[ S E C U R I T I E S
M A R K E T
S T R U C T U R E ]
T
echnological innovation has
reshaped many elements of ev-
eryday life over the past decade,
be it in retail, transportation,
travel, communications or per-
sonal finance. Despite the massive strides
achieved elsewhere, securities markets
have yet to make similar progress, and are
instead continuing to operate much as
they always have done. There are a num-
ber of reasons why the industry has found
it difficult to implement and execute
change, although some market infrastruc-
tures – including leading stock exchanges
and central securities depositories (CSDs)
– are taking proactive steps to uphold and
future-proof their businesses.
Chastening returns
Market volatility has made it harder for
investors to generate returns, with a
number of empirical studies showing that
active asset managers are falling short of
their benchmarks. These negative head-
winds are having a trickle-down effect
on securities markets leading to falling
margins elsewhere. Securities services
– which comprises custody and asset
servicing, fund administration, corporate
trust and prime brokerage – have seen
revenues grow by only 3% since 2010,
according to McKinsey, margins that
cannot be sustained for long.
User costs are also exacerbated by the
existing operational framework enshrined
in securities markets, which is inefficient
and intermediated by a range of different
infrastructures and participants, all of
whom provide their own incremental
services to support the buying, selling
and safekeeping of financial instruments
on behalf of end-clients. Many interme-
diaries are themselves considered by
regulators to be systemically important,
subjecting them to capital requirements
and enhanced supervision, adding to their
costs.
While regulation is absolutely integral
to the integrity and security of capital
markets, its application is also sometimes
disjointed and fragmented. Even within
the European Union (EU), rules such
as the European Market Infrastructure
Regulation (EMIR) and the Central Secu-
rities Depository Regulation (CSDR) are
not entirely standardised across different
jurisdictions, nor are they homogenised
with legislation in third countries. This
6
Securities@Sibos
January 2019
naturally creates barriers for institutions
when they are venturing into or trading in
new markets.
All of these obstructions are creating a
fertile ground for disruption in securi-
ties markets. Market users are certainly
optimistic about disruption, according
to a study by SIX, where it found 63% of
respondents identified robotic process
automation (RPA) and artificial intelli-
gence (AI) as the technologies most likely
to deliver the greatest value. This was
followed by distributed ledger technology
(DLT) with 57% and application pro-
gramming interfaces (APIs), which polled
in at 37%. All of these new technologies
are being explored by forward-thinking
stock exchanges.
No closer to the lightbulb moment
Admittedly, an assemblage of FinTechs
have repeatedly staked their claim as
being disruptors in waiting, but the
impact of these organisations on the
broader industry has been trifling. While
a minority of successful FinTechs such as
Digital Asset Holdings have entered into
commercial arrangements with market
incumbents like the Australian Securi-
ties Exchange (ASX) and Hong Kong
Exchange and Clearing (HKEX), many
have liquidated, as they were unable to
monetise their products or struggled to
attract reliable funding sources.
Disruptive technologies could of course
bring a number of efficiencies to tra-
ditional market practices, but even the
established providers are fast realising
that innovation is not a straightforward
enterprise. Despite a number of stock
exchanges pursuing proof of concepts
(POCs) testing the applicability of various
disruptive technologies over the last few
years, the fundamental processes under-
pinning securities markets have remained
intact. To date, nobody has come up with
a technology prototype or breakthrough
application which has the potential to
remaster securities markets.
Tokenised assets in securities markets
Digital assets are, however, an innova-
tion which could prove transformative
for the industry, and a number of stock
exchanges are taking decisive action.
These instruments have unique proper-
ties but generally comprise crypto-cur-
rencies (Bitcoin, Ripple XRP, Ethereum),
initial coin offerings (ICOs) and tokenised
securities, namely instruments whereby
ownership of a tangible asset (equity,
bond, real estate, exchange-traded fund)
is held in token form on a blockchain.
Market participants are fairly bull-
ish about the opportunities available
through trading digital assets such as
crypto-currencies. A study by SIX, for
example, found that 50% of respondents
believed digital assets would be the in-
novation which brings the greatest value
to securities markets moving forward.
Conscious of the potential that these
new instruments may offer, SIX is taking
a lead in providing a secure platform for
market participants to transact in digital
assets – with SIX Digital Exchange. By
designing an infrastructure giving users
security, safety and transparency, SIX
intends to bridge the gap between the
digital world and traditional financial
services.
The benefits of tokenised assets
In theory, tokenised assets could con-
fer a number of benefits on securities
market participants, including easier
price discovery, cheaper access to illiquid
instruments and enhanced liquidity for
end-users.
Collateral management is one area in
particular where tokenised assets could
play a major role. Under regulations such
as EMIR and Dodd-Frank in the US,
over-the-counter (OTC) derivative users
must post initial and variation margin
to central counterparty clearing hous-
es (CCPs) to offset the risks associated
with each transaction. Simultaneously,
bilateral OTC contracts must also be fully
margined by each trading counterparty as
part of the recommendations laid out by
the International Organisation of Securi-
ties Commissions (IOSCO). This margin
needs to be of excellent quality, with cash
or high-grade government bonds usually
being the preferred options.
This sort of eligible collateral is in finite
supply because of the various capital
requirements presently imposed on major
institutions under Basel III’s Liquidity
Coverage Ratio (LCR), a rule-change
which has forced banks to move away
from overnight repo markets in favour of
longer duration financing. OTC market
users are therefore finding it difficult to
access suitable collateral to post as mar-