Eddie Heaton, Managing Editor of International Securities Services magazine.
Richard Jones, Director, Transition Management Prime Services
Nicholas Gant, Head of Sales Trading and EMEA Head of Fixed Income Prime Brokerage
Will Gow, Liquidity Management Agency at Societe Generale CIB
WG: Just by way of setting the scene I’m going to look back to pre-financial crisis because I think this provides an important backdrop into understanding the business and how it’s evolved. If we look back to before the financial crisis, we will recall that the banks were siloed by product. The equity teams of a bank would just deal on the equity side of the business. That is fundamentally changing. Secondly, you had those on the repo side, trading fixed income against cash and that was really driven by the bank’s need to fund their inventory. So, in response to the financial crisis, the regulators are deleveraging the system and harmonising tax requirements across Europe. That’s changed the equity field considerably. Regulation is forcing banks to focus on more efficiently managing their balance sheet. I think those are important factors; particularly the management of balance sheet, that has driven a lot of the change that we are seeing today. Additionally, the need to free up liquidity and optimise inventory, in the most efficient way with the drive to move OTC products into an exchange traded and cleared environment, has really driven these businesses together.
NG: You had product silos, you had asset silos, you had the idea that you’re either trading as a principal or as an agent. Will mentioned balance sheet, pre-2008, I’ve seen balance sheet given away for 2 basis points, and that was seen as a really good transaction. That just wouldn’t be the case, now. I think 2008 was a real watershed moment for the market in general. I remember when UBS put their treasury team together with their repo desk and that that was seen as being very innovative. Why would the treasury department be sat with the fixed income repo desk? So, pre-2008 was a completely different environment, and I think we’ve probably seen more change in the last ten years, than we saw in the previous 20 or 30. I think we are really talking about two different phases of the market, pre-2008 and post-2008.
EH: But aren’t we talking about pre-2008, post-2008 and then also around MiFID II and SFTR? So, isn’t that three phases we’re talking about?
NG: I guess that’s probably fair, because, as Will said, regulators then reviewed what was there. They made some decisions as to why they thought there had been some exuberance in the market, and they’ve spent the past ten years putting in place regulations in order to control certain activities. In some of the 90 odd different matching criteria that are going to be coming out, they’re quite detailed. This last ten years has been about what the regulators need to do in order to feel comfortable. But that’s not been a strain on the market. Then, as the rafts of legislation came in, and continue to come in, it’s brought new challenges to all market participants. The buy-side in particular, I think, have had significant requirements, and will continue to have significant requirements, which hopefully, if we’re nimble as an institution will present a fantastic opportunity for us to provide new and combined services to our clients.
EH: You’ve mentioned balance sheet. I know there’s an SFTR transaction reporting obligation that doesn’t come in until 2019. How does that differ from the present transaction reporting obligation, and those under MiFID II?
NG: I think with SFTR coming in, there are significantly more reporting fields that will be required. It’s timing is interesting because in theory SFTR comes in in Q2 2019. We appear to have Brexit coming in at that time, as well. So you’ve got a really interesting set of criteria coming in all at the same time because a lot of institutions are having to make decisions as to where they will be situated as well as what their preparation and their requirements are for SFTR. Obviously, vendor services are there to assist with that, and are positioning to do so, but it’s a lot of work. When you think of MiFID being the work that’s coming in for this year, that’s a significant architecture review that everyone’s had to look at. It comes down to a resource issue, sometimes, because you have clients who, maybe, don’t have the budget to be able to pull everything in. That’s where they have to lean on providers to assist them with that. As I say, it’s an opportunity for us to assist our clients, and again, if you’re looking at this phase from 2018 onwards, that’s where we absolutely think that a much less siloed approach will be needed. You can’t look at things as independently as you would have done previously. Fixed income equities, agency, principal etc. In order to be efficient, you have to look at things as a more holistic view.
WG: That’s an interesting point. Is SFTR going to be the catalyst that really changes the securities finance market? Because, effectively, what that allows regulators to do is to collect big data on the whole of the securities financing market, because these repositories will hold every single transaction that takes place. So, once that data is circulated and people start to understand the implications of that data, it’s not going to take a genius to start applying artificial intelligence to that data, to actually manage trading strategies. So, it’s an interesting diversion from the subject, but could SFTR be the catalyst for fundamental change in this business?
NG: I’m absolutely certain that the regulators, when they looked at how opaque the securities financing market was, compared to other exchange driven markets, will have decided that that’s not going to fly any more. They need to know what is going on under the hood, so to speak. All the different firms that employ securities lending, repo and margin financing will need to be aware of the leverage impact and the activities relating to it.
RJ: Now, for ourselves, I know that from when SG acquired NewEdge, the idea was that SG would spend time to see the various brokerage models that were out there. They very much wanted to put together a division which had the capacity to look across all products and provide some offsets with variation margining across products. You’ve got three people here from what would previously have been considered very different parts of a bank. We work very closely together, because there is so much interconnectivity between all the products now for us. and since we have got rid of the silo culture, we are all working towards the same P&L and thus all incentivized to get the client live with as many products as possible, which may not have been the case in previous years
NG: I’m going to use a phrase that everyone here has heard a million times before, and they’re probably going to leave the room, it’s the idea of pick and mix. For us, as a provider of services to our clients, we would like to be able to provide them with as many different products as possible, so that they can select the appropriate ones for them. For us, as a division, it doesn’t matter if they want to look at something that’s an agency model, and/or a principal model. Whether its equities or fixed income or the futures side, whatever the client’s looking at, the idea is that we pull everything together, we try to make a single point of margin call, we try to then ensure that they make the maximum use of their (HQLA?) assets. This is something that I think in the environment we’re going to see post-2018, if you’re not maximising the assets you had, as an area, you’re going to be spending an awful lot of money that is a direct result of the regulatory costs that come with that. To be more efficient we need to make savings now and that’s why I think we can bring that in.
WG: Just to add to that, from the bank’s perspective, and again, going back to balance sheet and balance sheet constraints. The whole concept of bringing in different distribution channels – so we’re talking about CCP, bilateral, tri-party, pledge accounts – all of these are becoming more significant. So, back to Nick’s point, certainly on the securities finance side, it’s very important the demand side is a key driver for distributing client assets. If regulation is changing the way they have to think about the way they work, clients will adapt, because they’re going to get better value from adapting. So, these are new ways of transacting, and we are going to start seeing more traction with them In fact we already are.
NG: One of the other items that probably doesn’t get so much in the way of headline, where there’s been a significant movement, is the reduction in the time of the settlement cycles. You will have significantly more pressure as the settlement cycles are reduced. You’re looking at the European government bonds sector, moved from three days to two days for a standard settlement cycle. Suddenly, there’s more pressure on moving the assets into the right area, you’ve got same day collateral requirements for margin purposes and cash reinvestment. The whole of the timeframe has reduced significantly in the last ten years, or even less, we’ve seen massive reduction. You would argue that it’s potentially going to be become even shorter as a result of blockchain initiatives, on, for instance, settlement. When you have a product where the settlement cycle is T+0 you have to be more efficient with your assets in your accounts, otherwise you can’t function in that market.
EH: On the data side, significant research unbundling will now be required, but also a complete decoupling of research and execution, how will that affect your business?
NG: That’s a good point. In Prime Services we can’t really comment about the research business of the bank because as a business line Prime Services doesn’t generate research. It is a different business, within the bank. Regardless, yes of course our clients are impacted by that result, and in an effort to continue servicing them, it is something we invest time and money in to ensure we have solutions for your clients but with regards to the nitty gritty and actual T&Cs, we are not best placed to comment because we do not generate research in prime services.
EH: What about venues? There has been a fragmentation in the area of venues and new venues that have come into being? Are we seeing the end of dark pools?
NG: From a fixed income perspective, we have a number of ECNs for the outward execution of bonds in Europe, probably more than you would see in, say, the US. We also have a larger number of CCPs in Europe than there are in the US. I don’t think the number of ECN venues is a factor, each one seems to have its specialist area, where it has liquidity. For us, as in PB, again it’s back to pick and mix, where we like to offer all of the venues available. Our challenge, which we’ve devised solutions for, is to ensure that we can capture all the data coming from the ECNs, and bring that into our internal system, seamlessly. So, I don’t mind if there are 30 venues, as long as we can connect to them and offer them to our clients. If the market moves towards a multiple venue set up, or we add a multiple venue set up, I really don’t mind. I’m agnostic on that. I must make sure that from the prime perspective, we can capture that data and manage the data, and the client’s happy. Will, what do you think from the agency side?
WG: Yes, from the agency side, we look at, for example, CCPs as another distribution channel. There are various peer-to-peer platforms out in the marketplace, and there seems to be a growing number of them. How many of them are going to survive? Well, that survival rate will depend very much on the liquidity and the flow that goes through them. Effectively, our clients might want a percentage of their flow to go through an alternative platform which is not reliant on bank counterparts mitigating potential risk of quarter end bank squeezes, around balance sheet management. So, alternative platforms for a certain percentage of flow, could be valuable alternative distribution channels.
NG: That’s a very good point. We’ve been heavily involved in the CCP repo for bi-siding initiatives that are ongoing. Again, because it’s a product that has a demand from our client side. The capacity to be trading on what would be the original inter-dealer platforms for repo, has been something that our clients were keen for. Some of that related to the dislocation of the repo market in 2016, and subsequently, the concerns over having the month-end liquidity provision by their traditional liquidity providers, and some related to the requirement for them to get same day collateral quite late in the day. As a new avenue of liquidity for the buy side, it’s something that we’ve been at the forefront of with the offerings from Eurex and LCH.