Guest Contributor: Nick Jackson, Partner , Capco
We are currently experiencing unprecedented volatility in the markets and are potentially on the brink of another systemic failure … only 3 years on since the last one. We have rogue traders out there again who could bring down financial institutions and are seeing downgrading of Government debt for some of the largest, most stable, countries in the world. What did we learn from 3 years ago and why are things not improving?
As an industry we talk about regulatory reform but the speed of reform is slowing to a snails pace … Dodd Frank dates continue to move out and the implementation of new controls and processes is proving to be more complex than originally perceived. Take the OTC derivatives space for example, we have new acronyms, SEFs, CCPs, etc but who really truly understands the implications and impacts of these process changes. The aim is to reduce risk but all I see at the moment is uncertainty causing confusion causing fear and potentially increasing systemic risks. What happens if a CCP fails?, who bails it out?, what are the global versus local implications?, do I need to trade on or off exchange?, which CCPs should I join?, how do I confirm OTC transactions? How do I manage collateral? And on and on … If anyone has worked out where all this will land then they have a significant advantage over the rest of us.
What we can see beginning to happen is an even larger bifurcation of the market to the “haves” and “have nots”. The Tier 1 investment banks who have clearing capabilities will win client franchise from the smaller Tier 2/3 organizations due to their inability to provide capability to the buy side market who are now being told they have to clear their transactions and provide margin against their transactions. The Tier 1s will get bigger and the rest will get smaller. Is that not concentrating more risk into fewer institutions?
The tier 2/3 organizations will not be able to keep up with this rate of change. They cannot justify the investment dollars and do not have the depth of skills to drive this level of change so will implement more and more tactical capabilities to meet regulatory deadlines which in themselves will create systemic failure risk … So what is the answer?
We believe there will immerge a new generation of service providers to solve for this problem. OTC derivatives clearing and settlement outsourcing utilities, OTC derivative connectivity solutions for exchanges, confirmation services, clearing and settlement services and local market infrastructures to support the needs of local regulators to control their participants.
This will be an exciting but bumpy journey over the next few years … but the end outcome should be worth it.