Partnering with regulators: It’s time to strategise on operating efficiencies and risk reduction

By: The WFE Focus Team Sep 2017

We hear from Arjun Jayaram, CEO, Baton Systems about why partnering with regulators matters.

Capital markets are extremely powerful financial infrastructures designed to foster economic activity and promote prosperity for countries and their people.

To work properly, they need to be operated fairly. Otherwise, market-level failures can significantly hurt the economic underpinnings of an economy, banking structures and ultimately the people. Regulators have typically been the arbitrators of ‘fairness’ which has led to a complex framework of requirements.

Why regulation matters

Let us first look at why regulations like MiFID, Dodd Frank, EMIR, FATCA, etc., exist. A common theme that I found is lack of transparency across systems of different financial institutions. Sometimes, the opacity exists even between systems within the same institution. At the risk of greatly oversimplifying, I’ll outline the real problems with market infrastructure today:

  • Not all investors and institutions are equally sophisticated, as sophistication requires significant investments. A fair marketplace requires that smaller investors are not disproportionately disadvantaged in market participation.
  • Lack of transparency into the entire end-to-end trade execution including venue, timing, price, supply-demand at the time of trade, etc. 
  • Lack of consistency in reconciliation reports from multiple counterparties to ensure that they all agree to the trade details.
  • Lack of transparency into the obligations and exposures during the life cycle of the trade until settlement.
  • Lack of transparency into clearing and settlement as part of the trade, including cash and security positions at various accounts.

This lack of transparency across the board leads to serious market and counterparty risks. The role of the regulator is to reduce the risk and ensure fairness. The role of the participant should be to provide as much transparency and interoperability as possible. Transparency and interoperability increase velocity of information sharing, improve efficiencies in clearing and settlement, and reduce costs. (And no, a blockchain does not do this automatically, just the same way as an Oracle or DB2 database cannot do this.)

The disconnect of regulatory analysis

What we have now is a set of rules that require petabytes of data in the form of reporting. Unfortunately in most cases, the data and analysis happen well after an irregularity has already occurred or a rule has been broken, leading to enforcement actions and a degradation of the relationship between financial institutions and regulators. If these requirements could be monitored and analysed while the transactions are in process, it could give the regulators a sharper view of ‘fairness’ to ensure markets are protected.

To solve this problem requires a deep understanding of the myriad rules and regulatory reporting requirements, and tying it back to the operations in the pre-trading, trading and post-trading systems. Only then can one find some commonality and rational demands by the regulators. I have seen two suggested approaches as a solution – neither of which address the entire picture:

  1. Incumbent solutions from multi-billion dollar companies. These are at best a cocktail of tools and outsourced services. They might as well be labeled as ‘Let us manage this headache for you, so you can get back to other work’.
  2. The blockchain. This is not going to magically solve these problems. I will explain why.

These options are missing key tenets of the above-mentioned regulations and what they are aiming to address. They also don’t acknowledge the lack of collaboration which has led to each side not quite seeing the other side’s position.

At Baton, we believe there is a better way. We have had the opportunity to learn from some of the best minds in capital markets, including many central bankers, to inform how we should address the transparency and interoperability issues. We have already started with post-trade clearing and settlements. But we think our approach to solving the payments and reconciliations problem can be used for addressing many of the issues above as well, including these three systemic limitations:

  • Heterogenous systems do not communicate and synchronise information.
  • Trading systems have moved to real-time, event-based processes, while pre-trade and post-trade have remained in batch mode.
  • Clearing and settlement of currencies and securities still do not take full advantage of central banks and CSDs, leading to higher costs and risks.

It is possible to solve several of these obstacles today using existing infrastructure – without the need for settlement coins or digital coins, new operating rules, etc. I also think the regulators could be less prescriptive on some of the required reports. As mentioned, today’s reports (and the subsequent analysis of reports) happen after an event has passed. We can do better. We can do real-time. In our meetings with regulatory authorities, I have shown them the power of real-time, permissioned regulatory reporting and real-time analytics, including anomaly detections. In the areas of post-trade, for example, we were able to demonstrate much clearer and real-time views into systemic risk. That is good for everybody.

Baton Systems did not invent real-time technology, of course. It has been available for the likes of Google, Facebook, Twitter, Uber, etc. We just brought it to capital markets to solve the current, real challenges of slow processes for payments, lack of transparency and reporting risk. The real power of the Baton solution is the interoperability. We are able to deliver this for faster payments and faster reconciliations today by moving real money from real accounts faster and cheaper than anyone else. And by collaborating with regulators and market participants, we are addressing today’s operational inefficiencies, opacity and risks to encourage strong and fair markets.