Too many people are talking about disruptive technology. I have a message: technological change is always disruptive in the sense that the apparatus of process changes, but true disruption comes with process change. Much as many feel financial services is now part of the FinTech sector, it is not; FinTech is critical to our future but our business remains process with all its accompanying logistical challenges and financial risks.
In my 50-year career in finance, certain events have been disruptive to the extreme. The majority have been linked to technology. Looking over those years, I can identify progress and cataclysmic change. An example of progress is the migration from paper-based markets to digital. An example of a cataclysm is Lehman. Within that context, it should be noted I see events in our technology space as progress rather than disruptive or cataclysmic.
As a UK originated custodian, I learnt the technology ropes in the shadows of three projects, namely Taurus and Crest alongside in-house automation. Taurus – an ill-fated attempt by the London Stock Exchange to move the local market from its paper-based traditions was a total failure and a lesson for all on how not to run a project. CREST, the Bank of England inspired project to succeed where Taurus failed, was a great template, which I used when I focused later on the certificate hungry markets of Asia, on how to influence people for the greater good. And our in-house reengineering taught me that key to re-engineering is a blank sheet of paper.
I have described Taurus in the past as the project that brought the masters of the then London Stock Exchange universe to their knees; and deservedly so. They had no clear vision. They never really signed off on any final design. They pandered to the preferences of the powerful in their decision-making forum, irrespective of their value to the business. They assumed the market would accept their design, their bespoke standards and interfaces; and they believed that would happen automatically. They misjudged the power of lethargy among the UK clearing bank custodial population, the strength of feeling among the disintermediated transfer agents and, at the time, the poverty of understanding of process and technology by the major players. The project was not unsound in concept, although limited in imagination, but the absence of any sense of understanding the population outside the magic circle of the then London Stock Exchange (whose successor in name is thankfully light years away from its ancestral roots) meant that failure was inevitable. And the major lessons to learn were the need for an agreed design which could only change pre-launch for legal or regulatory reasons and support from the paymasters especially those outside one’s normal circle of influence.
CREST was a revelation with its idiosyncratic mix of Bank of England executives – the smoothly diplomatic, the brutal visionary, the fast-learning economists and the mildly eccentrics. Under the leadership of Iain Saville, a man who did not believe in taking prisoners, and the commitment of a great steering group (of which I was proud to be part) and under the leadership of the visionary late Pen Kent from the Bank of England, it stripped dematerialisation down to its basics and ensured we could have the bulk of value transacted in dematerialised form with a true delivery versus payment mechanism. Refinements would follow but key was fast and effective delivery. My then organisation agreed to be, and became, a fast tracker in adopting CREST. Others were slow-to-reluctant and it is noticeable that the clearing bank custodians of the time were all acquired by more forward-looking peers in the years that followed. The key message was not to fight progress but to focus on the benefits of change. In the case of my then organisation, we sought to be an efficient digital custodian.
CREST encouraged a re-engineering of process. It was accompanied by an upgrade of the then fairly embryonic commercial electronic banking applications. The re-engineering was revolutionary. Much traditional expertise became semi-redundant. Swathes of unskilled staff, often unable or unwilling to change after decades of repetitive narrow process management, were let go and others, from the relationship and sales force through to the process operatives needed major retraining. But a huge volume of paper and inefficiency was removed from the system and any barriers to the further reach of digital information flows and straight through processing were shattered; at least technically although the human battle took longer to win. The challenge was the blank sheet of paper on which I wrote the objectives of our change and then planned through, or rather saw my expert colleagues plan through, a new universe that was no automated version of its paper roots but a true revolution as we took the first steps to a digital age.
The most brutal disruption came from Lehman. It placed securities services, and especially prime services and prime brokerage, into the clear line of sight of their firms’ risk management. It caused, on balance on the negative side, a torrent of regulation, an avalanche of new procedures, the triumph of bureaucratic stakeholder decision making over management policy and, on the positive side, reinforced the concept of the personal accountability of senior management. Lehman in 2008 was a risk waiting to happen. Leverage had got out of control across the financial sector. Historical norms were no longer valid. Lehman taught us not to depend overly on regression analysis and the 99.5% certainty factor of the quant analysts. Lehman was exacerbated by the Ponzi world of Madoff, whose survival was a classic case of name adulation (he was a former chairman of NASDAQ) and regulatory blindness. But what else has changed since? Due diligence processes have been enhanced. Leverage has not reached again the sorry heights of the pre-Lehman era; securitisations are technically much sounder. Risk reporting within firms has improved. But returns remain derisory and bad habits, such as covenant light lending, are still prevailing. So, warning lights are returning but, especially after the manageable (to the extent they did not lead to bank default or need for bail outs) shocks of Greensill and Archegos, it is possible that some of the emerging risk appetite will be seriously curtailed. Dismissal of senior executives, highlighting accountability, will help. But pricing models still need to be further adapted, risk models need to be more centre scene and risk capital allocations enhanced for the lessons of Lehman to be accepted by all. Indeed, risk remains a challenge for the industry, both its Achilles heel and paradoxically also the greatest barrier to new entrants from the non-financial sector.
Risk is a disruptor. Process change is a disruptor. Technology is an enabler. Securities services is a risky transaction processing activity. It needs technology partners to overcome many of its deficiencies. And it also needs visionary leadership to take it through the challenges it faces.