Securities Services - Regulatory Readiness Series - Issue 1
Standard Chartered Securities Services Regulatory Readiness Edition 1 – Preparing you for upcoming regulatory and compliance developments
*Securities Services* **Regulatory Readiness**
Edition 1
Preparing you for upcoming regulatory and compliance changes
Preparing you for upcoming regulatory and compliance changes
Our industry is among the world’s most tightly regulated, due to the importance of financial services to individual wealth and collective economic growth. The scope of regulation continues to expand, with almost 400 implementations in progress during 20201. Post-2008 reforms aimed at systemic stability and consumer protection are almost complete and subject to review. But it doesn’t stop there.
The regulatory agenda continues to expand as the digital technology revolution presents opportunities such as open banking and risks such as new cyber-security threats.
Coupled with the growing need to disclose, measure and report the non-financial impacts of investments on our societies and environment, and the continual evolution of AML/KYC requirements, regulatory preparedness will remain critical to long-term success. We hope this Regulatory Readiness series will help securities services clients stay abreast of, adapt to and accommodate these regulatory developments.
As the scope of regulation widens, complex change management projects are becoming the norm. To operate effectively and safely within an evolving regulatory framework, firms need to understand the spirit as well as the letter of the law, and its impacts all along the transaction chain:
- What is the underlying objective for the new regulatory requirement?
- What change in behaviour or process is required?
- What need or threat does it address?
- Do you need to discuss changes with your clients or suppliers, or potentially even develop new relationships?
Our Regulatory Readiness series provides the context behind the new rules to help clients understand the potential breadth of their impact and to prepare for it.
1 RegTech Beacon – JWG Group (March 2020)
As well as being highly regulated, financial services is also one of the oldest industries in the world. It delivers value to clients based on timeless principles which cannot be outmoded by changes in taste or technology. Trust, custody and safekeeping, for example, are as fundamental to the provision of securities services today as they have ever been.
Custody has always meant more than the literal safekeeping of client assets. To us, it also means protecting clients’ investments in the much broader sense by keeping them apprised of emerging and evolving risks, responsibilities and opportunities.
To this end, our first three primers in this series highlight the potential for open banking to support new services, as well as the due diligence implications of new asset safety rules and operational changes needed to comply with CSDR. By regularly sharing our insights on the wider implications of regulatory developments with you, our clients, we aim to better safekeep your assets and safeguard your interests in a holistic manner as our industry continues to grow in complexity.
Across the diverse regulatory themes covered in these individual primers, safety and efficiency are among the most resounding, for both you, our clients, and your own downstream clients. As custodians, we at Standard Chartered look forward to sharing our expertise and experience, supporting you to innovate and thrive within the context of an ever-changing regulatory environment.
As well as being highly regulated, financial services is also one of the oldest industries in the world. It delivers value to clients based on timeless principles which cannot be outmoded by changes in taste or technology. Trust, custody and safekeeping, for example, are as fundamental to the provision of securities services today as they have ever been.
Margaret Harwood-Jones
Co-Head, Financing & Securities Services, Financial Markets
Disclaimer
This material has been prepared by one or more members of SC Group, where “SC Group” refers to Standard Chartered Bank and each of its holding companies, subsidiaries, related corporations, affiliates, representative and branch offices in any jurisdiction, and their respective directors, officers, employees and/or any persons connected with them. Standard Chartered Bank is authorised by the United Kingdom’s Prudential Regulation Authority and regulated by the United Kingdom’s Financial Conduct Authority and Prudential Regulation Authority. This material is not research material and does not represent the views of the Standard Chartered research department. This material has been produced for reference and is not independent research or a research recommendation and should therefore not be relied upon as such. It is not directed at Retail Clients in the European Economic Area as defined by Directive 2004/39/EC. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. This material is for information and discussion purposes only and does not constitute an invitation, recommendation or offer to subscribe for or purchase any of the products or services mentioned or to enter into any transaction. The information herein is not intended to be used as a general guide to investing and does not constitute investment advice or as a source of any specific investment recommendations as it has not been prepared with regard to the specific investment objectives, financial situation or particular needs of any particular person. Information contained herein is subject to change at any time without notice, and has been obtained from sources believed to be reliable. Some of the information herein may have been obtained from public sources and while SC Group believes such information to be reliable, SC Group has not independently verified the information. Any opinions or views of third parties expressed in this material are those of the third parties identified, and not of SC Group. While all reasonable care has been taken in preparing this material, SC Group makes no representation or warranty as to its accuracy or completeness, and no responsibility or liability is accepted for any errors of fact, omission or for any opinion expressed herein. The members of SC Group may not have the necessary licenses to provide services or offer products in all countries, and/or such provision of services or offer of products may be subject to the regulatory requirements of each jurisdiction, and you should check with your relationship manager or usual contact. You are advised to exercise your own independent judgment (with the advice of your professional advisers as necessary) with respect to the risks and consequences of any matter contained herein. SC Group expressly disclaims any liability and responsibility whether arising in tort or contract or otherwise for any damage or losses you may suffer from your use of or reliance of the information contained herein. This material is not independent of the trading strategies or positions of the members of SC Group. It is possible, and you should assume, that members of SC Group may have material interests in one or more of the financial instruments mentioned herein. If specific companies are mentioned in this material, members of SC Group may at times seek to do business with the companies covered in this material; hold a position in, or have economic exposure to, such companies; and/or invest in the financial products issued by these companies. Further, members of SC Group may be involved in activities such as dealing in, holding, acting as market makers or performing financial or advisory services in relation to any of the products referred to in this material. Accordingly, SC Group may have conflicts of interest that may affect the objectivity of this material. You may wish to refer to the incorporation details of Standard Chartered PLC, Standard Chartered Bank and their subsidiaries at http://www.sc.com/en/incorporation-details.html.
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<Br><p style="color:#404040;">How to prepare for CSDR’s settlement discipline regime
How to prepare for CSDR’s settlement discipline regime
Although CSDR is a European regulation, its impacts will be global. Market participants need to act now to avoid penalties for themselves and their clients.
The regulatory recap
CSDR – setting standards to drive settlement discipline
The Central Securities Depositories Regulation (CSDR) aims to make the securities markets of the European Economic Area (EEA) more efficient and transparent, largely by standardising post-trade processes.
Following the European Market Infrastructure Regulation (EMIR) and Markets in Financial Instruments II (MiFID II), CSDR is the third leg of reforms to the region’s securities market structure. All are aimed at greater harmonisation, transparency, consumer choice and protection, and systemic stability.
CSDR standardises many aspects of securities settlement, but its biggest impact on market participants is settlement discipline rules designed to eliminate trade fails.
Initially scheduled to come into force in September 2020, the European Commission had accepted the European Securities and Markets Authority’s (ESMA) proposal to delay the settlement discipline regime until February 2021. However, at request of the European Commission, the ESMA is working on a proposal to further delay the coming into force of the CSDR by another 12 months until February 2022. This extension of delay is to take into account the COVID-19 pandemic’s ongoing impact on implementation of other regulatory projects and IT deliveries being undertaken by central securities depositories (CSDs)1.
1 Asset Servicing Times, ‘ESMA confirms preparations to further delay CSDR’. 28 July 2020
Scope, scale, structure
Targeting trade fails and traversing beyond Europe
All entities along the European securities value chain are touched by CSDR, from the initial issuers of securities to the custodians and CSDs that hold them in safe-keeping, as well as the buy- and sell-side firms and intermediaries in between. CSDR also introduces common regulatory and business conduct rules for EEA CSDs and includes rules on internal settlement and dematerialisation.
Except for issuers, all parties in the securities settlement chain are directly impacted by the settlement discipline regime, including non-EEA based entities.
Market participants and intermediaries must adjust to the regime’s four pillars:
- Allocation and confirmation policies to support timely settlement;
- Fails monitoring and reporting requirements;
- Cash penalties;
- Mandatory buy-in rules.
CSDs are tasked with monitoring and reporting settlement efficiency rates and facilitating matching and related processes to support trouble-free settlement.
Thus, although CSDR is a European regulation, its impacts are global, requiring relevant market participants and intermediaries to review settlement-related processes to avoid cash penalties and other costs for themselves or their clients.
Many types of firms operating outside of the EEA are in scope – including asset owners and managers, broker-dealers, private banks and wealth managers – if they are or their clients trade EEA securities because the settlement discipline rules apply to all transactions intended for settlement on an EEA CSD. This covers transferable securities, money-market instruments and UCITS; exemptions include shorter-dated securities financing transactions.
Thus, although CSDR is a European regulation, its impacts are global, requiring relevant market participants and intermediaries to review settlement-related processes to avoid cash penalties and other costs for themselves or their clients.
Building the blueprint for your firm
Review, re-evaluate and respond – avoiding the cost of failure
Under CSDR’s settlement discipline regime, market participants deemed responsible by a CSD for a settlement-failure face cash penalties, calculated daily by the CSD; then, if not resolved within a specified time frame per instrument, a mandatory buy-in. This will incur further costs to the failing trading member, including appointment of a buy-in agent, and potentially higher market prices, to replace the original transaction. As well as immediate costs, high failure rates may cause longer-term reputational damage, harming relationships with counterparties.
Asset owners and managers, broker-dealers, other intermediaries and custodians are likely to need to make adjustments in one or more of the following securities processing areas:
- Look for weak links. All firms buying and selling EEA securities must have clear oversight over their entire securities processing transaction chain from pre-trade to execution to post-trade processes, including settlement and payment. CSDR requires them to understand and manage the whole trade lifecycle in an efficient, timely and compliant manner in partnership with trading counterparties and service providers.
- Dig deep, reduce risks. Firms should review their existing post-trade processes to assess fails ratios and identify underlying causes of trade fails, such as repeated incomplete / incorrect fields when trading with a frequent counterparty. Firms may look to tilt transaction flows toward counterparties and service providers with most robust settlement operations. Some may also adjust their trading operations, avoiding certain higher-risk activities, e.g. short sales or leveraged trades.
- Keep talking. Communicate effectively with internal and external parties involved in post-trade processes, particularly regular counterparties, broker-dealers and custodians. Firms must understand how service providers intend to communicate on settlement fails, cash penalties and buy-in processes, and factor this into their own communications flows, including, if necessary, to end-clients.
- Can you prove it? As securities buyers from third-party jurisdictions, some clients may be net beneficiaries of failed trade penalties. But they must also reassess their processes to validate fails-related communications, and to challenge penalties if necessary, providing well-documented evidence to resolve disputes quickly.
- New partners. Market participants may need to select a buy-in agent, as the receiving party is responsible for sourcing replacement securities, before passing the cost to the failing party. Buy-in agents may be in short supply due to multiple regulatory requirements.
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Check your paperwork and processes. Firms may need to revisit invoicing processes, to isolate payments relating to settlement discipline costs, and keep abreast of upgrades to SWIFT message formats. Industry working groups are exploring potential repapering needs.
Building the blueprint for the industry
Collaboration and consultation
CSDR will establish more harmonised, standardised and efficient securities settlement processes in the EEA. Post-trade harmonisation and integration has been a long-term EU goal, especially since the launch of the euro. The 2008 global financial crisis also highlighted the need for more efficient and secure cross-border securities settlement.
Settlement failure has long been tolerated in Europe, but CSDR’s preventative measures and related reforms should deliver greater standardisation and automation. Greater speed, reliability and transparency will cut back-office costs for market participants and allow them to better serve end-investors, potentially offering newer and lower-cost services.
But ongoing collaboration and consultation is needed to streamline and accelerate any extended transaction chain. As with EMIR and MiFID II, industry bodies are continually working to provide feedback to regulators, develop new best practices and support cost-effective compliance.
Settlement failure has long been tolerated in Europe, but CSDR’s preventative measures and related reforms should deliver greater standardisation and automation. Greater speed, reliability and transparency will cut back-office costs for market participants and allow them to better serve end-investors, potentially offering newer and lower-cost services.
Championing change with Standard Chartered
Facilitating the fail-safe for your CSDR plan
CSDR’s settlement discipline rules may influence the shaping of future standard practice beyond the EEA, meaning firms that prepare their operations now will be ahead of the curve in terms of pro-active failed trade management and improved ‘big data’ management to optimise post-trade operations.
At this point in time, several elements of the regulation – and the industry’s response – remain uncertain. Whether trading EEA-issued securities daily or less frequently, CSDR’s settlement discipline regime could require extensive preparations to handle new and unfamiliar processes. For many, the three biggest priorities will be: finding out your level of fails and tackling underlying causes; engaging with clients and counterparties on process changes to accommodate penalties and buy-ins; establishing dispute resolution procedures.
As an intermediary for EEA securities transactions, Standard Chartered has mobilised a coordinated bank-wide response to ensure clients are fully supported. We are helping clients to improve settlement discipline, implementing new processes and improving communication flows to ease compliance. This includes working bilaterally with clients and collaboratively at an industry level to understand further changes and support best practice and compliance.
To reduce costs and disruption, speak to Standard Chartered about your CSDR preparations.
As an intermediary for EEA securities transactions, Standard Chartered has mobilised a coordinated bankwide response to ensure clients are fully supported.
<BR>Are you open for
API business?
Are you open for API business?
The regulatory recap
Establishing digital connections for creativity and collaboration
Open banking is the practice of sharing data between new and established financial service providers to develop and deliver improved services and capabilities to clients. The term “open banking” describes the shift from a traditional “closed” banking model where data was retained within an individual firm, to a more “open” model, where data is shared with third parties1.
Initially adopted in retail payments and account services, opening banking is now increasingly seen in corporate and institutional markets – including securities services – and is often supported by national regulators to improve consumer outcomes such as increased choice, innovation and inclusion.
Open banking leverages digital technologies such as APIs to exchange information between service providers and clients electronically and securely. Starting in UK/EU, open banking rules have mandated open access for third-party financial service providers to consumer account and transaction data from incumbent institutions.
In parallel with near-universal smartphone use, open banking has spurred development of app-based services that offer greater immediacy, convenience and transparency, paving the way to new business models, partnerships and value propositions.
1 How to flourish in an uncertain future, Deloitte (2017)
National regulators take varying approaches, from facilitative to prescriptive2, balancing consumer and data protection priorities with promoting innovation and choice. As they expand scope within retail financial services, regulators are neutral or supportive of a market-led expansion of open banking into securities services, some saying banks are “welcome to extend”3 existing frameworks.
Securities services firms are rapidly exploring opportunities to use APIs and related data-transport mechanisms, both to achieve process efficiencies and add new client value. Asset owners, asset managers and other intermediaries such as broker-dealers could engage with their custodians to find out how open banking can improve operational efficiency, reduce or eliminate the risks and costs of manual processes, and streamline communication flows, thus enhancing insight and visibility.
Asset owners, asset managers and other intermediaries such as broker-dealers could engage with their custodians to find out how open banking can improve operational efficiency, reduce or eliminate the risks and costs of manual processes, and streamline communication flows, thus enhancing insight and visibility.
2 Report on open banking and API interfaces – Basel Committee on Banking Supervision (November 2019)
3 Open API Framework for the Hong Kong Banking Sector – Hong Kong Monetary Authority (Jul 2019)
Scope, scale, structure
Both rules-based and market-driven; beyond borders and breaking boundaries
Open banking started in 2016 as a regulatory response to limited competition and innovation, specifically in UK and European retail banking. It partly took its lead4 from how digital technologies such as APIs are connecting systems and organisations, creating new, integrated services, often accessed via apps on increasingly powerful smartphones.
Initially, the UK’s Competition and Markets Authority required large retail banks to allow secure third-party access to current account information, establishing the Open Banking Implementation Entity (OBIE) to oversee development and use of APIs, including security and message standards.
Europe’s second Payment Services Directive (PSD2) mandated third-party payment initiation and account information services from 2018, with implementation phased until September 2019. PSD2 aimed to enhance competition and client-centricity, integrate the European retail payments market, and increase access to user-friendly, internet-based payments services, whilst reinforcing consumer protection. In these markets, compliance was slow, but competition, innovation and competition are gradually increasing. Tension between security and access may require further regulatory intervention.
Starting with payments, but expanding across the financial services spectrum, API-enabled connectivity and integration is driving innovation across developed and emerging markets, as well as for corporate and institutional clients.
4 CMA paves way for Open Banking revolution (August 2016)
Open banking is being rolled out differently across jurisdictions. Whilst some markets are prescriptive about how APIs are used, Singapore and Hong Kong have only introduced API guidelines and measures to promote data sharing with third parties. China has seen strong adoption, despite issuing no mandate or standards, with Japan encouraging, rather than requiring, open banking partnerships. In the Middle East, Bahrain is mandating open banking to improve visibility across banking services.
APIs are enabling financial inclusion in countries which have leapfrogged previous generations of financial market infrastructure. For example, India’s Unified Payments Interface which was launched in 2016 supports a billion mobile payments per month via API-facilitated real-time interbank transactions5, leveraging the country’s Aadhar digital identity platform. In Africa, open banking also plays a supporting role in the National Bank of Rwanda’s Vision 20206, which aims to achieve 90% financial inclusion by the end of this year. Kenya has no such mandate, but e-wallet and related payments innovations are paving the way for increased data exchange.
The UK’s OBIE is expanding use of APIs into a wider range of financial services. However, no securities services provider has been mandated to open its data or systems to third parties in any major jurisdiction. Provided they observe data protection, cybersecurity and third-party risks7, securities services firms are free to develop standards and practices for API usage at industry level.
To ensure interoperability and safety in the open banking era, regulators are taking on new roles as trusted registration authorities to ensure only approved entities may access bank client data via APIs.
APIs are enabling financial inclusion in countries which have leapfrogged previous generations of financial market infrastructure. For example, India’s Unified Payments Interface which was launched in 2016 supports a billion mobile payments per month via API-facilitated real-time interbank transactions5, leveraging the country’s Aadhar digital identity platform.
Building the blueprint for your firm
Leveraging APIs – from design to deployment
Within securities services, APIs already have some potentially valuable use cases. These include developing alternative channels to existing host-to-host communications, serving as a transport layer for innovative new digitised products and services, e.g. chatbots, and supporting third-party authentication, to enable bank-sponsored client access to value-added services. Destinations will differ, but common principles will help firms get the most from APIs:
- What’s your vision? APIs are enablers of a business vision, rather than an end in themselves. As such, firms should start with their desired business outcomes in mind and evaluate whether APIs are the best tools for achieving them. Firms should have clear business-driven reasons for API-based information exchange, for example, to eliminate or reduce reliance on particular manual processes, or augment workflows for greater efficiency, or improve responsiveness to client needs. It may also make sense to start small, rather than placing them at the centre of a major project.
- Ready to receive. Firms must ensure their internal technology stacks are operationally ready to consume data from third parties via APIs, whether augmenting or replacing existing data flows, or creating entirely new connections. Typically, adopting APIs does not require major change to existing policies and procedures, particularly if supplementing existing data flows, but full thought should be given to supporting end-to-end workflows across traditional silos.
- Is API the best option? Although APIs streamline data exchange, many simply push and pull data between systems, making them less sophisticated than certain alternatives, e.g. XML over IBM WebSphere MQ. APIs may be just one option within a wider conversation and consideration about improving dataflow efficiency.
- Counting the cost. Firms must weigh the underlying costs of preparing systems to receive, analyse and leverage API-delivered data. The cost/benefit analysis must include the skilled staff and security investment required to maintain API-based communications with third-party systems.
- Partnership priorities. Partnerships with third-party providers need to be mutually beneficial in terms of functionality and security. For example, partners must manage client data in line with local regulations on API usage, data security and privacy, and have the requisite cybersecurity infrastructure to deliver robust, reliable APIs.
Building the blueprint for the industry
Consistency is key to industry connectivity
While APIs have been around for some 50 years, they are in relative infancy in the finance industry, especially in sectors currently outside open banking mandates, such as securities services. Initial caution in markets where open banking was regulator-led has been replaced by greater appreciation of opportunities to add value to clients.
But the framework for wider use of APIs is being built, both by regulators and the industry. Growth of use cases inevitably means innovation and creativity, but some degree of standardisation is also needed to drive efficiency and scale. For institutional markets, standardisation initiatives – such as those sponsored by SWIFT – will drive API growth, as will integration with digital identity frameworks to allow greater control over what data is shared and with whom.
Championing change with Standard Chartered
Playing a pivotal part in digital innovation
Standard Chartered has collaborated with clients in many markets on open banking initiatives over the past 18-24 months, making APIs available via its pioneering aXess platform, which helps to foster innovation and partnership with fintechs. Our comprehensive suite of securities services APIs already provides information on trade status, holdings, market news, NAV, cash balances etc, with settlement initiation and corporate actions APIs in the pipeline.
APIs are enabling new partnerships, functionality and business models. But the true innovation often lies in the creativity they enable, serving as a transport layer on which powerful and valuable new apps run. At a time when many firms are switching from pipeline to platform business models, APIs will play a key role in connecting counterparties in new, more efficient and value-added ways.
As well as enabling competition and innovation in the retail market, APIs are also helping corporate and institutional clients adjust their client propositions to the needs of the digital economy. APIs have undoubted value in the securities services sector, but their impact may be most significant in combination with other digital technology innovations.
For example, Standard Chartered is leveraging APIs and machine learning to automate account opening and streamlining digital asset transactions via an API that simplifies blockchain platform integration. Talk to our experts to help maximise their potential for your organisation.
<Br><p style="color:#404040;">How to meet the rising global standards for asset safety
How to meet the rising global standards for asset safety
The regulatory recap
Raising safety standards to protect investor interests
Asset owners and investors may require a chain of financial intermediaries, including global custodians and sub-custodians, to hold their securities and help them facilitate safekeeping and asset servicing.
These assets are typically held by the custodian in an account at the issuer’s national central securities depository. But asset owners can lose access to – and control of – assets in the custody of a financial intermediary that becomes insolvent or is otherwise unable to meet its obligations to depositors or other creditors. This can happen if records and processes are not properly maintained throughout the chain, especially where the assets are held in shared (omnibus) accounts. It is hardly surprising, therefore, that safekeeping of securities has come under particular scrutiny.
Rules around asset safety are being tightened in many major jurisdictions, e.g. at the European Union (EU) level, but also at national level such as in Australia and the UK. This comes in response to high-profile examples of inadequate clarity and protection for asset owners during and after the 2008 global financial crisis. Fundamentally, the rules require asset owners and managers to ensure assets are fully under their control, regardless of where they are held or the length of the custody chain. But these stricter requirements have far-reaching implications for service providers too.
Fundamentally, the rules require asset owners and managers to ensure assets are fully under their control, regardless of where they are held or the length of the custody chain. But these stricter requirements have far-reaching implications for service providers too.
The central challenge for all parties is legal certainty over the ownership of assets in event of insolvency. The collapse of Lehman Brothers in 2008 demonstrated the difficulties in identifying and returning assets to their rightful owners following liquidation of a service provider. Subsequent cases highlighted flawed segregation practices along with poor record-keeping and controls, and governance not being rigorously observed and enforced. This has resulted in the improper commingling of a client’s assets (securities and cash) with those belonging to other clients and with the service providers’ proprietary assets. Fines have been issued and rules both clarified and toughened to ensure asset owners and service providers are rigorous in the oversight of assets.
Although requirements vary across jurisdictions, the overall direction urged by regulators is toward more transparency, control and segregation in the safekeeping of assets. This requires asset owners and managers undertaking reviews – and possibly upgrades – of due diligence processes in terms of selecting and maintaining service provider relationships. They may also need to revisit day-to-day operational processes, including reconciliation and reporting, to underpin and verify asset ownership and safety.
The central challenge for all parties is legal certainty over ownership of assets in event of insolvency. The collapse of Lehman Brothers in 2008 demonstrated the difficulties of identifying and returning assets to their rightful owners following liquidation of a service provider.
Scope, scale, structure
A global shift in the rules for segregation and safe-keeping
Major jurisdictions are continuing to tighten and clarify rules around asset safety, potentially requiring asset owners and managers and their custody service providers to review and strengthen their operational frameworks. Although service providers can be expected to provide supporting processes and information, the responsibility often starts with the asset owners and managers to comply with the rules.
This post-global financial crisis tightening of asset safety requirements are part of a wider reform effort to improve efficiency, transparency and standardisation of post-trade and custody processes, including shorter settlement cycles, standardised processes and universal identifiers.
Increasingly, asset safety rules have more effective extra-territorial reach, meaning their authority extends to overseas jurisdictions where assets are held on a regulated firm’s behalf. Firms must ensure all agents involved in safekeeping their assets are meeting required regulations, regardless of location.
Although mature markets may be first movers in tightening rules, smaller jurisdictions already follow similar principles. Firms need to embrace the spirit of the changes being introduced and not simply the letter of the (new) laws.
The common aim is to guarantee sufficient levels of account segregation by custodians and other service providers for assets to be identified and reclaimed by their owners, effectively ring-fencing them from being used to settle creditors’ claims in the event of the financial intermediary’s bankruptcy or liquidation. At the point of engaging the custodian, this may require a legal opinion about the treatment of client assets under the prevailing insolvency laws that the custodian is subject by, and thorough due diligence regarding its service standards. On an ongoing basis, regulated firms must also ensure adequate oversight of their custody chain, including internal processes for monitoring, reconciliation, reporting, controls and dispute resolution.
In Europe, regulations covering mutual and alternative investment funds – specifically the Undertakings for the Collective Investment in Transferable Securities V and the Alternative Investment Fund Managers Directive (commonly referred to as the ‘UCITS V’ and ‘AIFMD’) respectively – were amended in 2019 to establish EU-wide rules protecting client assets in the event of custodian or depositary insolvency. Service providers must now support accurate and frequent information flows and reconciliation processes to enable identification and traceability of assets held in omnibus accounts.
In the UK and the US respectively, the Financial Conduct Authority’s Client Asset Sourcebook (CASS) and Securities and Exchange Commission (SEC) Rule 17f-5 impose high standards on fund managers and custodian when it comes to oversight of client assets. The SEC rules apply specifically to assets of US firms held overseas; the CASS applies to UK-incorporated firms and non-EEA firms with UK branches and was updated in 2015 to require more detailed, frequent and automated reconciliation and reporting processes.
Amended in 2018, Australia’s RG 133 requires investment schemes and their custody providers to observe minimum standards on records, organisational structure, resources, staffing and segregation.
In the UK and the US respectively, the Financial Conduct Authority’s Client Asset Sourcebook (CASS) and Securities and Exchange Commission (SEC) Rule 17f-5 impose high standards on fund managers and custodian when it comes to oversight of client assets. The SEC rules apply specifically to assets of US firms held overseas; the CASS applies to UK-incorporated firms and non-EEA firms with UK branches, and was updated in 2015 to require more detailed, frequent and automated reconciliation and reporting processes.
Building the blueprint for your firm
Taking control means taking responsibility
Increasingly stringent asset safety rules require asset owners and managers to review how they select their custody service providers and how they interact with them on a daily basis. To ensure control and oversight of assets, regardless of where they are held globally, firms may need to improve their due diligence and operational processes.
Due diligence – Prior to engaging a custodian, asset owners and managers should establish a framework to determine their satisfaction with the level of asset segregation, transparency and control offered by the prospective service provider, perhaps including scores, metrics and periodic reviews. This may be achieved through questionnaire (e.g. Association for Financial Markets in Europe template) or site visits, in line with the firm’s risk management policies. Areas to consider may include, but are not limited to:
- Expertise, experience of staff
- Account opening and maintenance protocols
- Available account structures (segregated vs omnibus)
- Frequency and automation of reconciliation processes
- Frequency and automation of reporting on holdings and transactions
- Risk management/controls policies and procedures
- Ability/willingness to provide legal opinions
- Local market expertise and ability to deliver regular market updates
- Consistency of user experience and service levels across markets
- Framework for appointment and oversight of sub-custodians and other agents
- Robustness, integration and security of technology and operating infrastructure
- Business continuity and disaster recovery arrangements
Ongoing oversight – To ensure effective control and oversight of assets under custody, asset owners and managers must not only monitor their service providers on a regular basis, but also their own internal processes. In particular, this requires reviewing and updating processes involved in handling and reconciling statements of holdings and transaction reports, and regularly reviewing account usage.
Building the blueprint for the industry
In testing times, can technology deliver transparency?
Asset safety and control are integral to investor confidence and therefore crucial to the functioning of financial markets. The industry is embracing efforts to remove uncertainty over investors’ ability to achieve oversight over their assets – and retrieve them in light of unforeseen circumstances on a timely basis, especially given growing sources of volatility and uncertainty.
However, moves toward more robust asset safety rules are likely to accelerate consolidation among service providers and could reduce choice, especially if a market event leads to even stricter segregation standards. Custody service options have always involved trade-offs: strong protection is balanced against higher costs and lower speed of access. Increased segregation typically adds costs and makes it harder to offset these via revenues from ancillary services. With regulatory and market infrastructure changes having already increased costs over the past decade, further margin pressure could narrow the field.
Technology is helping service providers to improve transparency, increase efficiency and develop more value-added services. Innovations include the Single Touch Model (“STM”) offered by Standard Chartered’s international custody hubs. Compared to the traditional model between a global custodian and its sub-custodian where each intermediary maintains its own ledger of transactions, STM enables a shared ledger between the Standard Chartered entity acting as a ‘Hub’ and its affiliated sub-custodian within the Standard Chartered network. In this way, by giving both parties access to the same central records and shared ledger, STM minimises the need for reconciliation and reduces the potential for error while also improving settlement efficiency and speed.
Championing change with Standard Chartered
Safety first
Asset owners and managers are already alert to the need to protect their assets. In a volatile and unpredictable business environment, it’s particularly important that firms assert and maintain full control and ensure rigorous oversight of service providers. As such, all market participants support the efforts of regulators to increase investor protection and systemic stability.
As a provider of custody services in 40 markets (and access to a wider range of markets via our network of relationships) Standard Chartered offers a consistent level of service – and safety – combined with deep local expertise. Wherever your home jurisdiction, we stand ready to support your evolving needs, up to and beyond the new requirements being set by regulators.
