The Group of 30 describes it as a “macroprudential” issue. The financial industry, however, simply calls it systemic risk: the interconnectedness of thousands of financial market participants having the potential to affect the safety, soundness and integrity of the global financial system.
Virtually all financial institutions today have controls in place to help safeguard assets and limit the risks and exposures they face. These risk management practices are essential to protecting firms, their counterparties and, most broadly, the system as a whole. Behind the scenes, financial market infrastructures operate primarily to help mitigate systemic, credit, market, operational and liquidity risk. But for companies, financial market infrastructures stand to do much more.
Financial market infrastructures — the clearing, recording and settlement systems for transactions — have a long history of enhancing operational efficiencies and reducing the costs of posttrade processing and other back-office operations. But the 2008–’09 financial crisis prompted the financial services industry to try to find ways to utilize these frameworks to handle postrecession market deregulation.
A study conducted in 2013 by the Depository Trust & Clearing Corp. (DTCC) found that total financial industry spending on operational processing reached as high as $100 billion a year. But only 5 percent of that is managed by market utilities. In other words, a significant amount of money is being spent on redundant and duplicative processes that in most cases don’t provide firms with a competitive or economic advantage.
For an industry struggling to regain its footing and facing significant costs to meet new regulatory, risk management and compliance mandates, market infrastructures have an increasingly important role to play. Along these lines, financial executives are beginning to rethink the industry’s operating model by taking a fresh look at how certain non-revenue-generating functions performed across the industry can be shared in order to reduce risks and costs.
This represents a shift in thinking. In the past, many firms felt they needed to control the operational processing stack in order to have a competitive advantage. This mind-set is no longer realistic or sustainable. According to an estimate from Standard & Poor’s, the compliance costs of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act for the eight largest banks could amount to as much as $34 billion annually.
Utilizing existing market infrastructures — industry-owned ones, in particular — to manage certain middle- and back-office functions can lead to improved performance for financial firms by squeezing more savings out of the system. The fact is that market infrastructures have proven capabilities, strong governance and can deliver significant efficiencies — such as the establishment of standard legal entity hierarchies, collecting regulatory compliance data and processing tax-compliance documents.
Think about it. Why should virtually every single financial firm collect its own know-your-customer (KYC) documentation on many of the same clients when one organization can manage these data for the greater industry? With return on equity down industrywide and cost-cutting reaching a breaking point, the financial services industry needs to rethink its cost base if firms are going to grow in the future. Market infrastructures have the expertise and experience to deliver risk mitigation, cost savings and operational efficiencies.
The question is whether the industry is ready to seize these opportunities.
Donna Milrod is chief administrative officer of the Depository Trust & Clearing Corp. (DTCC).
