Post-Trade Challenges: Eliminating Settlement Risk in Financial Markets
Our CEO, Dave Sissens, writes in Global Banking & Finance Review why Herstatt Risk remains one of the single biggest post-trade challenges in the interbank FX market.
With globalisation increasing across all sectors, digital transformation has become a priority for many businesses. When it comes to technology in Financial Services however, wholesale financial institutions have been slower to adapt than consumer-facing financial institutions. In the financial market, this is a cause for concern as macroeconomic events such as the pandemic, economic instability, and current geopolitical developments have exacerbated the impact of technology on continuity of operations.
Although post-trade technologies and processes are critical components of the financial ecosystem, innovation in this area has generally lagged. Although wholesale financial markets are investing in innovation in the front-office, there is much to be done for post-trade processes, which are still manual, complex or duplicative.
What are the issues currently at play?
In terms of innovation, post-trade and client onboarding are still behind in comparison to other financial industry segments. Because many procedures are still manual and duplicated, errors upstream can have a significant impact on processes downstream. As such, inadequate data and delays in onboarding new clients can be a significant burden to operational resilience. Overall, it raises market participants’ expenses, driving up the cost of financial services.
Inefficiencies and a lack of automation in the use of Non-Economic Trade Data (NETD) also contributes to the overall fragility, risk, and lack of innovation in the financial market. According to a recent Depository Trust & Clearing Corporation (DTCC) survey, it found that missing or incomplete SSIs are the primary cause of trade failures for 78% of respondents. The DTCC explained that if the global failure rate grows to 2%, industry losses and damages could total up to $3 billion per year.
While market participants are aware of and understand these costs, they are often regarded as tolerable when the system functions properly, so no one feels strongly enough to act to resolve them. With growing economic uncertainty, this is no longer feasible and financial institutions must offer solutions that are agile and meet the needs of banks and businesses today, tomorrow and in the future.
It’s time for a change
Recently, the Bank of England’s Post-Trade Task Force advised that the financial services sector should look towards emerging technologies to strengthen the post-trade ecosystem, but stressed that technology alone is insufficient. To overcome these difficulties, the financial services sector as a whole will need to work cooperatively.
The need to abandon legacy technology has been made even more pressing by regulatory pressures, which include the need to reduce settlement failures, expedite settlements, and prepare for the growing adoption of digital assets and changes to market structures.
When we consider the types of innovation that the industry has seen since the initial systems were developed, there is now a wide range of opportunities provided by new technologies and functionality. In fact, if there continues to be a lack of innovation and collaboration, the cost of financial services will grow, creating more risk in operational resilience.
We need a concerted effort from the industry to come together and focus on innovation in post-trade processes. Only then, with a single, consistent approach, can these processes be streamlined and improved.
Finding a solution
To have a payments system that is fit for today and the future, the market requires a highly secure cloud-based solution that is adaptable, has a standardised structure, and a network that can meet the needs of all market participants. Transactions should also be carried out in real-time to improve efficiency and accuracy, and ultimately reduce risk and error in post-trade procedures.
Financial institutions can also reduce duplication in situations where each asset class has its own siloed approach of engaging and communicating with counterparties. This can be done by digitising middle and back-office procedures, which can result in significant efficiency improvements. Additionally, post-trade digitisation can provide new insights by feeding back data gathered in back-office workflows to help front-office traders understand the capital and collateral implications of their positions, as well as the true cost of a deal.
Regulators and post-trade participants have recognised the potential of disruptive new technology. If market participants are willing to work together to find a solution, the future potential is limitless.