If regulation rolls back, do you?
Ten years after the Lehman bankruptcy some of the most heavyweight post-crisis regulation is being revised. Banks and brokers who have built processes and businesses around being compliant with those rules are in a quandary. And the pressure to change is not letting up.
Forward momentum for much of the regulatory agenda means that capital markets firms need to continue supporting the path as set out post-2008. The final margin requirements of the European Markets Infrastructure Regulation (EMIR) are still coming into effect this September and will only complete in 2020. The industry is expected to see filings for local central securities depository (CSD) licences under the CSD regulation (CSDR) in Q4 2018, which will harmonise European settlement rules.
Further work will be engendered by the Securities Financing Transaction Reporting (SFTR) in 2019 as securities lending and repurchase agreements are subject to new reporting, and the third iteration of the Markets in Financial Instruments Directive (MiFID III), is somewhere on the horizon, following MiFID II’s January 2018 roll out.
Many of these regulations are characterised by the need to measure and report risk metrics, in both quantitative and qualitative ways. Having been pushed towards disclosure, the recently implemented procedures around data handling and security under the General Data Protection Regulation (GDPR), have conversely constrained the movement and sharing of customer data.
Consequently banks’ and brokers’ middle- and back-offices, where the majority of compliance activities are focused, have seen a considerable post-crisis re-architecting in order to create post-trade workflows which reflect these ongoing regulatory changes. Maintaining these will be crucial to ensure efficient trade processing and accurate reporting.
Forwards, and backwards
However, some regulators are – in part – starting to reverse gear. In May 2018 in the US, President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act which rolls back parts of the 2010 Dodd Frank Act. It simplifies rules by exempting banks from certain capital requirements and other strictures, according to the value of assets they have. Smaller banks are exempted from a wider set of rules – including the ban on proprietary trading. Separately the Chairman of US derivatives regulator, the Commodities and Futures Trading Commission (CFTC) Christopher Giancarlo has set his sights on reforming cross-border derivatives regulatory coordination.
There are also open questions regarding the post-Brexit cross-border derivatives landscape between the UK and the European Union, which will only be answered during the ongoing Brexit negotiations. The UK’s political uncertainty creates the potential for a new regulatory framework to emerge for one of the world’s most important capital markets.
This may be frustrating for market participants. Will businesses that have set up technology and operations in order to comply with the status quo need to dismantle that infrastructure?
There are some elements of certainty that can illuminate decisions being made by compliance, operations and risk functions.
Firstly, the likelihood of regulatory harmonisation is very low in the near future. Despite the consent across the G20 about post-crisis regulation, there is significant variance in market micro-structure across major markets, and regulation is still evolving.
Secondly, as global capital markets infrastructure has become digitised and electronic, the importance of data capture and analysis has grown exponentially. The way in which organisations manage data is becoming central to how they manage their business.
Thirdly, the very real breakdown in consensus between major nations could result in different regulatory regimes developing that undo existing rules.
A positive step
The key to operational success in such an environment is flexibility. Building systems from components that are difficult to integrate, configure and automate is clearly a flawed strategy. ‘Run the bank’ and ‘change the bank’ are actually the same challenge given the frequency of changes and the need to constantly evolve otherwise hardwired technology. Working with regtech solutions to tackle point problems without addressing the underlying legacy processing platforms themselves builds layers of complexity that will have to be addressed sooner rather than later.
If data is the ‘new oil’ as has become a commonplace description, the very real risk of creating a ‘new oil spill’ exists, given the volume and speed at which data is forced through systems. The flow of information from front-to-back-office must be seamless, but configurable.
Compliance and reporting functions will still need accessible and high quality data that can be analysed and used for reporting. Aggregating that data from numerous systems implies a limited capability for supporting any real-time or automated workflows. Most middle- and back-office systems, which one analyst firm recently noted have an average age of 35 years, do not support the use of more modern data structures, and few have the infrastructure to run more advanced analytics or build data sets that can facilitate machine learning.
Firms need to manage static and reference data centrally, ideally in a modern, open and agile cloud-based post-trade system to anchor their operational workflow with a single source of data. Centralization makes management of regulatory and reporting requirements more efficient and more adaptable when required. When change is constant, rigidity is a weakness.
Mack Gill – September, 2018
October 11, 2018
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