The European Commission has published proposals for improving securities settlement and access to Central Securities Depositories (CSDs – the entities that operate settlement systems) in order to reduce the current high rates of trade failure, costs and operational risks, particularly on cross-border transactions. The proposed rules, termed CSDR (Central Securities Depositories Regulation), are currently with the European Parliament and Council for discussion with the next steps likely to involve the establishment of a taskforce to develop the specific rules.
The major item of note within the proposals is the shortening of the securities settlement period across Europe to 2 days (T+2). The introduction of financial penalties for trades which fail to settle on time has been supported by a majority of market participants and is seen to encourage faster and more efficient settlement practices which will lower counterparty risk.
Germany, Bulgaria and Slovenia already have a T+2 settlement policy so there is a precedent within Europe that proves this can work, adding weight to the proposal for the remaining 26 member states to follow suit. A deadline of 1 January 2015 has been set for this, though participants may need to have capabilities in place as early as mid-2014 as this is also a prerequisite for T2S (Target2 Securities) which is also due to go live early in 2015.
Will asset managers be ready for a transition to T+2 by this time? Staffing levels, or other commitments to mandatory or discretionary projects will all affect asset managers’ ability to make system changes and amend processes to accommodate a move to T+2. Specifically the changes will need to address:
* same day affirmation, requiring verification of the trade to be completed on the same day the trade is executed;
* a potentially substantial increase in the number of trade failures – front offices are currently struggling to confirm and settle those trades at T+3;
* pressure on STP workflow – resulting in a higher number of settlement failures due to inefficiencies in systems or data issues;
* administration of additional fines levied for not reaching T+2.
The above may be very costly. A ThomsonReuters Risk Management report published in October 2011 claimed that on average across US capital markets: 60% of instructions needed repairing; 10% of confirmations were mismatched; and 15% of trades failed to reach settlement. For an institution making 10,000 trades per day this equates to an annual cost of approximately $4.8m, not to mention an immense risk burden.
T+2 will also have an impact outside of Europe. Cross border transactions will also need to be brought into line with the T+2 deadline. Additionally there are discussions reopening in the US around shortening their limit from T+3 to T+2.
So is the European asset management community ready for T+2? Current settlement periods in Europe are shown in the table below:
Source: CSD Statistics Exercise, ECSDA, February 2010
ESES = Euroclear’s single settlement platform
SCLV/CADE = two platforms operated by Iberclear
Following consultation, the British Bankers’ Association agrees with the move to T+2, however it does not support a standard settlement cycle of T+2 for over-the-counter (OTC) trades. They believe“there is little-to-no evident risk associated with non-standard settlement cycles in the OTC market. More seriously, not only is there no compelling economic case for OTC settlement cycles to be standardised on a T+2 basis, legitimate and economically desirable trading activities may also be hindered or rendered practically impossible by such a stipulation.
These trading activities include:
Repo trading: In many cases, neither leg of a bilateral repo trade will settle on a T+2 basis. Given the CSDR’s prime objective of enhancing the safety and stability of financial markets, it would be a perverse outcome if repo trading – a crucial tool in risk mitigation and exposure management – was inadvertently prohibited due to its unsuitability to settle according to the T+2 standard. This exemption also needs to apply to exchange traded repos, which again, cannot settle on a T+2 basis.
Trades which are agreed off regulated markets, MTFs, and OTFs and according to their rules but are executed on regulated markets, MTFs, OTFs: These types of trade are, in practice, OTC trades, with parties to such transactions free to agree their own terms and conditions. This flexibility is a crucial tool for investors and is a vital component within risk mitigation and strategic hedging strategies.
Pre-IPO trading: Where transactions are agreed before the securities are issued, i.e. the issuances date of the securities, therefore there are no actual securities to settle by T+2.
Trade in illiquid securities: This is of particular concern, as the illiquid securities market is a vital tool in the financing of small to medium enterprises”
As is highlighted above, the European Commission has so far not presented clear intentions for treatment of these types of trade and where exemptions will apply. The BBA has therefore recommended that policy makers exempt all OTC trades from the T+2 settlement period requirement.
Until a more complete picture is given as to how the T+2 restriction is intended to function, how much work will be involved within the asset management industry to make this happen for basic bonds, equities and funds cannot be assessed. It can be assumed that although additional work will be required in the initial period to reassess processes and gain efficiencies, the deadline should be achievable. Should the European Commission disagree with BBA then an increased amount of work may well put the deadline at risk.
Kevin Archibald, Senior Consultant, Citisoft
Can Thematic Investing provide investors with growth opportunities in uncertain times?
New whitepaper from CAMRADATA explores
CAMRADATA’s latest whitepaper on Thematic Investing, considers the role this type of investing can play in asset management and explores trends that can permeate society and traverse sectors. The whitepaper includes insights from guests who attended a virtual roundtable on Thematic Investing hosted by CAMRADATA in November, including representatives from CPR Asset Management, Sarasin & Partners, Impact Investing Institute, PwC, Quilter Cheviot, Scottish Widows and Stonehage Fleming.
Sean Thompson, Managing Director, CAMRADATA said, “In these seminal times, thematic investing has the potential to shape how the future unfolds. Yet running a successful thematic fund is no easy feat – it is a bit like navigating unchartered waters trying to identify the trends and the long-term opportunities.
“Trends such as AI and biotechnology are still in their relative early days, for example, and global economies are undergoing dramatic changes. But mapping out certain trends, identifying potential sustainable returns through a unifying thread that spans multiple sectors, could help future-proof investments. “Our roundtable guests considered current key themes, which themes worked well, and which have not and how thematic investors could identify trends with the potential to offer future growth.”
The guests named themes they currently like which included artificial intelligence, China, climate change, clean energy, automation, evolving consumption, ageing, digitalisation, water, waste management, biodiversity, and board diversity.
After discussing themes that have worked or not, the guests looked at total allocation to themed funds, and whether clients might be blinded by themes to the overall risk exposure in their portfolios.
Key takeaway points were:
- Themes have a habit of coming and going. One guest recognised that automation and robotics, for example, were cyclical, which means that investors will have to think carefully about entry-points.
- It was agreed that the commodities ‘super cycle’ of the 2000s came about with the economic development of China. Many commodities-based products found their way into mainstream investing, but this is unlikely to happen again.
- One guest was surprised by some of the themes that interested their customers; with their research showing that Board Diversity was almost the lowest-ranking concern among the ESG choices they listed.
- There was correlation between environmental impact and social benefits to investing. The theme that concerns the Impact Investing Institute, which is less than two years old, is improved measurement of such relationships.
- In terms of successful themes, one clear winner due to COVID had been digitalisation.
- One theme that has not done so well is the Ageing theme focused on older people travelling and enjoying experiences abroad later in life.
- One guest said their firm used themes for ideas generation, not as a shortcut for portfolio construction. They said themes lead to good ideas, but they then spend at least three months researching a stock, so that the best themes are represented by the best investments.
- The final point was that there are sensitivities for any global investor in allocating to themes, even the biggest one of all, Climate Change.
- But on a positive note, one guest added if all stakeholders can resolve their differences on definitions such as impact and ethical investing, then more capital will be readily transferred into opportunities.
The whitepaper also features two articles from the sponsors offering valuable additional insight. These are:
- CPR Asset Management: ‘Central Banks: leading the path towards Impact Investing’
- Sarasin & Partners: ‘Theme or fad? How to invest for the long term’
To download the Thematic Investing whitepaper, click here
For more information on CAMRADATA visit www.camradata.com
Promises, Promises: Navigating the Reputational Risks of ESG Investment Pledges
By Nir Kossovsky and Denise Williamee, Steel City Re
As the trend towards ESG investment and a low-carbon economy continues, banks are being backed into a reputational corner. Law firms specializing in representing the expanding pool of litigious shareholders are salivating.
On one hand, banks understand the inherent financial risks and challenges involved with making a wholesale move towards a low-carbon economy. The transition to a greener corporate world can’t happen overnight; as long as “brown” assets continue to be profitable, those in bank leadership positions have to balance their green aspirations with their responsibility to shareholders.
On the other hand, while not renewing loans on existing coal mines or fracking sites may improve a bank’s carbon disclosures, it could have social and financial ramifications that disappoint other stakeholders—i.e., causing people to lose their jobs. Still, financial institutions are experiencing pressure from all sides—from ESG investors to social license holders – to divest the fossil fuel industry and adopt drastic “green financing” practices now.
To alleviate these pressures, banks are pledging greener financing initiatives. Almost every large global bank has made some sort of commitment. Goldman Sachs, for example, announced they would spend $750 billion on sustainable finance over the next decade. Bank of America pledged $300 billion.
Bank boards and executives likely don’t fully appreciate the reputational risks posed by the aspirational statements they’re making. They are making promises and raising expectations without the operational or governance systems in place to ensure those expectations will actually be met. Overpromising and increasing the risk of angering and disappointing stakeholders is the very definition of reputational risk.
Banks are in a unique position: integral to every aspect of our economy, well-known brands that work hard to build and retain the trust of their customers and the general public while operating in an environment of intense scrutiny by politicians and regulators at every level of government. Satisfying all the stakeholders calling for greener policies while fulfilling their responsibility to their shareholders is a demanding balancing act fraught with risk. The Business Roundtable pledge, led by JP Morgan Chase CEO Jamie Dimon, and elevating employees, communities, and the environment as stakeholders, was an attempt to strike that balance. Already, though, that pledge is being dismissed by politicians like Senator Elizabeth Warren, who characterized it as an “empty publicity stunt.”
The price of missing expectations is costly, and bank executives and board members could find themselves in a legal hot seat. Federal securities lawsuit filings alleging reputation harm from missed expectations are up 60% over last year, the third year of a rising trend.
This trend stems from SEC regulation S-K that calls for more human capital disclosures, and the Caremark decision that sets the bar for most securities litigation and makes board oversight of mission-critical corporate operations a test of the duty of loyalty. Other cases, like In Re Signet, have made ESG-like pronouncements—historically “immaterial corporate puffery”—now potentially material in the securities arena.
For example, directors’ duty of loyalty were successfully questioned in alleged failures of innovation (In Re Clovis Oncology, Inc., board failure to protect the firm’s reputation for pharmacologic innovation); safety (Marchand v. Blue Bell Creameries, board failure to protect the company’s reputation for food safety); and environmental sustainability (Inter-Marketing Group USA, Inc. v. Armstrong, board failure to protect the firm’s reputation for oil pipeline-related environmental protection).
In other words, aspirational pledges are now being considered by courts with the full weight of a material public disclosure. As wealth managers chase ESG-informed investing and capital markets chase ‘green underwriting’, the plaintiff’s bar chases boards and executives making pledges that appear to be no more than aspirational marketing.
The only way to strike a balance and mitigate these risks is through a robust Enterprise Risk Management (ERM) strategy that’s centered around understanding who your key stakeholders are, what their interests are, and ultimately, what their expectations are. Coincidentally, it is also one of the three key behaviors the world’s largest asset management firm, Blackrock, is demanding of all investee companies in 2021 thus communicating the type of authenticity to its slogan “beyond investing,” that BP failed to accomplish with similar sloganeering a decade ago.
Banks need to create a central intelligence unit with board level oversight to comb through every aspect of the organization to identify stakeholder interests, potential risks and/or exposures. Pledges and communications should be informed by a rigorous and honest self-assessment of the institution’s public filings and operational capacity. Overpromising is costly. ESG pledges must be rooted in achievable goals that a bank’s leadership are confident their institutions can reasonably execute on an operational level. Banks also need to consider transferring or financing risks using the broad range of conventional and parametric insurance products currently available.
Enterprise risk management, when executed properly, will fulfill ESG commitments, reassure stakeholder groups and give marketers, counsel, and investment as well as government relations professionals an authentic story to tell about strong corporate governance. ERM focused on reputational intelligence will provide confidence to ESG funds, institutional investors, bond raters, and government officials alike.
The popularity of ESG investment and chasing ESG ratings is not going to go away, and stakeholder pressures will continue to mount. Investors doubled the size of the ESG sector this year, putting $27.4 billion into ETFs traded in U.S. markets. According to a recent survey conducted by Bank of America relating to ‘Gen Z’—which is just entering the workforce—80% take ESG into account when making their investment decisions.
Bank leadership that is striving to attain the correct balance between stakeholders and shareholders need to lean more into the “governance” portion of the ESG equation; pledges backed by enterprise risk management are the strongest pledges you can make.
ESG – Bubble or Bandwagon?
By Josh Gregory, Founder of Sugi
Isaac Newton was a successful investor, but he lost a fortune (£15m in today’s money) in the South Sea Bubble of 1720. When asked about his misadventure, he supposedly replied that he ‘could calculate the motions of the heavenly stars, but not the madness of people’ (presumably, himself included).
The rise and fall of South Sea stock was one of the earliest and largest instances of a market bubble and crash. Three hundred years later, we’re facing another massive investing trend: sustainable investing. In the last year or so, almost every investment institution has jumped on the sustainability bandwagon.
It’s now arguably more notable to find an asset manager who hasn’t committed to sustainable, ethical, responsible, impact and/or ESG (environmental, social and governance) investing than one who has. The numbers are telling: in August 2020, assets in global ESG exchange traded funds and products topped $100 billion (£73 billion) globally.
Demand for sustainable investments has been bolstered by two main factors. Firstly, with climate change firmly on the global agenda and all eyes watching the Biden administration’s transition to power (and the subsequent climate change policy that will follow), ‘greening up’ has never been more of a priority for businesses and individuals. This includes the investment industry, with both retail and institutional investors increasingly demanding that their money has a positive impact on our planet.
Secondly, since the start of the COVID-19 pandemic reports have continually claimed that ESG funds are outperforming ‘traditional’ investments. No longer is going green cited as a ‘nice to have’; rather, these reports demonstrate the value and resilience of ESG funds to the investor community, increasing demand. Surely, this can only be a good thing? Yes, but only if investors know what they’re buying.
It’s no secret that ESG investing suffers from complexity, lack of transparency and a lack of any universal standard. Fundamentally, this is why we created Sugi – a new platform enabling retail investors to track the environmental impact of their investment portfolios using clear and objective carbon impact data.
Today, ESG terms can lawfully be used to label pretty much anything. Ultimately, this means that the ESG label is not a guarantee of good practice. In fact, an ESG rating is a financial risk metric – the scores calculate the extent to which ESG issues affect a company’s economic value. Many investors, even institutional investors, don’t know how to decipher this. The scores themselves are designed to be used in tandem with portfolio dashboards and other data to make financial decisions. This effectively means that the scores on their own without any context are not of much use to anyone.
This has led to a glut of greenwashing in the sector, where investment products are described as green, ethical or sustainable, but the description is unsubstantiated. And while the top financial performance of ESG funds seems uncontroversial, those digging a little deeper may be surprised at what they find. Many ESG funds are heavily weighted in favour of technology companies, which typically have low carbon emissions. These stocks skyrocketed in 2020 but it’s important to note the context. It was largely due to the COVID-19 lockdowns and had nothing to do with the stocks’ ESG credentials.
The EU, the UK and the US are all working on their own strict definitions of ESG. This should, in theory, go some way to clarify what investors are getting when they choose an ESG or sustainable investment product. However, this will take a while to implement and there will still not be a globally recognised definition or standard.
It would seem many people are pouring money into investments when they don’t know what they’re buying. That’s nothing new. But underneath the ESG label lies something meaningful, worthwhile and, above all, valuable for the world in which we live – environmental, social and governance best practice.
The question remains though, is it a bubble? A bubble exists if ESG investments are over-valued (i.e. over-bought). Right now, ESG funds may be in bubble territory because many of the underlying stocks that make up the funds are themselves in a bubble. But does that make ESG a bubble? If it is, when do we call it?
Historically, all bubbles –whether they be tulips, canals, railways or the internet – no-one knows. And if I knew now, I’d be sunning in the South Seas rather than writing this blog!
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