The buoyancy of infrastructure management on stage at Sibos contrasted with the growing concerns among the user community about fault lines in this ever-burgeoning segment. These were so aptly portrayed in Dominic Hobson’s leader and Paul Amery’s thoughtful “Unstable Foundations” article in the fall issue of Global Custodian. The specialist compliance stream, albeit somewhat doom laden, exuded the confidence of a growth sector, whilst, around the conference, the talk was on the true meaning of the high standards of care in AIFMD and the added potential challenges from UCITS V.
Standards seemed to play a much lower-key role in Dubai. Is this a reflection of standards’ fatigue post ISO20022? Or is it simply that the standards’ stream was little changed over the last year and had a sense of déjà vu?
Some stage presentations were enthused by better volumes and higher market indices. The more thoughtful off line comment voiced concern at the inevitability of lower asset management fees feeding into the custodian wallet. Interest rates remain low and foreign exchange spreads much more transparent, whilst regulation is seen as a threat to the asset finance market. FTT was almost banished from the cavernous Dubai Trade Centre, although surely it remains , admittedly in revised form, a threat to the industry.
Those three themes—infrastructure resilience, profitability and risk—were, though, the off line key subjects of debate. The contrast between institutional speak, conference peroration and true sentiment has never been greater.
Management of risk at the CCPs, the true risks of a CSD and the data integrity issues of the new trade repositories are issues for real debate. The relationship between these infrastructures and the mass of Exchanges, MTFs or SEFs is complex. Data was often discussed but as if bandwidth, latency and data capacity were no issue. There is, according to many independent commentators, a genuine and growing problem in respect of consistency of data, interoperability of data, and collation or manipulation of data. The problem will ease, for exchanges and their downstream partners will undoubtedly consolidate. From the current insane numbers, that is inevitable. But consolidation also brings concentration risk. Capital adequacy and, especially, technical integrity are critical to the future of our brave new world.
And data is not the only challenge. High-frequency trading is really back in vogue as if it had never been a component of the problems of the last decade. Some see it as a value creator providing much needed liquidity to markets; others question the ability of markets, so many with distinct fault lines in the transaction life cycle, to accommodate such volumes. And overhanging all is the threat of more regulatory incursion into the conduct of markets. FTT may affect that other perennial discussion point of the markets—collateral. The focus in Sibos appeared to have moved away from the adequacy of prime collateral to the money generating capacity of the new and more liquid world as highways and hubs, now envisioning a perfect world of global interoperability, facilitate access to ever more assets. But the asset finance markets remain vulnerable to sentiment for they still carry substantial execution risk, especially in periods of high volatility.
Profitability is almost a pariah word these days as the line between open debate and cartel behavior becomes ever finer. But the changing demographics worldwide, trends in savings ratios and savings vehicles, and the likely volatility of equities, allied to an inevitable fall in fixed income values, threatens the assumption of continued growth. Added to this, government incursion into the pensions market worldwide and changing cost structures across the funds’ business is hitting fee income. There is serious concern that deep regulatory supervision across banking institutions is excessive, not unnecessary in key areas of risk, but both over costly and risky as it spreads its tentacles across all business areas. Innovation is definitely being adversely impacted. Compliance oversight is eroding business management accountability. And the cost of excessive compliance is less its absolute cost but more its innately destructive effect as it seeks to take all the risk out of a risk business.
Yet risk is increasing. AIFMD, EMIR and Dodd-Frank create challenges beyond their excessive verbosity. For the securities markets, the risk of custody has not increased that much in reality. Where many assumed they were liable for commercial reasons for any loss of client assets, they are now bound by regulation to be absolutely liable. But, even accepting this fact, the biggest danger could be in penalties for technical non-compliance rather than absolute loss. Admittedly there was concern on the floor at Sibos at the question of sub-custodian liability. There was concern that lawyers were not united in their assessment of the delegation clauses in AIFMD in respect of CSD risk, although there is a strong majority consensus on the issue. There are questions as to the value of the new cash management rules. These may restrict some managers as administrators eschew too complex structures or too exotic funds. But it is the high standard of care requirement that worries the most. Like “best endeavors” and “reasonable efforts,” it is seen as another example of intentional regulatory ambiguity. The market may agree how they operate to this standard, but it is unlikely that any framework will gain regulatory approval. For, as many noted quietly in meetings and private discussions, the aim is always to ensure that event risk is a commercial sector liability. For, irrespective of the fairness of such a model, governments are unable to carry the cost on the public purse.
And that brings one back to the question of infrastructure robustness. As many noted, somewhat warily, infrastructure is deemed invincible. And infrastructure, with one or two exceptions, has proved this to be the case. The trouble is that infrastructure is risky; users are much less receptive than in the past to regulatory suasion to intervene, and so the potential for the next crisis to be in this segment is as high as it has ever been.
Sibos, this year, was living in a parallel universe. The challenges and the threats are much greater than anyone would like to admit.