While the pandemic is transforming the global securities landscape in terms of the adoption of new technologies, it has also highlighted the need for market participants, regulators and financial market infrastructures (FMIs) to cooperate on key initiatives such as digitization and digitalization.

Digitization, or the conversion of data/information from analog to digital, is not necessarily the same as digitalization or the conversion of business processes from analog/offline systems to digital technologies.

For asset owners, asset managers, and asset service providers, the difference between digitization and digitalization, two similar but distinct processes, has been made more obvious by the periodic market volatility and remote working resulting from the ongoing health menace.

The appetite for both digitization and digitalization is clearly increasing as their potential to transform the industry becomes more widely acknowledged by market participants and FMIs alike, according to a new study by Citi Securities Services, “Disruption and transformation in financial market infrastructures”. 

The focus now is on how increased automation can deliver even greater resilience and efficiency, while simultaneously reducing risks and costs.  In the early days of the pandemic, high market volatility and volume underlined the critical role that FMIs and securities services providers play, according to the paper.

Settlement process

“It is clear that there is an increased need in the industry to strengthen resilience, reduce risk and costs, and enhance efficiencies,” says Okan Pekin, Citi’s global head of securities services. “This paper not only highlights the benefits and challenges for a shortened settlement cycle but also the associated emerging technologies and digitalization efforts underway across the industry.”

This is where the need for cooperation is becoming very relevant based on the sheer diversity of views expressed by the respondents in the study, both by geography and entity type.

One of the challenges highlighted by the study is the global drive to increase equities settlement efficiency and reduce risk amid the technological transformation.

For example, settlement compression continues to be one of the most pressing issues for the equities post-trade industry, with the planned transition to T+1 in the United States, together with the recent global volatility spikes.  According to study, 44% of market participants surveyed expect the prevailing settlement timeframe for equities to be T+1 within the next five years.

The study also finds that while the pandemic has accelerated and condensed many existing efficiency and digitization initiatives, it has also given rise to a whole new set of previously unforeseen challenges, including managing through periods of higher volatility. This combination of factors is driving market participants to re-examine how the settlement process could be accelerated and simplified to reduce risk.

Opposing views

Results of the study also show that FMIs and market participants have opposing views on a number of topics. Examples:

• FMIs see the major benefit of reducing settlement cycles as risk reduction, which will in turn enable lower margin requirements and the release of capital; however, 44% of market participants rank greater efficiency in investment and trading processes as the greatest benefit of a shortened cycle for their respective organizations.

• Most FMIs interviewed don’t consider technology as a barrier to settlement compression as they have already undertaken considerable planning and investment in technology during the last transition (from T+3 to T+2). Market participants, however, have an opposing view, with almost 50% indicating that upgrading legacy technology would be a key factor.

• The greatest challenge to achieving a shortened cycle from an FMI’s perspective is business process efficiency and alignment, in contrast to market participants, of whom only 10% rank this as a primary factor. Market participants instead see cash, funding and liquidity management as the greatest obstacles.

• Most FMIs don’t view distributed ledger technology (DLT) as necessarily essential for settlement compression, but draw a distinction between T+1 and T+0, only seeing a role for it in the latter. However, 64% of market participants believe a DLT-based market infrastructure would significantly or moderately improve overall market efficiency and reduce cost.

Other key findings:

• 50% of market participants believe that atomic/immediate settlement would be achievable in the near future (within five years) and that emerging technologies such as DLT would be a key factor for enabling this (46%).

• Majority of market participants (57%) would require some investment for additional capability to accommodate any reduction in the settlement cycle while only 29% believe that their existing technology would be adequate.