Phase 1 – New regulations
At the recent Euroclear Collateral Conference in Brussels, the audience of 600 leading players in Europe’s custody, clearing, settlements and payments systems were asked whether they believed that the sum of regulatory change is pushing a fundamental change in the way collateral is managed. More than 96% of those who answered said that it did, with more than one third of respondents saying that the whole structure of the industry needs to be fundamentally re-thought. The new regulations surrounding collateral management will determine in which direction the industry will travel. But it is likely that the collateral management industry will also be affected by unintended consequences of the new regulations.
Phase 2 – New technology
Alongside the new regulations affecting collateral management is a parallel development of new technology that enables those changes to occur. One such new technology that is particularly suited to the new environment is the distributed ledger and blockchain applications. “Blockchain is a part of a general move to digitize everything,” says Colin Platt, Co-Founder DPactum, a firm which specializes in distributed ledger and smart contract technologies for derivatives clearing. “Distributed ledgers allow us to think of think of new ways to do business. As an industry, we can cope with it and in a few years’ time the hype will have died down and it will appear normal.”
What is particularly attractive about blockchain technology in the world of collateral management is that it allows much more transparency for identifying and moving collateral around. “The wallet software that works in conjunction with blockchain allows for an infinite number of sub-accounts,” says Steve Wager, EVP of Blockchain Product Solutions at Paxos, a New York-based financial technology company. This will help market players to resolve their need for enhanced segregation of client accounts, especially when it comes to collateral.
When new technologies achieve widespread adoption is hard to predict, especially when a period of initial hype gives way to what the research firm Gartner refer to as the trough of disillusionment, when the hype outpaces the reality. In the world of blockchain solutions for collateral management, the technology is moving out of this phase of disillusion and into the slope of enlightenment where second generation products and services start appearing and best practices are developed. “It is incredible to watch the pace of change in blockchain,” says Platt. “But there is a long way to go.” Platt believes there are three to five years before there will be any mainstream market operations using blockchain. “But we are planting the seeds now and waiting for the crops to go.”
Phase 3 – Willing adopters, new competition
Many in the market see the changes coming and are trying to analyse the rate of change of new adoption. “I think the changes will appear to be incremental until they reach a tipping point, at which time a revolution will occur,” says Tina Hasenpusch, of CME Clearing Europe. However, for other market participants, it is not enough that new regulations and new technology are available. Those who operate the market will be the ones that dictate the pace of change. Interestingly, technology companies appear to have a more measured vision of how quickly change will happen, because of their experiences of trying to effect change from without.
“Because banks and service providers are looking to use existing pipes to win business and market share, the process of change will be accretive,” says Wager at Paxos. Other market participants agree that it will be those already in the market who will drive the change process forward. “None of the changes that are coming will happen without the incumbents, and that is not necessarily a bad thing,” says Kevin Cook, CEO of Spring Treasury, a collateral infrastructure solutions provider established in 2016.
Phase 4 – Emerging standards
Many believe that as a pre-requisite for change, the market needs to come together and agree one common set of standards to encourage the widest use of the technology. But those with a vested interest in the status quo, can use the issue of standards to actively thwart new competition.
Technologies with the widest adoption are the ones that survive and then become the standard. With financial technology, standards tend to come from the bottom up, rather than being imposed from the top down. This can be expected for collateral management, which is at a stage where multiple new technologies are being tested. It is too early to say which ones will become the standard. And yet, most observers agree that standards do allow for one set of protocols to produce a network effect, which benefits the entire ecosystem. “We do need to look at a new governance framework and so from a market infrastructure perspective, new partnering is necessary,” says Hasenpusch. “New technology will create change, but only when everyone works together in a network.”
This is arguably the phase of change most fraught with difficulty. It is the process of evolution. “The market needs new infrastructure to quickly become the standard because if you leave it up to individual banks or brokers to do it, there will be innovation, but it will lead to closed siloes rather than open architecture. We will end up with a tournament effect until only one player is left standing. That is a hugely unproductive use of resources and is not good for the market,” says Cook.