Reporting and Governance

The pandemic has taught businesses of all shapes and sizes that they need to radically rethink outdated ways of working. It has shown that almost every industry is capable of rapid digital transformation when needed, and many industries’ histories will now forever be split into two distinct chapters: pre- and post-Covid-19. By David E. Rutter, CEO at R3

This unprecedented moment in time presents a game-changing opportunity for CEOs to challenge their firms’ business models and embrace the new technologies at their disposal. Arguably, nowhere is the need to capitalise on this opportunity more pressing than in the middle and back offices of financial institutions.

As Jamie Dimon, chairman and CEO of JPMorgan, recently pointed out to shareholders, banks also face the growing threat of extensive competition from fintechs and ‘Big Tech’ companies, and they must act now to defend their role in the global financial system.

As a 30-year veteran in the e-trading space, I’ve seen first-hand how advances in electronic trading technology have slashed operating costs related to brokerage and execution. With digitisation long established in the front office, it is now time for the industry to turn its attention to tackling middle- and back-office inefficiency. This is the critical next step for the digital transformation of capital markets, helping firms move the profit dial further in their favor. 

By collaborating in the sharing of a digital middle- and back-office platform built on a common infrastructure, financial institutions, who are fierce competitors, will be able to work together to more efficiently access a greater variety of post-trade services. This will increase competition and efficiency, reduce risk and lower costs without compromising proprietary information. 

The technology already exists to make this a reality, but an industry-wide shift is required to tackle this industry-wide challenge. The onus is on the C-suite to drive this change and to position their firms for a new, more agile and competitive future.  

Not fit for purpose

Currently, middle- and back-office operational costs dwarf front-office and execution costs. Banks spend billions of dollars each year on outdated legacy post-trade systems, and still have to dedicate hundreds of staff to processing, reporting and reconciling trades.

Regulators are taking note — for example the Bank of England has established a task force aimed at tackling outdated post-trade technologies — but the onus is on market participants to drive real change. Currently less than a third of fintech investment is spent on the middle and back office. Given that firms are spending upwards of $20bn per year on post-trade processing systems alone, this situation has to change.

Electronic order management and trading has transformed the way trades are executed in virtually every single asset class since it was introduced in the late 1980s, yet middle- and back-office infrastructure has failed to keep pace. 

The key difference is that middle- and back-office functions have little, if any, shared infrastructure outside of central markets, such as central counterparty clearing houses, despite being one of the largest sources of costs to a financial institution.

A single trade today creates multiple records for all parties — sometimes being replicated over 30 times within the post-trade lifecycle — and has to be reported, surveilled, matched, valued, margined, subject to risk calculations, optimised, aggregated, netted, reconciled and more — often all day, every day, for the whole of the transaction’s lifecycle.

Staggeringly, there can be over 50 vendors involved in processing each trade, adding significant complexity and risk of errors. It has been estimated that 50–80% of back-office time is spent purely on reconciling systems. 

Complex and opaque cost structures for post-trade services have also become the norm, with trading institutions facing multiple license fees, messaging charges, IT overheads and staff costs. Coupled with diminishing spreads, the reduction of risk appetite and increased regulatory costs, post-trade costs in some areas exceeds the potential profit from execution of the trade.

Part of the reason for this is that, to date, there has been very little competition for post-trade services, in particular for payments, standard settlement instructions and regulatory reporting. As a result, the space has failed to modernise and mutualise costs — even as the industry has become predominantly electronic. 

Capital markets play a vital role in the real economy, and it is therefore critical that they function fairly and effectively. To do this, they must be supported by resilient and cost-efficient post-trade processes.

Post-trade reform is no longer just nice to have — firms must make this their top strategic priority today. Their current infrastructure is a significant and expensive problem. It is costly, risky and materially restricts their agility to grow and innovate, and take on new markets and clients.

Sharing offices

With purpose-built enterprise blockchain technology, there is finally a solution that enables the industry to move away from duplicated and inconsistent isolated systems of record held at each firm. By moving those records to a digital ledger with shared data, business logic and processing, blockchain can facilitate mutualised middle- and back-office systems that assure that one firm’s view is identical to its counterparts. 

The level of transparency this delivers could also help play an important role in preventing situations such as the recent failures of Archegos Capital Management and Greensill Capital, again without compromising the confidential bank–client relationship or specific trade details.

Moving to a shared middle and back office will allow firms to start decommissioning expensive elements of their bespoke infrastructure, break down silos and significantly reduce costs while positioning the banks to better compete in today’s very competitive landscape. 

The seemingly simple premise of bringing multiple parties into consensus about common facts provides the foundation upon which a whole new ecosystem of post-trade services can be built and deployed, driving competition among vendors and greater choice for end users.

This holds the key to releasing banks and other financial institutions from the technological binds in which they find themselves after years of unstructured investment in multiple generations of expensive legacy post-trade technology.

Banks are standing on the brink of a brighter future that promises radically reduced costs and massive increases in efficiency and profitability. It may end in the middle and back office, but it starts in the C-suite. Be bold and take action today.

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