The hope is that Covid-19 pandemic will fade this year but the impact of the pandemic will have long lasting consequences for the post-trade and derivatives industry. Lynn Strongin Dodds looks at the major trends for 2021.
As we kick off the near year, industry pundits, trade groups and market commentators are looking back at what has been an extraordinary year in every aspect. For derivative markets, many of the trends started long before the Covid-19 pandemic began but remote working and volatile markets have accelerated them. It has not only impacted timelines for key regulations but also underscored the need for greater digitalisation and a more flexible workforce. Below are some of the key developments to watch in 2021.
REGULATION
UMR
Firms will have their work cut out next year preparing for Phase 5 transition of the uncleared margin rules (UMR) if the State Street survey is anything to go by. Canvassing 300 asset managers from 16 countries, the State Street study showed that 81% with a September 2021 or September 2022 deadline are unprepared to comply with all facets of the rules.
It found that only 19% are fully ready for compliance, while 42% are preparing in all relevant functions, with the remaining 39% have only begun preparations in just a few areas.
Earlier this year, the Basel Committee on Banking Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO) agreed to extend the deadline for completing the two final implementation phases of the margin requirements for non-centrally cleared derivatives by one year.
Under the revised deadlines, covered entities with an aggregate average notional amount of non-centrally cleared derivatives above €8 billion will be subject to the requirements on 1 September 2021.
There has been some talk of a further extension due to Covid-19, but it is unclear as to whether this will materialise. In the meantime, Nadine Chakar, Head of State Street Global Markets, said in the paper, “As we approach the deadline for the next phase, it is critical for buy-side firms of all sizes to be aware of the pending requirements and to not only effectively manage, but optimise, their liquidity and collateral needs with the right solutions and technology in place.”
Libor and benchmark reform
Although the UK is moving ahead with its Libor transition to Sterling Overnight Index Average (SONIA), the US is heading in a different direction. The ICE Benchmark Administration, which compiles and oversees will continue to publish daily rates for the most widely used dollar benchmarks until the end of June 2023 — 18 months later than originally planned. The move, supported by global authorities including the Federal Reserve and the UK’s Financial Conduct Authority, formed a marked contrast to the previous hard-line stance against shifting the end-2021 deadline.
According to commentary from Fitch Ratings, primary markets have yet to move to alternative indices, and this means that regulators and legislators might need to facilitate orderly transition for hard-to-fix legacy contracts and liquidity needs to develop in derivatives based on the US reference free rate – Secured Overnight Financing Rate (SOFR).
The ratings agency said despite the extra time, the slower shift to using SOFR as the benchmark rate for newly originated dollar cash products has reflected a ‘wait-and-see’ approach from some market participants, as well as SOFR’s lack of credit spread and term structure. Proactively embracing workable solutions would reduce, rather than simply delay, disruption.It added, that the ‘wait-and-see’ approach also reflects a less forceful approach by U.S. banking regulators relative to their UK counterparts, particularly in the transition’s early stages, although the former has increased efforts to make sure risks are addressed. The Fed, Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation said in response to IBA’s announcement that they ‘encourage’ banks to stop using Libor in new contracts as soon as possible and no later than end-2021.
EMIR REFIT
The European Securities and Markets Authority published draft technical standards under European Market Infrastructure Regulation (EMIR) REFIT at the end of the year which dealt with requirements for financial counterparties and their obligations on timely and accurately report OTC derivatives contracts.
The standards recommend alignment with international standards in particular those developed by CPMI-IOSCO on the definition, format and usage of key OTC derivatives data elements reported to trade repositories including the Unique Transaction Identifier (UTI), the Unique Product Identifier (UPI) and other critical data elements.
They also propose data quality harmonisation across trade repositories as well as standardised process for data access. It addition, it is looking to simplify rules for extension of registration from the Securities Financing Transactions Regulation (SFTR).
The purpose of Refit is to address disproportionate compliance costs, transparency issues and insufficient access to clearing for certain counterparties. Its aim is to streamline the rules and reduce regulatory and administrative burdens where possible, especially for non-financial counterparts (NFCs), without compromising the regulatory goal of EMIR.
Cyber security
Cyber attacks were growing in sophistication over the years, but the pandemic took them to a new level as the financial service industry along with many others as employees switched to remote working. The increased use of video and voice communication left networks vulnerable to opportunistic attacks. With cyber threats unlikely to lessen in the foreseeable future, industry experts believe organisations must allocate sufficient resources to developing people and technology frameworks as well as enhance their cyber security processes, policies and procedures.
These concerns are reflected in the annual Depository Trust & Clearing Corp (DTCC) risk barometer report where 54% of the 220 respondents surveyed ranked it as one of their top five concerns. “The speed and global impact of the pandemic created an ‘overnight’ fundamental shift to cyber practices across all industries,” said Stephen Scharf, DTCC’s Managing Director and Chief Security Officer. “The long-held structure of an onsite workforce was immediately pivoted to massive telecommuting and remote connectivity.
He added, “While many firms had pre-existing infrastructure to support this shift, in most cases, environments had to be expanded and/or built from scratch. Given the opportunistic nature of cyber criminals, this created a greatly expanded attack surface which firms had to move quickly to address. As long-term staffing and technology models continue to be further defined, cyber defences will need to adapt and adjust to the workforce they are protecting.”
Geopolitical risks
Global political risk hit a multi-year high in 2020 and is set to continue in 2021. Markets have continually been rattled by a confluence of Covid-19, trade tensions between the US and China, Brexit and the recent US presidential elections. The DTCC barometer found that respondents were particularly worried about trade and the outcome of the US elections due to its impact on future fiscal and monetary policies.
Ali Wolpert, DTCC’s Managing Director, Head of Global Government Relations said, “Shifts of power within the U.S. Administration and on Capitol Hill undoubtably impact the financial industry. Narrow majorities in the House and Senate will mean that legislative common ground will need to be identified, in order to garner broad Congressional support. For example, the global pandemic significantly impacted U.S. legislative priorities and spurred bipartisan action to provide economic relief.”
She added, “Looking ahead, emphasis is expected to remain on potential further relief efforts in addition to policy issues regarding privacy and cybersecurity. A bipartisan approach will be key to advancing legislation to address potential risks and challenges for 2021 and beyond.”
Brexit is also expected to impact derivatives markets whether there is a deal or not. Financial services are not been included in the trade talks and so far, Brussels has not granted “equivalence” or permission for platforms in London, the world’s major centre for derivatives trading, to continue serving banks and companies in the bloc from 1 January 2021.
Digitalisation
Operational resiliency has become the new mantra in 2020 as Covid-19 exposed the cracks in organisations’ processes and highlighted the need for more sophisticated digital tools. While the industry was moving in this direction, the pandemic gave it the requisite push to employing tools such as artificial intelligence, natural language processing, machine learnings as well as shifting to the cloud.
John Omahen, head of product strategy for Post Trade Technology, Capital Markets, FIS expects the experience of this past year will colour the perspective of both buy and sell-side firms throughout next year. “There will be a greater focus on how they can engineer their businesses for the future,” he adds. “This means reducing manual touchpoints and upgrading core processes so that they can more readily adapt to market changes and future spikes in trade volumes.”
More specifically, in the middle and back office, Omahen points to the need for greater automation to increase efficiency, as well as greater adoption in general of cloud- based technologies that enable market participants to work remotely. “Firms will need to increase internet bandwidths for employees, as the speeds at home are insufficient for traders to keep up with rapid changes in the market, and for back-office staff to process trades as quickly as possible,” he adds.
Bolstering the nuts and bolts of market infrastructure is only one part of the equation. There also needs to be greater enhancements to the compliance and risk management functions. This is why, Carlo di Florio, Global Chief Services Officer at the ACA Compliance Group believes chief compliance officers should be given a “seat at the table” and be involved in the decision-making process especially in terms of the data and analytics that are being deployed to help meet regulatory requirements.
