The post-trade landscape is in desperate need of transformation; the technology that underpins it has reached a critical point in terms of cost, capacity and complexity. It is fraught with risk.
Consequently, banks and infrastructure providers need to initiate transformation – either without impacting legacy technology, or with a view towards wholesale replacement. In other words, they need to “mind the gap.”
This is what was generally agreed at The Realization Group and Software AG’s recent industry round table, where leading subject matter experts in clearing, settlement and post-trade operations came together to discuss the subject of innovation in post-trade.
In summarizing the problem that faced the industry, one participant noted that, in the absence of acquisition targets for the front office, and with investment banks’ returns on equity currently resting below 6%, the key for most firms today is to reduce costs. On that basis, innovative new technologies are something of a sideshow in the back office, he argued.
Other participants felt that technologies such as artificial intelligence (AI) and robotic process automation (RPA) can help buy a firm breathing space through the creation of scale without incurring significant cost, by reducing (sometimes by an order of magnitude) the number of people needed to work on a task. This can then open up new opportunities for a firm to commercialize and sell that process as a service.
Barriers to entry for FinTech
Several participants representing technology start-ups noted frustration with the capacity of banks to engage with new ideas and technologies, because the procurement cycle is often slower than the obsolescence cycle. Onboarding was seen as a painful and lengthy process, sometimes taking so long that start-ups can run out of funding before the process completes.
Risk aversion – a post-2008 necessity, participants all agreed – is also making it difficult to get new ideas through the door. One speaker made the case for internal sponsorship to drive change forward, citing the example of working directly with the chief operating officer and the head of architecture in their own organization.
Another barrier to entry for FinTech start-ups, noted one observer, is that their size and funding limits their ability to solve front-to-back challenges; they can generally only address specific point problems. Creating a utility that could offer an outsourced model to the back office might offer a “way in” for FinTechs, by solving one problem for many firms at once.
Even technology providers that are able to successfully provide a solution to a major challenge within a financial institution – whether large or small – often face barriers after tailoring it to a specific firm’s requirements, because they do not have a product that they can go on to resell, limiting the replicability of their investment. Greater standardization among Fintechs – along the lines of the FIX protocol, for example – might help to address this issue and increase the potential for onboarding.
Drivers for change
It was suggested that Brexit may provide an impetus for firms to start afresh instead of physically moving operations from one geography to another. One speaker noted that planning does not cost money, so there is a need to uncouple the strategy from the budget request. Then areas that need changing can be sequentially targeted in order to support the strategy.
That does require an articulation of the return on investment (ROI) on each part of the process however, requiring that data be available to describe those parts; data which is often absent due to the complexity of operations.
There are also macro-level dynamics which will have a bearing upon the back office. Passive investment and the use of synthetic products that lack physical settlement create different pressures such as real-time margining. The move to distributed ledgers could potentially allow real-time settlement and remove the need for reconciliation processes.
As one speaker put it, what the industry needs in order to consolidate action is a “bad guy,” i.e. a villain to fight against in the back-office space. This villain could be the lack of standards (however there doesn’t seem to be agreement on the “good guy” standard that should be formed to fight it). Utilities that could solve all of the agreed challenges – with points that are disagreed upon being handled at a later stage – would be one way forward.
Equally, some of the core infrastructures, such as central securities depositories, were cited as needing to take the lead in driving change, or risk becoming the “bad guy” themselves. SWIFT had succeeded in becoming a standardized framework; however some observed it allowed firms to customize messages to such an extent that it allowed the creation of inefficiency.
It was concluded that firms need to “mind the gap” on several levels when bringing in new technology and bringing together solutions.
One recommendation is to engage with partners who can ease the process of integration, working with start-ups who can overcome legacy hurdles and established firms who can integrate. Another is to bridge divisions within the industry to cooperate where possible.
Finally, they need to be aware that, as their peers and non-banks widen the gap in service capability, they themselves may fall behind and suffer significant losses as well as rising costs.
This article was first published by SoftwareAG here
Paul Fermor – UK Solutions Director for Software AG. Paul has spent his career creating solutions for very large-scale data analysis & real-time processing in a variety of applications, ranging from medical imaging to capital markets trading. He holds a first-class honors degree and PhD in Physics from the University of Surrey.