It is difficult to attend a conference and not hear how the internet is changing and is going to change business. A recent Paris conference on securities lending was no exception. More than 20 speakers from institutions as diverse as The Economist, NASDAQ, Chase and the Bank of England covered every aspect of the securities market – straight-through- processing-custody, clearing, settlement, developments in technology, collateral innovation, global trading and the European repo market. One common theme, the internet and IT developments, ran through every presentation.
According to Richard Jinks, Thompson Financial’s business manager in Europe, securities lending is up 25% in the past year and the technology that has fuelled the industry will need to support further development. Estimates by BNP Paribas suggest cross-border trading will reach 600,000 trades a day by 2003 – an alarming figure given that a fifth of cross-border trades fail or encounter some kind of glitch. Thompson figures suggest the cost in post-trade processing is indirectly proportional to the level of automation in the process. In the US and UK, both markets with a high level of automation, the annual cost of post-trade processing is 37 and 47 basis points respectively. This rises to as much as 176 in India and 106 in Greece, markets with little automation. Hence the need to develop straight-through processing (STP).
Fund managers now use STP when pitching to pension funds, boutique brokerages list STP as a priority and Jean-Luc Delassus of BNP Paribas Group bolstered the logic with a few statistics – worldwide assets reaching $15trn by 2004, listed financial assets reaching $90trn and mutual funds doubling to $16trn by 2003. STP will meet the development of cross-border activity and shorter settlement cycles. Delassus quoted the Global Straight Through Processing Association, the pressure group pushing for global STP, and its transaction flow manager model which, he said would benefit all parties. Fund managers will benefit from quicker and less risky settlement; brokers and dealers benefit from efficient settlement producing fewer failed trades and lower operating costs and custodians and agents benefit from more timely notification of trades.
John Dowsett, director of Perot Systems Europe, spoke on the nature of the back office. Pressure to cut costs and the enormous expense of IT investment will revolutionise the running of the back office and Dowsett spelled out four potential options. Under what he called the traditional banking model, small and medium-sized banks select larger banks to provide back office requirements. Alternatively, banks club together to share key elements of their processing and operations capability and under the communications model, banks co-operate and standardise to reduce overall costs. The likeliest (and somewhat radical) outcome, he suggested, is an investment bank or global custodian merging with a technology company to provide post-trade links and processing. So convinced is he of the theory, it’s a question of when, not if – the concept is simple, the devil is in the detail, he said.
Paul Hedges, director of risk and control, global custody at Royal Trust Corporation Canada, spoke on the prospects for custodians; one of whose greatest concerns is technological development. “The pace of change is so rapid that it places organisations in a Catch-22 situation. They grapple with whether to upgrade their own system or replace it with a new one,” he said.
Custodians and their clients will be able to work on common benefits like streaming trading interfaces and real-time reporting courtesy of the internet. As with the continuous change in IT packages, the internet provides custodians with a dilemma. “Global custodians will have to think about weighing up the risks of investing in an internet strategy versus what is called an old economy strategy of updating the present system,” he said.
Growth in the industry makes the latest technology all the more urgent. Widespread cross-border M&A activity in Europe has boosted multinational pension funds, grist to the custodian mill. A surge in mutual funds and funded retirement systems mean the three largest custodians now account for over $17trn in assets and, according to Hedges, the market will further segregate into big, general providers and niche specialists. The generalists will offer a standardised product and bulk processing while the latter will focus on building specialist solutions.
Martin Brennan, regional director of Clearstream, said the market was undergoing great change and that the timing was perfect for further consolidation in clearing and settlement. Quoting Thomas Perna of Bank of New York who has said clearing and settlement shouldn’t encourage fierce competition, he set out the rationale for a merger between Clearstream and Euroclear.
Time is at a premium, otherwise the different clearing houses are likely to go their own ways, he said, making an eventual merger unfeasible. If consolidation does not happen soon the separate bodies will deepen and further fragment the market. Were the two to merge, they would save an estimated annual E60m–80m in operating costs and E60m in IT investment and operating costs. Duplicated investment in new business and risks, credit costs and exposure would all be reduced.
Deutsche Bank’s Andrew Dyson gave an engaging talk on the European repo market and the concept of a unified market. On the latter, his conclusion was a resolute no, the euro has yet to produce a single repo market: “While in a single currency environment the foreign exchange element disappeared overnight, nothing else effectively changed. We still have a long way to go and perhaps we were expecting too much to expect a fully formed single market overnight,” he said.
A lack of political union, a variety of tax, regulatory and legal environments, and differences regarding collateral and its trading in Europe are hindering a single market. There are other talked inefficiencies in the European repo market, he said, referring to the 11 central depositories and two international central depositories. “Legal requirements range from no documentation through to the higher standards of ISMA/PSA,” he said, adding that he believed most would welcome a standard documentation. The ISMA/PSA and ERA documentations are converging, not before their time if Europe is to avoid the risk of being caught between two different systems. More heartening is that institutions are realising they can no longer ignore Europe. “The previously London-centric groups that were populated by the big broker-dealers have embraced the wider European market… it’s much better for the industry that we have a European group that is itself a subset of a global approach to managing the repo business,” he said.
Fixed income markets are likely to follow consolidation in the equity markets and electronic trading platforms will ease the shift. He warned those in the repo business not to rest on their laurels, since the internet had effectively eliminated traditionally high barriers to entry. Unification of the repo market is on its way but unfortunately Brussels will decide the pace of progress: “We have to work in the environment we’re in and it’s probably presumptuous of us to assume that 11 or so European government heads are going to necessarily change their regulatory environment to suit the securities lending repo market.”
Speaking on collateral innovation, Marie Connors, managing director of Bear Stearns in New York, pushed for the use of convertibles as collateral. She said brokers want to use convertibles as collateral as a means of reducing balance sheet exposure. She also spoke of an increased pressure on lenders to take convertibles as collateral and warned them that if they tried to up their fees to reflect what they considered inferior collateral, they would price themselves out of the market. Donald Pepper, executive director at Goldman Sachs, put the case for cash as collateral. The euro had merged 11 separate currencies to produce what he called a deep liquid market. Lenders can also increase their returns by investing cash collateral in high-rated money market instruments. Lending euro-denominated securities versus euro cash (as opposed to dollars or T-bills) also eliminates currency risk and cash collateral gives the lender the greatest flexibility in reinvestment.
The euro has begun the unification of the European markets, bond returns are stabilising and Europe is warming to equities. Combine this with the inexorable development in technology, the push for STP and consolidation in every aspect of the market and you can expect a different environment at next year’s conference. As Euroclear’s Martin Brennan said, the industry is undergoing a mini-revolution.

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