a post-trade common infrastructure

INTRODUCTION AND BACKGROUND TO THE MARKET AND THE PROBLEM 

 A Market Problem

“The Bank of England said post‐trade processes that support fixed income, currency and commodities markets are complex, costly and inefficient and has launched a one-year task force to encourage market reform. The UK central bank said in a report, The Future of Post-Trade: Findings from the Post-Trade Technology Market Practitioner Panel, that financial firms have traditionally invested in front office technology, such as electronic trading. However, many post-trade activities still rely on a patchwork of manual or outdated technological processes” 6th April 2020 See appendix 1.

The current FX landscape is one of extreme price competition with low margins, complex, high frequency and low latency technology-enabled execution. With regard to Post-Trade, the end-to-end process is reasonably common, but the data and architecture is disparate, bespoke to each participant, and has been neglected hitherto from any robust transformation or utilisation perspective. The ever-expanding competition and demanding regulatory oversight, further exacerbate these issues.

The FX Post-Trade Schema shows a simplified overview of the key steps of an FX trade’s lifecycle. The number and inter-relationship of functional domains provides a high-level insight into the complexity of the data and technology challenge. 

Background: The Market Shifts

Throughout the last 30 years, the FX industry has undergone four significant environmental, technological and business model shifts:

FX 1.0 - Access: 

Knowledge is power. Access to pricing information, deal-flow and processing settlement capability was primarily the domain of banks. This coincided with a period when monetary policy remained a key governmental lever in the management of the economy. Central Banks therefore welcomed a small cadre of banks with large control.

FX 2.0 - Balance Sheet:

The rise of the Prime Broker. Size matters! Given the success of the equities prime brokerage model a decade or so earlier, FX prime brokerage quickly emerged as a means to better serve the client, utilise balance sheet and credit risk capabilities while reducing overall friction in the end to transaction flow. Combined, these enabled clients to trade FX more often, with larger ticket size, and an expanded set of spot, forward and derivative products.  

\\Market growth exploded; tripling of daily volumes from 1990-2000 to $1.5 Trillion - BIS FX Market 1998*\\

Electronic front-end broking systems such as EBS and Reuters enhanced prime brokers ability to trade and fulfil customer orders at scale. 

FX 3.0 - Technology: 

Speed. Low latency, proliferation of venues and near perfection pricing. The emergence of the electronic trading venues mentioned above, characterized the next growth spurt. Macro currency trading demand expansion was aided by Unification (EU) - Electronification (Multi-Dealer Platforms) and Globalisation (China, CIS)

\\Market growth tripled again between 2000-2010; with average daily volumes approaching $4 Trillion.\\

The favourable macro-economic conditions and technological advances fuelled the expansion of the FX market. Unification of currency across Europe alongside the opening up of new markets in the form of China and CIS created new, high margin opportunities. Increasing advances in front-end trading technology enabled greater opportunities for all.

The domination over FX markets held by the bigger banks was challenged by the development of multi dealer, enlarged access platforms such as Currenex and Fxall. The game had changed. With the proliferation of participants, market pricing became increasing transparent resulting in tighter spreads. Tumbling profit margins followed. Speed and connectivity became the mark of success. The winners would be those investing in lower latency technology enabling extremely profitable lower-touch, low margin trading.  

\\Higher-Touch engagement anywhere along the trading or customer axis was expensive.\\

The Seismic Shift

The Financial Crisis had a large, but time-bound impact on the economy. However, the resulting regulatory requirements that followed resulted in a seismic change in the banking landscape.

\\Regulation, both Prudential and Conduct, became the biggest cost, but also a key competitive differentiator.\\    

The Regulator(s), through their regimes (Regulatory Frameworks), taxed banks (via Regulatory Reports) in the form of increasingly complicated, overlapping and voluminous information extraction, sharing and delivery processes. This fundamentally changed the way information was viewed, managed and valued. 

Whilst data lake, entity data management and chief data officer entered the banking lexicon, the availability of outsourcing and offshoring arrangements meant that the key focus remained on labour as the primary solution to the increasing information processing demands.

Although, transformation from a hierarchy based, uni-directional information flow to a hub-directional has been largely carried out across the industry, fully de-centralised, multi-directional data flows remain elusive.

Competition

A simultaneous business model change brought about even more data pressure for banks; their clients (such as BlackRock and Citadel) became their peers who then “serviced” their own customers and put the onus on the banks to meet this demand thereby pushing the problems with allocations, reconciliations, confirmations and settlement complexity onto the banks!

FX 4.0 - Data: 

Data. Intellectual Property and Data as a Core Competence. The ability to leverage and use data as a core component is becoming a key strategic pillar within many banks. 

Daily trading volumes reach $6.6 Trillion in 2019, with $2T spot, $1T outright forwards, $3.2T swaps.

‘Platformification’ of the front-end to market dimension led to large technological focus and improvements. This above the line, organised inter-connectivity, has hitherto, evaded post-trade activity.  Increasing regulatory burden, low margins and high cost base present an unsustainable business model in search of solutions.

OVERVIEW OF THE VISION AND PRODUCT (THE WHAT)

Product Vision:

Post-Trade Nerve Centre - atomise and make trusted, a master data set, ensuring process flows are transparent and enable inter-connectivity. This will lead to reduced costs, eliminate/minimize the need for copies, facilitate seamless / significantly fewer reconciliations and data asset configurations, in the post trade domain.

The vision is to create a single, multiparty utility/eco-system where trusted, confirmed FX contracts would be posted to the respective counterparty nodes, through which participants could then determine which services they want to leverage on ledger, from a suite of FX CorDapps and consume the results inside their institution.

These services address risk, operational and reporting obligations such as margin management, FRTB, and Payment requirements. Refer to appendices. To facilitate the ledger based services the data set would be exposed to, and the results published back to the ledger.

For example, a “golden” record is created once a trade is matched and confirmed and this ‘master record’ is stored on the ledger and continuously kept golden. The master date set proceeds through the trade life cycle and is augmented en-route. It is key that duplicated versions of this ‘master record’ are not created inadvertently by process such as valuations, credit risk or capital calculations which typically store their own amended version of the truth as this would negate the benefit of a master record. To maintain an augmented master record, it is clear that some information should be readily shared between external counterparties to the trade for example valuations and that other information may not for example regulatory capital. Therefore, the solution needs to be flexible to cover both eventualities, one where the master record is augmented and the result shared and the another where the record is updated to show that a result has been calculated but that the result itself would not be shared. The augmentation of the record could be initiated by the counterparty themselves or preferably by the third-party vendor providing this specialist service as a CorDapp.

Product Mission: 

Allow Financial Services Institutions to define and determine a common post trade-trade infrastructure to access a comprehensive spectrum of post trade application services via secure nodal relationships, efficiently and securely. 

Product Strategy: 

Build out supply and demand side to cover all post-trade, operational and reporting domains.

Key Features: 

Include Banking grade, secure, safe, inter-operable communication facilitating immutable trusted data transfer and/or operations.

Solution:

Implementation of a FX common post-trade infrastructure and eco-system with a suite of generic services accessible on a solo or bundled basis to manage the life cycle. 

This utility will provide vendors with a ready-made superhighway through which they can leverage a wide range post trade services safely and cost effectively.

Adopters will be presented with a choice of CorDapp services with standard connections, that enable the architecting of a self-prioritised roadmap delivering cost reduction and future regulatory compliance. 

Initially envisioned to include services for Payments, FRTB, Market Data, Trade reporting, Multilateral and Bi-lateral Compression and Un-cleared Margin Rules, the common infrastructure solution will enable limitless expansion of services and products.

Network Creation:

Peers join the FX ledger, clients are sponsored by peers. Cobalt provides the FX business logic, Corda the network alongside other post-trade services.