2024: How technology is revolutionizing the securities finance industry

APIs, artificial intelligence, DLT, data harmonization, Cloud and smart contracts; these are technologies and solutions frequently heard on everyone’s lips as their use across industries and daily life gathers pace.

In a more complex, interconnected world, they boost efficiency and reliability while reducing the need for manual intervention in tasks. This enables professionals to focus more on higher-value strategic thinking, create new products, and deepen client relationships.

In financial markets, such as repo and secured lending, where participants compete in volatile markets across multiple jurisdictions, the advantages of incorporating the latest technological tools are hard to ignore. So where can they best be applied, and how best to do so?

How smart contracts can bridge the gap for securities

One area where technology is starting to make its mark is repo, a USD 10 trillion market widely considered slow to modernize. Bilateral transactions and manual processes are commonplace, and siloed systems often mean trade booking and post-trading procedures are noted on each party’s system instead of a shared platform. A process with no single source of truth for the lifecycle of a transaction can generate data mismatches and trade settlement failures, costing both time and money, and affecting business agility.

This is where blockchain or distributed ledger technology (DLT) can help. As the code that supports smart contracts, DLTs enable trade agreements, execution, and settlements to register on a shared ledger, a reliable and neutral source of truth. Each counterparty’s data is instantly synchronized at every stage of a transaction by design.

The potential efficiency gains are apparent, but building and migrating to new platforms can be expensive and complex. In the risk-averse climate of financial services, particularly in the enterprise-critical areas around settlements processing, DLT-based systems are yet to be widely adopted – but the business case for them is becoming increasingly undeniable.

Intraday funding with DLTs

Intraday funding, where firms need to raise liquidity for hours or minutes to meet business day payments, has expanded in popularity in the wake of global financial crises and interest rate spikes. Treasury operations have become incentivized to find intraday liquidity where cash and collateral management is more efficient and cheaper.

Today, technology has made such short-term funding a viable and efficient option. DLT-based platforms and smart contracts can be scaled and adapted to other areas of repo, such as bilateral transactions, which can be agreed upon, executed, and settled instantaneously.

The DTCC, which clears almost every trade on the US stock market, began live-testing a private blockchain (Project ION) to clear and settle transactions in the world’s largest equities market. It’s a project that’s taken on more relevance in the run-up to 28 May, when the US market switches to a shorter transaction settlement time (T+1).

Other innovations include short-term borrowing through the exchange of cash for tokenized collateral, regarded as faster and more cost-effective than other intraday credit agreements and overnight repos.

Having collateral held by third parties, such as custodians and collateral agents, can be a drag on time and cash. Combined, DLT, smart contracts, and tokenized assets can provide the solution by securing collaterally digitally and releasing it instantly according to the embedded terms of each transaction’s contract.

Industry-wide calls to tap the digital revolution

Collateral is used broadly in securities financing and elsewhere, but only a fraction is tapped globally. A 2021 study by BNY Mellon and Euroclear has previously highlighted that less than 10% of the $201 trillion universe of marketable securities was being used as collateral – which presents a significant growth opportunity. Many industry groups agree and are urging stakeholders to seize the opportunities that technological developments afford to help unlock the potential of digital assets.

As part of a paper published last September, clearing houses DTCC, Clearstream, and Euroclear called for increased collaboration to develop a better ecosystem. With current challenges cited including fragmented standards, varying regulatory treatment, limited integration, and siloed liquidity, industry-wide transformation will likely slow unless the challenges are tackled. Scale and interoperability have been highlighted as key priorities to address.

CDM applications and beyond

Although DLT might still be far from becoming the dominant operating architecture, there are alternative innovations on offer to the securities finance sector.

One is the Common Domain Model (CDM), which has been developed by the ISDA, and promoted by ISLA, and ICMA, in a cross-industry collaboration since 2019. It is a standardized, machine-readable, and machine-executable data and process model that facilitates trade processing of repo, securities lending, bond and derivatives transactions.

Version 5.0, released in November 2023, helps in “reducing the operational burden and freeing up resources to automate manual tasks and prepare for potential industry innovations such as the shortening of the settlement cycles and the emergence of digital bonds,” said Gabriel Callsen, Director, FinTech and Digitalization, at ICMA, in a December 2023 report.

APIs for securities finance

Another highly appreciated technology applied in financial services contexts is the Application Programming Interface (API), which allows for the rapid and direct exchange of data between two systems, inside an organization, or externally between providers. However, API take-up in the securities finance sector has been slower relative to other market segments.

Last November, a report by BNP Paribas highlighted how external APIs (between customers and providers) are growing as their usefulness becomes clearer. More efficient data sharing and access enables firms to comply better with certain regulatory requirements, including the Settlement Discipline Regime of the Central Securities Depositories Regulation (CSDR). With shorter settlement times on the horizon, too, the almost instantaneous access to data that such tech offers could be of value.

Moreover, APIs are facilitators – the best examples of API use demonstrate powerful, flexible and efficient speed to market, and support easy integration between systems. It’s a technology that ‘enables open banking strategies by improving connectivity between industry participants, hence supporting the creation of new business models’, and they also ‘unlock the potential of other technologies such as artificial intelligence’, BNP said.

The use of the cloud as a tool in the securities industry is another area that has grown in importance. A 2022 Celent survey commissioned by the DTCC in the US found cloud adoption was almost universal within the securities industry. Respondents quoted business agility, operational efficiency, and security and resilience as their primary motivations.

From Australia to Italy – lessons on transformation

Despite the momentum in API, cloud and DLT adoption, not everybody is prepared to abandon legacy systems altogether. Many prefer to update existing platforms due to challenges including the requirements for cultural shifts, time to transition and the cost of adoption.

According to the Celent survey referenced above, computer mainframes remain prevalent across capital markets, with more than 50% (and 44 of the top 50 banks) still using one. Slightly more than half said they intended to retire their mainframe, which can take at least five years. The rest said they planned to maintain and modernize it.

Large-scale projects to sweep away legacy systems are complex and contain a degree of jeopardy. Just ask the Australian Stock Exchange (ASX), which in late 2022 ditched a $200m project to replace its clearing and settlement system with a blockchain-based alternative, CHESS.

In 2017, CHESS was touted as one of the most prominent examples of a real-world use case of blockchain. A report by Accenture pointed to a series of flaws, including deficiencies in execution and misalignment of what progress would entail between ASX and its technological partner.

Others have had more success, including Spunta, a DLT-based technology used by 90% of banks in Italy for their interbank reconciliation processes, helping identify accounting errors, fraud, and risk. Led by the Italian Banking Association (ABI) in an industry-level collaboration, the platform went fully operational in October 2020.

Despite the occasional high-profile failure, most digital transformation projects succeed and bring benefits, but without broader collaboration, a fragmented, disjointed financial industry landscape will persist. And to prepare for future challenges, firms must apply technology and automate as much of their workflow as possible. Not to do so is to negate the exponential benefits of what is on offer.