, keeping closely in synch with collective challenges and opportunities. This is what I learned about collaboration from my experience developing AMQP – an inter-operable open standard for business messages fostered at JP Morgan which gained acceptance in many industries (even by the US Government) once we had built the necessary partnerships with rival technology giants – and which also provides the guiding principles of Taskize.
Participants in the OTC derivatives market face a common challenge. If they can find the common mechanisms and processes that enable them to move collateral in an efficient and transparent manner that meets the requirements of regulators and participants, the market will continue to thrive. Encouraging progress is being made, with best practice coalescing around solutions that help counterparts share information more efficiently, eg smart contracts.
Though based on automation and standardisation, these solutions are fault sensitive, flagging to users disputes and exceptions that will inevitably arise from human error or systems-based glitches as collateral transfers accelerate and multiply. Intelligent automation through industry collaboration to address the challenges of OTC derivatives reforms may do much to relieve the pressure on bank office staff and systems. But back offices need collaborative tools of their own if the exceptions, disruptions and disputes arising across multiple asset classes are to be tackled effectively. Collaboration takes many forms, but often the path of least resistance is the most successful.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.
CEDX opened on 6 September, offering contracts on Cboe Europe single country and pan-European indices.