REBUILDING MARKET INFRASTRUCTURE.
Bill Stenning, managing director of clearing, regulatory and strategic affairs at Societe Generale Corporate and Investment Banking explains how regulation is changing the intricate plumbing and how the bank is responding.
What further changes do you see under MiFID on sellside, buyside and market infrastructure?
In general MiFID II will drive fundamental changes to market infrastructure for non-equity products. They will be driven by a move towards electronic trading but as always with these things the devil will be in the detail. Although we have a good idea of the direction of travel, there are still gaps that need to be filled and we are waiting for clarification on a wide range of issues. For example, as yet we do not have any International Securities Identification Numbers (ISINSs). These identifiers, although widely used for securities, were not originally designed for derivatives, so finalising how this should be implemented is a big challenge for the industry. It also means that it is difficult to know how to build some parts of the market infrastructure and in-house technology to meet some of these new requirements.
What about with the European Market Infrastructure Regulation, which is already being implemented?
It is a phased approach, but in June the clearing obligation came in for Category 1 (clearing members) for G4 currencies and that will be expanded to other currencies and products in time. We have also done a great deal of work already with trade reporting and repositories. The next step is to enhance the quality of the data.
One of the biggest challenges facing the buyside will be the introduction of new rules requiring initial margin for uncleared swaps. In September, this came into force in the US for the largest swap dealers, with gross exposures of more than $3tn, as well as Canada and Japan, impacting 20 global firms. However, Europe has delayed implementation until 2017. The rules are still being defined and need to be formally agreed.
There have been several issues tied to the systematic importance of central counterparties. How do you see this evolving?
The attention has increased on a CCP’s resilience, recovery and resolution. The Financial Stability Board (FSB) in August reiterated their intention to prioritise this for the remainder of this year while The International Swaps and Derivatives Association (ISDA) also set out its proposed recovery and continuity framework. However, while effective resolution and recovery tools are designed to resolve a bad situation, the best solution is to avoid the bad situation in the first place. Therefore we must also want to ensure that the resilience part is not overlooked. This means a greater focus on membership quality, adequate resources and that the incentives across all participants are aligned so that CCPs have a strong first line of defence so that any shocks can be avoided.
What are your main concerns with the Basel III leverage ratio rules and how do you think this will impact client clearing?
The rules make it quite expensive and difficult for clearing members because they have to guarantee the performance of their clients to the CCP. Clearing members are also not able to net cash initial margin against total exposure and, instead, have to add it in the leverage ratio calculations. It is counterintuitive in that the more clearing members protect themselves the more expensive it becomes.
This has resulted in a general decline in the number of futures commission merchants (FCMs) offering clearing and those staying in the business are looking at the capacity they are willing to make available. I am not entirely sure that means less competition for a given account, but it has reduced the quantity of services to the market as a whole. FCMs may only focus on the most attractive types of clients which could undermine some of the key philosophies that underpin the design of the CCPs. CCPs need a diversified group of brokers with diversified positions to mutualise the risks and support all market participants. The industry is still debating the issue and making their viewpoints known to the regulators.
What impact do you see Brexit having on London as a hub for derivatives trading?
It is difficult to say because Article 50 has not been invoked and it will depend on the terms set in the negotiations. Passporting or equivalency is certainly a key topic and there will be a great deal of debate regarding these two issues. For Societe Generale, we believe we are well placed and able to handle whatever the outcome as we are organised around two hubs – one in London and the other in Paris.
How has SG responded to the new world regulatory order? What changes has the firm made?
As a general point, we are now more focused on the most effective use of scarce resources including the balance sheet, leverage and short and long term funding. We are also beginning to see a trend of clients becoming more sophisticated in their understanding of how their business impacts the balance sheet of broker dealers and I think this will continue.
As for the regulations, our response has been to work with the different businesses to assess the impact and we have also made a variety of systems upgrades to ensure we are compliant. We also have increased the number of pre-trade regulatory checks and under MiFID II we will need to ensure that we have all the data required about the trade, where clients sit and the jurisdictions they are trading in, etc.
I think one of the biggest challenges is the complexity that comes with being a global firm because there are differences between countries as well as cultural biases. For example, in the EU, both parties to a trade must report transactions whereas in the US it is only one party that must report. Overall, you have to take a good look at the new products and processes and make sure you factor in all the impacts. Then it can be broken down to bite-sized chunks and solutions can be found from a market infrastructure perspective.
I read that Societe Generale hosted the Accenture FinTech Innovation Lab with five investment banking start-ups. How are you collaborating with these firms?
We are not looking at specific game changers at this stage but are involved in a number of initiatives. There is a lot of talk about blockchain, for example, but I do not see large parts of the bank moving in that direction anytime soon. That said, there are opportunities and we are trying to get to the bottom of them. For now we see the technology building blocks as the beginning of an architectural system on which future distributed applications will be built instead of producing a specific solution today. It is also important to look at the cost benefit analysis as well as value of implementation of the technology. What we are seeing in general on the financial technology front is the automation of existing processes with an emphasis on the re-engineering of the workflow to obtain better results.
Bill Stenning is managing director of clearing, regulatory and strategic affairs at Societe Generale Corporate and Investment Banking. Previously he was Managing Director – Business Development at DTCC and before that COO-Trading at Sungard Trading & Risk, He was also COO at SwapsWire as well as Vice President – Business Management, The Chase Manhattan Bank and Supervisor – Product Line Accounting at Cargill Financial Markets. He started his career as an accountant at KPMG Peat Marwick before joining Cargill Financial Markets in Product Line Accounting.