By Daniel Carpenter, Head of Regulation, at Meritsoft, a Cognizant company.
As financial market participants of all types await the regulator’s decision on mandatory buy-ins, preparations continue for the introduction of the new CSDR Settlement Discipline Regime. With the focus on updating systems and operational processes to meet the requirements around penalties, as a minimum, how many have paused to think about what happens after the introduction of the new rules in February 2022?
CSDR is just one part of the story around trade settlement fails. Global institutions already process vast numbers of fails across the many regions in which they operate. They have no way of knowing what those volumes will look like in a year or two years from now. After CSDR, these firms will have to aggregate more data and establish more processes to handle these fails across numerous settlement platforms and different asset classes. Given the level of investment they are obliged to make in order to comply with this regulation, does it not make sense to address settlement fails as a whole, not just in the context of CSDR.
The surge in fails volumes during the volatility of March 2020 stands out as the most recent high-profile example, but outside of this there are many others which prove that fails are not specific to periods of extreme volatility. Back in September 2019, amid disruptions in the repo market, daily incidence of Treasury fails rose above $100 billion on two occasions. In Europe, the most recent Esma trends, risks and vulnerabilities report highlights that while fails in European corporate and government bonds have fallen from the peak in March 2020, the number in European equities remains alarmingly high. Given the sheer number of trades that fail to settle globally, market participants are increasingly aware of the need to find strategic solutions and leverage new technologies to address this industry-wide problem.
We already know that technology plays an important part in automating the settlement process to achieve greater efficiencies. Predictive analysis, artificial intelligence (AI) and machine learning (ML) also have an increasingly important role to play in identifying and anticipating settlement fails. Also, huge strides have been made to improve communication and collaboration between counterparties to identify points of failure and manage the remediation process. But this is only part of the picture.
In order for an institution to fully understand when, and with which counterparty, trades are failing to settle, all the relevant data needs to be centralised and accessible. Only with this ‘single pane of glass’, through which all the necessary transaction data can be viewed, can analytics and AI be applied effectively to help firms examine the likelihood of settlements failing and identify the sources of the most costly and frequent fails. With this level of insight, operational infrastructure can be optimised to allow remedial action to be taken to minimise the incidence of fails.
Financial institutions should also consider the computing power and flexibility of the cloud. While, arguably, not as exciting as the smart technologies, cloud has been well and truly thrust into the front line in capital markets as an enabler of powerful solutions.
Cloud can be key to minimising costs when scaling solutions across markets and regions. The flexibility delivered through the cloud means that financial houses seeking a broader fails management solution can tap into a more flexible pricing model – one that adapts to their needs at that time. For example, if a firm experiences a higher than usual percentage of settlement fails, it can quickly scale up its computing capacity to process these, or, conversely, minimise its spend should the number of settlement fails fall and the associated processing requirement reduce. The ability to de-risk investment in a solution, and to control costs, should be compelling.
For those prepared to look at the bigger picture, CSDR is a wake-up call to address the broader, longstanding issues around global settlement fails, which have become more acute in the months following the pandemic-induced volatility in March 2020. Regardless of the final decision on buy-ins, business and operations leaders at global institutions must continue their preparations at pace if they are to meet their CSDR compliance requirements from February next year.
The smarter firms, though, will be asking themselves what more they can do to reduce their overall rates of settlement fails. Whatever the answer, analytics, AI, ML and cloud should be in the picture as integral parts of any solution that seeks to resolve one of the industry’s most intractable and costly issues.