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THE FUTURE OF CLEARING

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Hans-Ole Jochumsen President, Global Trading and Market Services, NASDAQ

The clearing landscape is at an important crossroads. Regulatory reform is prompting unprecedented change and the upshot will be a very different clearing regime to what we have today. The overall aim is well understood – to create greater stability and transparency. However, the real challenge will be achieving this while balancing the needs of participants with those of the market and society as a whole.

This will require some careful navigation of the detail and, crucially, a re-think of clearing practices. While regulators iron out the specifics, CCPs have an important and collaborative role to play in defining this future. Three areas stand to have the greatest impact – capital efficiencies, investor protection and technology innovation.

The rise of cross-margining

Achieving capital efficiencies will remain an important consideration as participants look for ways to do more with less. Today, this is largely related to margin levels but that’s all about to change.

Decisions around what to trade and clear will be influenced not only by the product but also by the levels of margin required. This will become increasingly important with mandatory clearing, given that participants will clear more products while having to hold larger amounts of capital.

Cross-margining has emerged as a valuable tool to tackle this challenge. Currently, this is done to varying degrees across the industry, whether it’s cross-margining across OTC and exchange-traded products or net margining across multiple asset classes. It is where many CCPs have been able to differentiate their offerings based on their risk appetites. However, regulations will harmonise margin levels. Therefore, most participants could, eventually, achieve the same levels of efficiency through margining, regardless of where they clear trades. As a result, participants will be on the hunt for other ways to make the best use of capital.

Optimising collateral

Hans-Ole Jochumsen President, Global Trading and Market Services, NASDAQ

Hans-Ole Jochumsen President, Global Trading and Market Services, NASDAQ

Collateral management, while not new, will need to evolve to meet this need and it is this that will drive future capital efficiencies. Opinions and predictions differ on whether there will be a collateral shortfall and, if so, how great it will be. The reality will depend largely on how well these assets are managed. Therefore, the ability to optimise collateral in ways that are not related to margins will become highly valued.

On the broker side, efforts to address shortfalls on clients’ inventories or transform ineligible assets into suitable collateral will have a big impact. On the CCP side, there are several possibilities that could emerge.

One of these is integrated calculations between margin portfolios and collateral portfolios. This would allow full offsets where a participant holds the underlying security when trading, for example, an equity option. Clearing systems calculating the exposure in a participant’s portfolio against their underlying collateral is true collateral management.

Other opportunities include optimising cash, with total netting across all cash flows and full STP. This would apply to the entire cash flow, from instruction and confirmation to reconciliation of individual transactions. As a result, any excess collateral in cash could be used to cover cash settlement while a positive cash settlement could cover the margin requirement.

Delivering better collateral management will be subject to certain constraints – such as the time it takes to transfer cash and securities between parties.  It will also depend heavily on technology. Dealing with the complexity of clearing requires greater innovation and this becomes highly relevant when considering open access and interoperability. Whether the latter becomes a reality soon is not yet clear. However, the drive to increase competition in clearing means that innovation in collateral management will have a marked impact on what participants choose to clear and, importantly, where they clear them.

Collateral management will also be driven by greater automation, standardisation and anything that improves efficiencies. Connectivity and the continual drive for STP is one example. The elimination of manual intervention of flows between the participant, client and CCP could well push through the standardisation of FIXML, FPML and Swift-based messaging. Automation would also deliver further capabilities, such as direct debit or credit transactions that automate the paying back of any cash surplus on a member’s account.

Raising the bar for client segregation

When creating stability, the future of clearing must support the fundamental principle that investors should not have to bail out a defaulting CCP. Client segregation is vital for this. The reason that firms are still unpicking the collateral held at Lehman brothers and MF Global is evidence that segregated clearing was not in place.

While client segregation is now mandated by the regulators, it is demand from participants that will drive future offerings. They will want increasing levels of protection that give them confidence and peace and mind – and the regulatory minimum might not suffice.

The Omnibus model is a case in point, with CCPs holding one account for multiple clients. This falls short of truly mitigating risk as it lacks transparency around what collateral and positions each client has. As such, they will prove difficult to transfer.

More robust offerings are required, so the future will demand account structures affording different levels of protection, covering both ICA accounts and fully segregated structures. This approach has already proved its worth in real market circumstances. As with collateral management, technology will once again be the driver. In particular, this technology will need to include systems and account set-ups to manage a large number of these different segregation structures.

The industry has a false impression that this level of true segregation is costly and complex. The reality is that it is not only a must-have, ensuring stability and investor protection, but also entirely accessible.

New approaches for recovery and resolution

If we assume that all CCPs will eventually catch up on client segregation, then the real opportunity for change in investor protection will be through recovery and resolution. Getting this right could have the greatest effect on reducing systemic risk.

Market infrastructure is important and there are some clear divides of opinion. On the one hand, a market with one or two large CCPs would be better for capital efficiency. On the other, it creates huge systemic risk because a single CCP default would have a massive impact on the financial markets. A palette of medium- and large-sized CCPs would allow for more robust recovery options – and that’s going to benefit the market and society far more. The roadmap to achieving this will need to address the commercial interests of all involved. However, it should evolve naturally as a result of regulations encouraging competition in the market.

Recovery and resolution in this landscape of multiple CCPs would need to consist of carefully considered tactics. Every recovery situation will be unique, so having a one-size-fits-all approach could have unwanted negative consequences. For example, forcing mandatory transfers of positions to another CCP would create additional risks if that CCP is not equipped to take them on. A more flexible and robust solution would be a voluntary recovery arrangement for fungible OTC contracts that are cleared by all CCPs. This would allow the market to find the best fit in any particular scenario.

This would call for a high degree of dialogue and cooperation, which would be a big shift for the industry. However, it is a good example of where collaboration is essential to deliver real benefits to the market.

Paving the way with technology innovation

Ultimately, technology is going to be the driver for the future of clearing. In the past, the front office received most of the limelight. The future will be very different, with regulatory reform, increased competition and client demands affording clearing far more attention – and a new wave of innovation.

What’s clear is that change is inevitable. Greater competition through regulation is a positive step – and with that comes greater choice. Participants will be looking for ways to tackle costs and deliver the most efficient and effective clearing processes. As a result, the industry must collaborate and innovate if it is to promote competition and make a more stable and transparent market a reality.

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Jack Henry shares six areas of focus for financial institutions in 2021

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Jack Henry shares six areas of focus for financial institutions in 2021 1

Reflecting back on 2020, the community banking and credit union industries should be proud of how this unprecedented pandemic and resulting economic crisis was managed. It was a truly remarkable time in which organizations worked together to take care of their employees, serve and support our communities, and operate their businesses efficiently despite significant challenges.

Now in 2021, the financial services industry is focused on moving forward – and is well positioned to do so. The technology demands faced over the last year were tremendous, but they were not a surprise. Jack Henry has been steadily working toward building digital, user centric, and open technologies that allow community banks and credit unions to meet customer and member needs personally and at their time and location of choice. The company is constantly evaluating industry trends and developing the technology necessary to prepare financial institutions for continued success. Below are a few areas of focus in 2021:

  • The Paycheck Protection Program (PPP) continues. An additional $284 billion has been approved for PPP lending, including new loan eligibility and the option for qualifying businesses to receive a second loan. Preparing for the dissemination of these funds, all while managing the forgiveness process, is top of mind for many bankers. Community banks and credit unions can continue to benefit from participating in this program by gaining and strengthening small business customers as well as playing a significant role in extending loans to minority- and female-owned businesses. In fact, in addition to facilitating the majority of the small business PPP loans in 2020, community banks originated 72.6% of PPP loans made to non-white small business owners and 71.5% of PPP loans made to female small business owners.
  • Digital banking continues rapid acceleration. Digital banking adoption has reached record highs, and enhancing digital service is a top priority. The area is constantly evolving in speed, personalization and openness. The key to continued success is to stay focused on the needs of people, identify digital solutions that draw people in, engage them, and focus more on providing human-centered service in moments of need. Platforms should offer open infrastructure that makes it easy for institutions to embed their solutions of choice, preparing them for the future.
  • Payments platforms take center stage. It’s critical for financial institutions to broaden their payments options, moving toward an approach that provides end users with robust features combined with an excellent experience. An integrated payments infrastructure that provides frictionless, real-time experiences will be necessary to compete with big banks and fintechs. Financial institutions will partner with vendors that can help to build the right platform for their unique customer and member preferences.
  • Digital transformation in mortgage lending. Mortgages rates have dropped to record lows and the Federal Reserve has expressed no plans to change the rate environment until 2022 or beyond. Bankers must drive efficiency to compete. They need automation and seamless workflows that effectively measure credit risk and streamline previously manual processes. This empowers lenders to focus on building relationships and growing portfolios. Borrowers will benefit also from the added speed and connectivity with their lender.
  • Changes in the new administration. With the pending changes in Washington, a new administration will most likely swing the pendulum back toward an environment of stricter banking regulation. Economic recovery has also been identified as a top priority by the new administration. Banks and credit unions must have agile technology and processes in place to respond; outsourcing will help many with these adjustments.

Transparency and fairness in lending. Given the social environment in our country today, Jack Henry expects a real focus this year on diversity and inclusion in banking, especially around access to fair credit and lending costs. Many organizations, Jack Henry included, have taken a formal stance in supporting racial justice and equality. Working together to ensure that lending clients are treated equitably.

This year will continue to be about partnerships that are committed to doing the right thing and providing for local communities. Together, fintechs and financial institutions can develop joint strategies and modern technology that drive success, both today and tomorrow.

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Seven lessons from 2020

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Seven lessons from 2020 2

Rebeca Ehrnrooth, Equilibrium Capital and CEMS Alumni Association President

 

Attending a New Year’s luncheon on 31 December 2019, we played a game that involved predicting the world in 2020. Some of the questions included: would Uber become profitable? Would the three-decade bond rally finally come to an end? Would the US hit a recession?

Unlike any of our predictions based on a traditional approach to business and predicting, we now know that 2020 became the year where business, professional and personal plans were turned upside down, reshaped and put-on hold. The proverbial black swan had arrived.

As revealed in a new CEMS Guide to Leadership in a Post-COVID-19 World, to which I contributed, the COVID-19 pandemic has exposed deficiencies in the 20th Century vision of leadership, giving a rare opportunity to question the status quo.

So, what are the main lessons from 2020?

  1. Humans are enormously adaptive.  This is not an extinction scenario. The world is getting used to dealing with global human disaster which may become a recurring event. Life continues guided by new parameters.

  1. No sector or country is immune to rapid change. Just as the leveraged finance and equity markets ground to a halt during the Global Financial Crisis, we have seen a disruption in the financial markets (including M&A) in 2020, including a significant redistribution of wealth between sectors; think tech vs airlines and the hospitality industry. When a market is disrupted it has secondary and tertiary effects such as less work for accountants, lawyers, financiers etc.

 

  1. Location is not as important anymore. The belief that finance staff need to be based in one of the financial capitals to be effective has been forever altered. Pursuing a career in finance from anywhere is becoming possible. However, it’s likely that over time, financial controls and human interaction will move the work model back towards the traditional office approach, as work is a critical sanctuary for people. While working from home may allow more time for family, chores and sports, it is mainly effective for people who already have their internal and external networks. For junior employees it presents a notable challenge as they may be forced to spend their formative years without a chance to really build their networks.

 

  1. Change is likely to be lasting. The opportunity for alternative finance and tech focused providers is enormous and 2020 will accelerate this shift. For example, many retail banks are providing rather poor customer service, blaming the pandemic. Even the most loyal customers will be heading elsewhere. For recent graduates and current students this is a major shift; future winners and key employers may not be names we are used to seeing in the headlines.

 

  1. There will be a spotlight on leaders with visionary strategy and understanding of the operations. 2020 showed many politicians and business leaders behaving like they were playing a game of snakes and ladders, rather than executing a thought-out strategy. The next wave of thoughtful leadership is urgently required.

 

  1. Collaboration leads to success. The definition of a pandemic is an infectious disease prevalent worldwide. A global problem requires a collaborative solution rather than each country and industry on their own. Quoting Steven Riley, professor of infectious disease dynamics at Imperial College London: “Once you have the knowledge and you share the knowledge, then you are able to take measures to push transmission much lower”. This principle is transferable to management education. In a world more complex than ever, investing in a degree is hard currency. Combined with the full global alumni network, corporate partners and schools, CEMS is capital that doesn’t depreciate.

  1. Resilience has become a watch word. Saint-Exupéry’s quote resonates with me: “If you want to build a ship, don’t drum up people to collect wood and don’t assign them tasks and work, but rather teach them to long for the endless immensity of the sea.” We are in a new paradigm – so prepare for the next change. For COVID-19, while we hope that the vaccine will soon upon us, the broader long-term positive challenge remains.
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Data after Brexit: How does the end of the transition affect GDPR?

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UK's Post Brexit productivity puzzle

By John Flynn, Principal Security Consultant at Conosco

The UK has officially left the European Union now that the transition period has ended on January 1st 2021. But this could raise issues with one of the biggest bugbears for many companies – the international transfer of personal data.

Businesses can relax, somewhat – GDPR, which took businesses months to get their heads around, is not being replaced. It will continue as the UK GDPR 2018, and will still be based on the criteria of the Data Protection Act of 2018. However, the UK will retain the right to change the UK GDPR as it sees fit in the future.

The main changes apply to those who receive data coming into the UK from Europe. Transfers from the UK to other countries can continue under existing arrangements.

We know it can be difficult to cut through the legal jargon, so we have simplified what you need to know to protect yourself and your data:

1 – Update your privacy notice

Most businesses do not have the correct clauses in place ahead of January 1st, potentially exposing their liability, should something happen to their data. All company privacy notices online will need to be updated to specifically state ‘UK GDPR’, as opposed to ‘EU GDPR’. You will also need standard contractual clauses in place, which cover both parties – those transferring and those receiving the data.

 The Information Commissioner’s Office (ICO) has a list of what needs to be included in the standard contractual clause here. The ICO will remain the UK regulator for data protection, regularly liaising with each EU member state.

This also applies to Multi Corporate Groups who operate in multiple countries, who need to update their documentation and privacy notice to expressly cover the data transfers.  The UK has applied for an adequacy assessment, which would negate the need for contractual clauses, however this has not yet been approved by the EU.

2 – Data privacy assessments

Any company which runs applications and software should always perform a Data Privacy Impact Assessment. This was also in the guidelines before, but these assessments are now more important for those who outsource their IT operations internationally.

For example, when using a service such as a cloud-based system, the company must be sure that its service provider adheres to UK GDPR and stores the data within the European Economic Area (EEA), or has a binding corporate agreement with the company, where data is stored outside of the EEA. You should also, as mentioned above, make sure that a contractual clause is in place.

3 – Review local legislation

Contracts should now have contractual clauses that specify the responsibilities of the data controller and the data processor. If you are receiving personal data from a country territory or sector covered by a European Commission adequacy decision, the sender of the data will need to consider how to comply with its local laws on international transfers. You should check local legislation and guidance in this case.

4 – Cyber Security health check

The ICO is increasing its capacity and efforts to crack down on data breaches, post-Brexit. Now is a great time for all companies to have a health check to understand their Information Security posture and GDPR compliance. Nobody wants to be caught handling data improperly and fined when it could have been prevented with education and training.

A gap analysis performed by an expert is money well-spent. It’s also a fact that companies that have cybersecurity and Information Security controls are not only able to better defend against attacks but are also far better placed to recover from an attack.

Looking forward

It’s important that all businesses – large and small – are properly preparing their data storage and transferring for the 1st January. ICO has been busy setting examples by fining large, high-profile companies for failing to keep millions of customers’ personal data safe.

It will continue to come down hard on the data breaches of personal identifiable information and special categories of data. The saying ‘prevention is better than a cure’ rings truer than ever this year, and you will thank yourself if you make the efforts to properly store your data now, and not when it’s too late.

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