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Institutional clients

Issue 2 | May 2016

Inside this issue:

Beyond T2S Are there more benefits than meet the eye?

Up and away Exploring the cost of regulation

SWIFT innovation What to expect from this transformative programme

Commodities conundrum Is an end to the slump in sight?

Taking the leadBNY Mellon’s Suresh Kumar on why banks should drive technological change

Insights from Deutsche Bank Global Transaction Banking

This advertisement is for information purposes only and is designed to serve as a general overview regarding the services of Deutsche Bank AG and any of its branches and affiliates. The general description in this advertisement relates to services offered by Deutsche Bank AG Global Transaction Banking and any of its branches and affiliates to customers as of May 2016, which may be subject to change in the future. This advertisement and the general description of the services are in their nature only illustrative, do neither explicitly nor implicitly make an offer and therefore do not contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG or any of its branches or affiliates. Deutsche Bank AG is authorised under German Banking Law (competent authority: German Banking Supervision Authority (BaFin)) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and by BaFin, Germany’s Federal Financial Supervisory Authority, and is subject to limited regulation in the United Kingdom by the Prudential Regulation Authority and Financial Conduct Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority and regulation by the Financial Conduct Authority are available on request. Copyright © May 2016 Deutsche Bank AG. All rights reserved.

Deutsche Bank Global Transaction Banking

Expect more from T2SWith the right partner at your side, the real benefits of TARGET2-Securities are within reach: reduced cross-border settlement costs, optimised use of collateral and richer funding opportunities.

Deutsche Bank offers:

— connectivity in more than 80 markets including 34 with a local presence

— a wide choice of operating models and value- added services

— the kind of liquidity only a world-leading euro clearer can provide

Visit db.com/gtb, email gtb.marketing@db.com or follow us on Twitter @talkgtb to find out more.

Doremus Deutsche Bank Flow Ad TS2 273x208mm 302767 Proof 01 13-05-2016

WELCOME

Firm foundationsThese are challenging times, of that we can be certain, and we are operating in an environment that demands banks closely examine their business models.

Banks and other financial institutions are reconfiguring their structures, culture and product offerings to ensure they are future-

proofed and equipped to meet the requirements of their clients. In that context, Deutsche Bank has been very public about its own plans to invest EUR 1 billion in Global Transaction Banking, a clear endorsement of the strength and stability of our business.

It’s well known there are a number of hurdles facing the industry at present, not least the cost of regulatory compliance. Cyberterrorism and money laundering are also both on the increase, and we have to continue to invest in making our systems and security robust enough to deal with attacks from criminals.

We also have to be absolutely sure who our clients are, so our efforts around Know Your Customer (KYC) are being strengthened. These important elements of today’s business landscape represent some of our top priorities and those banks that successfully invest will be able to offer greater levels of security, efficiency and service to their clients.

Our industry is under close scrutiny and the very highest standards have become an absolute prerequisite, the bare minimum we should be striving to achieve. It is therefore essential our core offering is built on solid footings. Safety and soundness starts in our own organisation, but it can also make our contract with our clients even more compelling.

Werner Steinmueller, Head of Global Transaction Banking, Deutsche Bank

To learn more about Global Transaction Banking, visit

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Flow is published by Deutsche Bank Global Transaction Banking

Design and editorial concept by Wardour (wardour.co.uk)

Marketing: Christoph Woermann Editorial: Janet Du Chenne, Neil Fredrik Jensen (Deutsche Bank), Joanna Lewin (Wardour)

For more information about Flow, please email gtb.marketing@db.com

All rights reserved. Reproduction in whole or in part without written permission is strictly prohibited. Flow is printed on Edixion Offset paper, which is sourced from responsible sources.

Cover photography: Adam Golfer

This document is for information purposes only and is designed to serve as a general overview regarding the services of Deutsche Bank AG, any of its branches and affiliates. The general description in this document relates to services offered by Global Transaction Banking of Deutsche Bank AG, any of its branches and affiliates to customers as of March 2016 which may be subject to change in the future. This document and the general description of the services are in their nature only illustrative, do neither explicitly nor implicitly make an offer and therefore do not contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG, any of its branches or affiliates.Deutsche Bank AG is authorised under German Banking Law (competent authorities: European Central Bank and German Federal Financial Supervisory Authority (BaFin)) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and BaFin, and to limited supervision in the United Kingdom by the Prudential Regulation Authority and the Financial Conduct Authority. Details about the extent of our authorisation and supervision by these authorities are available on request. Copyright© March 2016 Deutsche Bank AG. All rights reserved.

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Deutsche Bank Global Transaction Banking

This document is for information purposes only and is designed to serve as a general overview regarding the services of Deutsche Bank AG, any of its branches and affiliates. The general description in this document relates to services offered by Global Transaction Banking of Deutsche Bank AG, any of its branches and affiliates to customers as of March 2016 which may be subject to change in the future. This document and the general description of the services are in their nature only illustrative, do neither explicitly nor implicitly make an offer and therefore do not contain or cannot result in any contractual or non-contractual obligation or liability of Deutsche Bank AG, any of its branches or affiliates.Deutsche Bank AG is authorised under German Banking Law (competent authorities: European Central Bank and German Federal Financial Supervisory Authority (BaFin)) and, in the United Kingdom, by the Prudential Regulation Authority. It is subject to supervision by the European Central Bank and BaFin, and to limited supervision in the United Kingdom by the Prudential Regulation Authority and the Financial Conduct Authority. Details about the extent of our authorisation and supervision by these authorities are available on request. Copyright© March 2016 Deutsche Bank AG. All rights reserved.

Flow is available online at

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Flow is regularly updated online with news and industry insights and is also available twice a year in print. Please email gtb.marketing@db.com to register your interest in Flow.

Through our website and thought leadership magazine, Flow, we deliver timely insights about the world of transaction banking and our role within it. Whether it is an important piece of research, graphics that provide greater clarity on key issues or transaction case studies, our stories – written by both internal and external experts – are tailored for corporate and institutional clients worldwide.

We hope you enjoyed this issue of Flow and we welcome your feedback.

3

contents

“Banks can play a huge role in providing the basic plumbing to provide completely new services”Suresh Kumar, CIO of BNY Mellon

10

“The negative interest rate environment is not a business cycle expression – it is a structural one”Anne-Katrin Brehm from Institutional Cash Management at Deutsche Bank

36

The many layers of T2S: What are the cost benefits? 8

4 INFLOW

The latest developments from the global transaction banking sphere

6 IN NUMBERS: THE DISRUPTORS

Who are the new FinTech players and what should banks consider when forging partnerships?

8 T2S: MORE THAN FRINGE BENEFITS?

Following Europe’s T2S rollout, we consider the cost benefits wrought by the new system

10 BEST OF BOTH

BNY Mellon’s Suresh Kumar shares his thoughts on the role of banks in the technological revolution

14 IN SAFE HANDS Outsourcing document custody is big business and offering efficiency is key

16 WHOSE COST IS IT ANYWAY?

As regulation continues to be rolled out, what costs can service providers expect?

20 A SHARPER FOCUS ON CLIENT RELATIONSHIPS

Satvinder Singh shares his views on traversing the current securities services landscape

22 NEW TOOLS, NEW RULES

A new platform is opening up the foreign exchange market and reducing costs

24 TIME FOR A CHANGE

Switzerland’s new interbank payments system is a landmark for the nation’s banking sector

26 PLAYING THE LONG GAME Why a sustained recovery in commodity prices could be on the cards

30 THE AGE OF FINANCIAL INNOVATION IS UPON US

How can banks make the most of a FinTech partnership?

32 THE NEVER-ENDING STORY

Basel III and PSD2 are charging forward. What are some of the latest developments?

34 SWIFT AND SURE

The Global Payments Innovation Initiative goes live at the end of 2016. How will it improve transactions?

36 FROM HERO TO BELOW ZERO

Anne-Katrin Brehm,Institutional Cash Management at Deutsche Bank, answers FAQs on negative interest rates

38 OILING THE PAYMENTS ENGINE

Why intraday limits are essential for a smooth-running payments market

41 ARE WE ROBOT READY?

Columnist Stephen Armstrong considers artificial intelligence in our business lives

54

Digesting the trends affecting institutions and corporates in the global transaction banking sphere

Money2020 opens eyes and ears

The leading financial technology conference, Money2020, reached Europe in April.

Normally held in the US, the conference this year was hosted in the Danish capital of Copenhagen – a reminder of the changing global business landscape.

The Financial Technology (FinTech) sector has commanded a lot of attention over the past couple of years. While some try to dismiss its rise as a bubble, it was clear from Money2020 that FinTech firms are already gaining significant client traction.

This was an eye-opener for the banks present in Copenhagen, but what was

equally clear from the conference was FinTech firms’ desire to work alongside banks. Regulators are also looking to link up with the sector in a bid to balance regulation and innovation.

Blockchain was never far away from discussion at Money2020. CEO of Digital Asset Holdings Blythe Masters, speaking at the conference, said Blockchain will be used by financial services companies within two years, and that the underlying technology will become mainstream within 5-10 years. Blockchain still has its hurdles to overcome, with some of the doubts driven by its connection to the sometimes-controversial cryptocurrency, Bitcoin.

Collateral mobility dichotomy addressed at SWIFT Business ForumApril’s SWIFT Business Forum in London saw topics range from UK settlement system CREST turning 20 to collateral mobility. An industry panel deemed that, with regulators advocating the increased protection of investors’ assets on the one hand and pushing for greater collateral mobility on the other, it should be up to service providers to find the structures that support both aims.

Mike Clarke, Director, Product Management, Global Securities Services at Deutsche Bank, moderated the panel with representatives from international central securities depositories. It addressed market concerns about whether the dichotomous nature of investor protection and collateral mobility regulations will allow for the benefits of TARGET2-Securities to be realised.

“The industry should be able to find structures that allow collateral mobility while still safeguarding client assets,” said Clarke.

EPC launches consultation on SEPA Rulebook amendments

The European Payments Council (EPC) has announced the launch of the Single Euro Payments Area (SEPA) Credit Transfer and SEPA Direct Debit (DD) rulebook consultations.

All stakeholders are invited to have their say in the evolution of the three existing SEPA scheme rulebooks published by the EPC. The SEPA Credit Transfer scheme, the SEPA DD Core scheme and the SDD Business-to-Business scheme will be subject to a public consultation until July 4 2016.

Suggestions that find broad acceptance in the overall payment community, and that are technically and legally feasible, will be taken forward. In November this year, the EPC will publish the updated rulebooks and implementation guidelines that will enter into force one year later. This is to ensure participants in the scheme have enough time to implement the necessary changes in their systems.

Survey finds 73% of US companies targeted for payments fraudNearly three quarters of all US businesses were targeted for payments fraud in 2015, according to new research by the Association for Financial Professionals (AFP). The 2016 AFP ‘Payments Fraud and Control Survey’ found that 73% of all US companies experienced payments fraud last year. That matches the largest percentage since 2009, and was up from 62% in 2014.

Business email compromise (BEC) scams are an increasingly common type of fraud that greatly affects wire fraud. In 2015, 64% of organisations were exposed to BEC scams. Though cheques continue to be the payment method most targeted by fraudsters, in 2015, 48% of organisations were exposed to wire fraud, an increase from 27% in 2014 and 14% in 2013.

inflow

72.5% The proportion of renminbi (RMB) payments processed by Hong Kong, the No. 1 RMB clearing centre[1]

Source: [1] SWIFT

For more Global Transaction Banking news, go to

cib.db.com

Imag

es: G

etty

76

FinTechs have technical expertise, regulatory freedom

and no legacy issues

Banks bring knowledge, tried-and-tested infrastructure

and experience

FinTechs must consider a bank’s

client base in relation to what they can offer

66%think partnering

up is risky[3]

think FinTechs will reduce reliance on banks[3]

62%

Banks should see FinTechs not as

vendors, but equal partners

FinTechs must be aware of cultural differences within

banks

Banks should ensure their services are in line with the

FinTech’s objectives

What do CFOs think?What are the key things to consider?

FinTech firms

Small startups Focus on payments

Technologically advanced

Digital ecosystems

Digital platforms Outside the payments space

Allow transactions within a marketplace

The estimated number of FinTech startups in Asia, the UK and the US combined[1]

The rise in FinTech investment in the first 10 months of

2015 vs 2014[2]

of payment startups will fail in their first four years[1]

c. 50%

1/3

6,500

IN NUMBERS

The disruptors

Sources: [1] Bobsguide; [2] Forbes; [3] Deutsche Bank

Imag

e: G

etty

Things are changing rapidly in the FinTech space and banks are looking to forge partnerships with new market entrants

Who are the new players?

See pages 30-31 for more on the opportunities for banks and FinTechs

at cost savings in relation to T2S, parties should not just look at fees. “You have to look at your overall processing costs in the new environment. Just by having a harmonised settlement day, and settlement process at the CSD level, can allow a single operational process rather than multiple different connections.” This should bring a reduction in full time equivalent (FTE) costs.

“Secondly,” says Clarke, “one of the components that became apparent within T2S as it evolved was that institutions could consolidate all of their funding for settlement into a single central bank. So, participants can fund a single account for all T2S markets rather than multiple accounts.”

That way, the overall liquidity need is reduced because money that comes in from a settlement in Germany can automatically be used for a settlement in Italy without having to move cash across locations. This will reduce funding costs in the region.

The harmonisation of the settlement day into an overnight and real-time settlement process complements this liquidity benefit, notes Clarke. In each overnight cycle, an institution’s cash account is only accessed for the net amount they need for what is settling in that cycle. “As a result, the overall amount of liquidity required within that overnight settlement process is reduced,” says Clarke. “We have also seen about 95% of settlement move to this overnight cycle, which has, in turn, reduced the liquidity need over the day during the real-time settlement periods.

“The liquidity benefit means that institutions need less cash or less credit requirement from their agent provider, which, in turn,

98

settlement is becoming cheaper. “While the settlement cost is not the 15 cents people were expecting, it should still be a reduced settlement fee in the CSD,” says Clarke.

However, the cost of asset servicing in the CSD may increase, since CSDs need to keep the position of record, the links through to registration and various other processes. This requires the CSD to continue to process all of the instruction flows in their systems to build that position of record. As a result, the assets under custody fee may go up.

“For a broker dealer trading flat every day, we’ve seen, and will continue to see, overall fees go down in T2S,” says Clarke. “Given that these clients are focused on back-to-back transactions, and therefore do a lot of settlement, their overall cost will likely fall.” But long-only clients and global custodians, who tend to hold assets for the buy side, are weighted a lot more towards assets under custody than they are towards the settlement volume. “What we may see is the cost model for that client sector changes to such an extent that the external fees rise higher than they have historically been,” says Clarke. “However, until we see full transparency from the CSDs in regards to their pricing schedules, we cannot fully confirm that across the board.

“With asset servicing fees being increased, then depending on how you are balanced between settlement volume and long positions, this can greatly influence whether infrastructure-related fees rise or fall before you get to fees charged by your custodian.”

Fees versus costs?For some parties, the fee benefits are clear. However, Clarke argues that when looking

The European Central Bank’s TARGET2-Securities (T2S) platform is a significant way towards realising its

goal of harmonising securities settlement in the eurozone for central bank money. The platform seeks to reduce the cost of cross-border settlement as markets migrate to the new platform in a series of five waves.

Yet, some in the industry wishing to recover settlement costs have described the second wave migration of markets as “anticlimactic” [Global Custodian, March], given delays by some central securities depositories (CSDs). So, what exactly has the platform delivered so far?

Peeling back the layers When the European Central Bank began to discuss T2S pricing in 2010, it announced that cross-border settlement within the platform would cost participants 15 euro cents per transaction, plus an additional matching fee of 6 cents, where required. Fees were previously a lot more. “When you start to peel back the layers, cross-border settlement should be cheaper on the T2S platform because the CSDs can be linked together via T2S directly,” says Mike Clarke, Director, Product Management, Global Securities Services at Deutsche Bank. “You no longer have the higher cost of settlement across bilateral links between the CSDs.”

Another difference of T2S is that, in domestic settlement, the CSD that used to provide the full settlement and safekeeping service has now outsourced settlement and matching services to T2S. As a result, CSDs have changed their systems for the most part, by taking away the settlement component, and reducing their settlement fees accordingly. So, the cost of pure

reduces the amount they need to provision on balance sheet, and this is what liquidity regulations have been driving,” says Clarke.

Easing the pressureAnother benefit is the real-time links between the CSDs, bringing real-time collateral mobility. Since CSDs have outsourced settlement to T2S, as long as there is a relationship between the CSDs, it’s much easier now for assets to move from a domestic market into a tri-party programme rather than relying on separately bilateral agreed processes between different CSDs. This greater mobility allows clients and counterparties to use a wider range of securities and reduce pressures on higher-grade collateral, leading to cost savings.

“Where the benefits are realised will vary for each client. Choosing the correct post-T2S model is about ensuring the model looks at the full picture, including regulatory needs, FTE reduction and, if necessary, collateral mobility. It’s imperative for institutions to focus on the value-added services needed from their provider,” says Clarke.

“People have to look at their overall business model in order to understand what it is that brings them value from their service providers, and who is best positioned to provide each of their required components. Then it is about understanding how those processes and fee components fit together for the shape of their business.

“Once you understand the value in the services required and understand how that revised engagement model can bring those benefits in the wider European landscape, they can start to quantify those benefits for their organisation,” says Clarke.

95%of settlement now occurs

in an overnight cycle

SECURITIES SERVICES

T2S: More than fringe benefits?Recent revelations about Europe’s new multi-layered settlement platform could turn industry attention from fee benefits towards the overall cost benefits, says Janet Du Chenne

For a broker dealer trading flat every day we will continue to see overall fees go down in T2S

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For more on TARGET2-Securities, visit

cib.db.com

1110

first things I hear is ‘how do we make sure the services we offer are highly secure and resilient?’ The second thing people would like to know is what is our digital strategy – how can our clients consume our services in ways that enable them to provide solutions to their clients in a faster, better and cheaper way?” he says. “Historically, the way that we provided a service was to deliver files to people via portals through which they could consume our services. Today, more and more people would like to have APIs to create client solutions.”

To make this possible, BNY Mellon has a central technology division called Client Technology Solutions. “We are moving from product-centric technology towards client-centric technology. We are trying to figure out, from a client’s perspective, how they would like to consume services from BNY Mellon – and that may have nothing to do with the way that our product-specific technology works,” says Kumar.

This transformation is also dependent on cooperation with BNY Mellon’s partners. “The whole industry depends on various institutions providing services, and we all depend on one another,” says Kumar. “We are a vertically integrated, large company that is accustomed to doing everything [ourselves], and now we are using different providers for different things, while honing our expertise to provide those services that give us a competitive advantage.”

For Kumar, collaboration among the various stakeholders in the industry is essential if all participants are to feel the benefit of the technology revolution that is taking place today. “To that end, we need to work together to have common standards and common approaches to solving problems,” says Kumar. One example he gives is BNY Mellon’s work with a number of firms on blockchain technology. “I don’t think any institution can solve that sort of problem alone. So at BNY Mellon, we

Banks should take the leadership position in the digital transformation of financial services. That is according to

Suresh Kumar, Chief Information Officer at BNY Mellon who places significant weight on the banking industry’s future role in digital innovation. And the world’s largest and oldest trust bank is not merely paying lip service to industry buzz words. It is itself setting up a digital ecosystem and inviting not only other financial institutions but also FinTech firms to jump on board. The ecosystem provides third parties a platform from which to offer services to their clients.

BNY Mellon uses Deutsche Bank as its agent bank in several markets and believes that the relationship is enhanced through technology. The two banks have a lot in common. The US-based bank, like its German provider, embraces disruption and technology, which it says is critical for survival. Three years ago, BNY Mellon invested in digitalising its business. Recently it launched its NEXEN digital ecosystem, a cloud-based Application User Interface (API)-enabled feature, through which different software interact to deliver services. BNY Mellon is experiencing the same challenges as any large company that has grown through acquisitions and large technology investments. “You see Silicon Valley firms leveraging technology to change business models, to change the client experience and to change the economics of businesses,” says Kumar. “We asked, how do we leverage [being] a large financial institution with all our years of experience in the business, and the new technology coming from Silicon Valley. How do we bring that together? To me, that’s really the crux of the digital transformation.”

Product-centric to client-centricKumar has found from speaking with clients that, along with the digitisation that is taking place in the industry, there is also a need for greater security and resilience. “One of the

CLIENT INTERVIEW

The best of bothSuresh Kumar, CIO of BNY Mellon, talks to Janet Du Chenne about trends in the banking and asset servicing industry and the importance of engaging with technology to meet clients’ needs

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leverage our innovation centres, we hold technology leadership forums where we bring together clients and experts from the technology industry, and we also hold client collaboration events where we work together to solve common problems.”

And that is where the benefits of BNY Mellon’s partnership with Deutsche Bank are clear. “We offer a lot of services to Deutsche Bank and Deutsche Bank offers a lot of services to us. Collectively, our clients benefit from the collaboration,” says Kumar.

In terms of solutions, a common denominator of both banks is asset servicing. “It’s a fantastic franchise with a fairly large number of clients who have significant market share in many other services we offer. We understand clients’ challenges and can re-imagine the services that we need to offer.”

BNY Mellon’s focus is on digitising the business, and this, says Kumar, involves answering some key questions: How do we enable our clients to launch a new product or how do we enable them to distribute their products to a larger client base? How do we help them improve their client experience or service levels? How do we get them to lower expenses in this marketplace? “I think we are going to see a lot more competition from the FinTechs and I think we have an opportunity to compete with them effectively with our offering,” he says.

Inefficiencies as opportunitiesKumar believes that there are substantial inefficiencies in the way the industry works, and therein lies opportunity. “Identifying those inefficiencies through innovative approaches to process and engineering and identifying standards that require fewer reconciliations, or real-time information being available, are areas where we can work together well.

“Between Deutsche Bank and us, we understand all the non value-added friction points that exist in the industry – it’s about identifying what we can do collaboratively to remove those inefficiencies from the marketplace.”

How does Kumar think this can be accomplished? “We need to get together with participants in the industry who are part of the value chain. We need to focus on creating standards and leveraging technologies like blockchain to collectively figure out how to solve these inefficiencies.”

Blockchain as an enablerIn the same way that standards such as FIX and SWIFT, and utilities such as Euroclear and the DTCC, brought efficiencies to the marketplace, Kumar believes blockchain can streamline processes. “Blockchain is an enabler. It can help us to make things happen differently to how we’ve done them historically.” But Kumar is quick to point out that innovations such as blockchain are not

so drastically different from the past, nor does he think they will replace banking as we know it.

“Blockchain is an additional technology that we can leverage and use to complement what we do today – it provides the bank with opportunities. It won’t eliminate the industry,” Kumar asserts. “It can certainly help the industry in improving client experience, cycle time and service levels. It can remove costs from the equation in the same way that the previous innovations like FIX did with regard to trading. Blockchain can do the same for functions like settlement, client, tax and regulatory reporting, corporate actions and cross-border payments. It will force banks to come up with common standards to make the exchange of transactions and information a lot easier.”

The FinTech question Kumar has the same opportunistic stance towards FinTech firms. “Let’s look at what makes a FinTech effective versus a financial institution that has been around a long time, and has lots of clients and capital. Banks have a phenomenal amount of data about the way the industry works and excellent relationships with the regulators – we understand the regulations to make the marketplace better for our clients. FinTechs have none of these, but they have the technology expertise and they have a desire to disrupt the industry. They believe technology can make that happen and they have a culture that enables people to get things done faster.”

For Kumar, strong collaboration with the FinTech sector relies on working out how to take the strengths that BNY Mellon has – its clients, capital, data, and regulatory and business expertise – and leverage the innovative technology, culture and processes that enable FinTechs to try different things faster, to provide clients with what they need.

“It is better to leverage the FinTechs than to see them as competitors,” says Kumar. “And that is core to the strategy of our NEXEN platform and its App store. The philosophy of the App store is that we don’t need to build everything ourselves. There is a lot of talent within these FinTechs and they have different ways of solving problems.”

Also, banks can enable FinTechs, says Kumar. “Our clients don’t want to spend a lot of money evaluating providers,

integrating them and expending capital to try them out. We want to make it easy for FinTech firms to offer their services on our platform. Our job is to provide that variable cost base, with lots of choices, to our clients.”

Collaboration with providersThe future of collaboration is in APIs, explains Kumar, as they provide a common language to developers across the industry – Deutsche Bank, BNY Mellon and FinTechs can all use APIs to create innovative solutions that are faster, better and cheaper. “I see APIs as a major enabler for us to work together. There’s also the potential to invest in some ventures and consortiums, and to create new products and services that would not have been possible before.”

With financial services becoming increasingly global, Kumar considers the role of banks such as BNY Mellon as vital. “The financial services sector is reaching people who have not been reached before – the number will go through the roof in 15 years. You need secure, resilient and flexible financial engines to make this possible.

“Banks like us can play a huge role in providing the basic plumbing. We can enable the various industry firms, such as FinTechs, to leverage financial services and to provide completely new services – ones that we haven’t even thought of yet.”

We need to focus on creating standards and leveraging technologies

It is better to leverage the FinTechs than to see them as competitors

Suresh Kumar is Senior Executive Vice President and CIO at BNY Mellon, where he leads the Client Technology Solutions organisation.

He is also the CEO of iNautix Technologies, a BNY Mellon company. Prior to his current role, Suresh was CIO for BNY Mellon’s Financial Markets & Treasury Services group and Pershing LLC.

Kumar has a Technology BA degree from the Indian Institute of Technology in Madras, an MBA from the Indian Institute of Management at Ahmedabad and a Master’s degree in Computer Science from the New York Institute of Technology. In 2012, he was named as one of Computerworld’s ‘Premier 100 IT Leaders’.

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The largest of these include Quicken Loans, PennyMac and Ditech. These organisations will retain the interface with the borrower or homeowner but will finance their lending through major banks, so-called warehouse lenders. The mortgage companies or warehouse lenders may then securitise their loans, or sell them to residential mortgage-backed securities aggregators or directly to Fannie Mae or Freddie Mac.

Despite the liquidity of the mortgage obligations themselves, the process of mortgage lending and administration is documentation heavy. Each home loan produces a file of key documents such as a note, mortgage and title policy. Physical possession of the collateral file is fundamental to the financing of the loans.

All participants, from loan originators to warehouse lenders, need to be confident

1514

document custody can still play an important role in sectors that are comparatively reliant on paper documentation.

Warehouse lendersThe funding of residential mortgages in the US is one example of such a sector. The process is driven by liquidity of tradable mortgage obligations that are packaged to attract investors.

It is worth recalling the size of this market. Latest statistics released by the US Federal Reserve show that as of the third quarter of 2015, the outstanding value of all forms of property-related mortgage debt held amounted to USD 13.7 trillion. Consumers may borrow from banks and credit unions but they are increasingly turning to mortgage companies that typically provide online services.

Outsourcing, particularly of middle- and back-office activities, is nothing new. Investors, institutions, fund managers

and securities businesses have been outsourcing the custody of securities and their administration for many years. As financial instruments have become digitised or dematerialised, however, handling them has become even more of a low cost, commodity business. Service providers with the largest economies of scale and the most powerful systems have been able to take over operations and respond to calls for greater efficiency, security and cost control. In doing so, they have been able to help institutions meet the demands of greater regulation and risk control.

While not all financial markets are as technically advanced as those of, say, equities or debt securities, outsourcing

that each underlying loan has an original note and evidences the mortgage debt obligation. “In the mortgage world right now, we exist to provide review, certification and safekeeping services, so the warehouse lenders can finance the mortgage companies,” explains Gary Vaughan, Head of Corporate Trust Americas, Global Securities Services at Deutsche Bank.

Of course, with advances in technology and cloud computing, it begs the question of why lenders need physical documents that take up space and cost to store. Since the 2008-09 financial crisis, collateral that you can touch and feel has become increasingly popular and important.

Consequently, the mortgage process produces a vast quantity of physical mortgage files that need to be securely stored. Some banks that lend directly to borrowers may retain their own documentation, but Deutsche Bank is the largest service provider to non-bank lenders.

“Our file room in our building in Santa Ana, California, currently holds 7.5 million loan files,” Vaughan continues. “They’re not just mortgage files but auto and other asset files and we hold these in safekeeping. Safekeeping is our core competency.”

In practice, Deutsche Bank acts for both the mortgage company and the warehouse lender in the custodial transactions. The value proposition is clear: it is more cost-effective for both to outsource custody of files than to do it in-house.

High maintenanceDeutsche Bank’s Document Custody business receives between 15,000 and 17,000 files per day. In the space of six to seven hours following receipt, the Bank reviews and verifies the contents of each file and the findings are advised to both clients. This triggers the mortgage disbursement process.

“In addition, we’ve taken over some of the cash functions from the warehouse lenders’ back offices,” says David Co, Head of

SECURITIES SERVICES

In safe handsSince the financial crisis, institutions have increasingly expanded their outsourcing activities. Service providers are using economies of scale to provide more efficient ways for institutions to manage their document custody needs, as Richard Willsher explains

Americas, Asset-Backed and Mortgage-Backed Securities Trust & Document Custody, Global Securities Services at Deutsche Bank. “When you are closing a loan in the US, there’s a wire that goes to a title, or an escrow agent or closing company in order for the borrowers to be able to finalise their purchase and move into their house. We’ve taken over that wire function from the various warehouse lenders.

“These lenders wire us often substantial sums of money. We get the corresponding wire instructions from the mortgage companies. We do the verification on the files and then we split up that large wire transfer from the warehouse lender into thousands of wires – 30,000-plus a month – to those escrow or title companies.”

Once a transaction is complete, the bank holds the documents in safekeeping under agreement with the parties until it receives further instructions from an authorised party. While the documents are in custody, they are tracked and subjected to regular checks. In addition to this, customised reports are provided to the clients under a custodial agreement.

The operation is mechanised as much as possible, but there is no escaping the physical nature of the operation. The file room at Deutsche Bank is regularly inspected by clients, as well as government agencies and regulators. “We’ve invested in technology and we’ve just increased the size of the file room from 45,000 sq ft to 70,000 sq ft,” says Vaughan. “It is a matter

of considered and strategic investment in the product.”

Natural development“Execution,” explains Co, “is our core competency.” This points to the core attraction of outsourcing for both the lenders and the mortgage companies. “The warehouse lender can concentrate on the lending piece while we take over their back office,” adds Vaughan. “It has also enabled warehouse lenders to leave the hiring of staff and the storing of these files up to us. This increases their lending capabilities.”

This thinking also applies to bank lenders wishing to enter or re-enter the market. Co says that they have no need to invest in new facilities. They can outsource the administrative back office functions and start lending more or less straight away.

Meanwhile, the document outsourcing business is steadily expanding. Up until the credit crisis, banks were largely involved with mortgage lending, but this has now diversified into other asset classes. Today, 45% of Deutsche Bank’s document custody operation’s monthly volumes are non-mortgage related. This includes a range of other large-ticket consumer lending, particularly auto finance. “Anything that is written in contract form we can review,” says Co. “We started in mortgages but it was a natural development to market this to other segments.”

Outsourcing document custody is clearly big business. Despite the dematerialisation of security documentation in other areas of financial services, consumer finance remains doggedly underpinned by paper transaction documents. The growth of Deutsche Bank’s Santa Ana Document Custody operation also shows encouraging momentum.

If the business ever becomes digitised, third-party custody, as in other securities segments, would likely be needed. Deutsche Bank would be well placed to assist in such migration. For the moment, however, this is a story that is not yet ready to be written.

7.5mThe number of loan files held in Deutsche Bank’s

file room

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The change to securities industry business models, stemming from several unprecedented regulatory

initiatives, is set to bed down over the coming years. By supporting trends towards investor protection and asset safety, initiatives such as increased regulatory reporting, steering trades through market infrastructures and cybersecurity could mean increased liability for securities service providers, resulting in a change of focus and increased investment. Banks are working out what these initiatives will mean for their business and the cost of providing services.

Transparency and investor protectionThe first cost comes with meeting the regulatory need for increased transparency and investor protection. This means providers, such as central securities depositories (CSDs) and custodian banks, should hold client assets in such a way that the ownership and location of those assets are easily determined, ensuring that if there

is a problem with the wider infrastructure or the bank, investors can easily get their assets back. To this end, providers are increasingly being required to offer segregated accounts, as well as omnibus accounts, to hold client assets.

Several regulations are supporting this trend towards greater transparency and oversight. For example, the Markets in Financial Instruments Directive II legislates pre-trade execution and post-trade investor protection. Depending on how they are implemented, the Undertakings for Collective Investment in Transferable Securities Directive V (UCITS V) and the Alternative Investment Fund Managers Directive (AIFMD) require assets to be held in a way that allows liability to be determined.

The Central Securities Depository Regulations (CSDRs) requires CSDs and their participants to offer both omnibus and segregated account structures. Lastly,

the Securities Financing Transactions Regulations (SFTRs) will affect the reuse of assets by another party.

The way assets are held could profoundly affect client relationships, says Angus Fletcher, Head of Market Advocacy, Global Transaction Banking (GTB) at Deutsche Bank. “The more we segregate, the fewer efficiencies there are in the model, and the greater the costs to support this through the intermediary chain,” he says. “The client benefits more as they have a choice between omnibus and segregated account structures. But they should be aware that there are different risks and costs that come with offering that choice and choosing one model over another.”

Increased liability risk Certain regulations could also increase risks for securities services providers. AIFMD and UCITS V put depositary banks on the hook for any loss of assets to which

REGULATION/SECURITIES SERVICES

Whose cost is it anyway?It’s no secret that regulatory overhauls come with increased compliance and, ultimately, higher costs. Janet Du Chenne explores the types of costs that banks can expect, to help them see the wood for the trees

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investors could lay claim. These regulations also mean more focus on liability down the chain. “The regulations are about ensuring the client has a single point to go to in order to get their assets back,” says Fletcher. “This has consequences for a depositary bank since they need to account for the risk where the customer will hold them liable for the loss of assets in the intermediary chain. The depository bank must review their operational risk models, their intermediary relationships and potentially their pricing structures to account for that risk. This is difficult, as at the same time, the buy side is looking for its fees to go down.”

Regulatory reportingRegulators also want more quantifiable transaction data and regular reporting to ensure banks and their clients are in compliance with the new regulations as they are implemented. This requires increased investment in technology and data management.

“Regulatory reporting brings a new set of challenges in the form of legal entity identifiers (LEIs), or standardised customer identifiers, which will need to be incorporated into systems and processes,” says Fletcher. First mooted for derivatives, regulators now want LEIs to be applicable to all asset types, with securities at the forefront of this expansion. An additional requirement to report unique transaction identifiers will need to be incorporated into processes for reporting purposes. These bring standardisation benefits, but also challenges for all parties as to how to incorporate them within the short timeframes required.

Added to this are the requirements for dual-sided trade reporting in the EU and single-sided reporting in the US, message formatting standards – ISO versus FPML – and whether those trades should be reported to central banks, regulatory repositories or regulators directly. Each financial counterpart will need to determine how to tackle these challenges and whether to report in-house or to outsource reporting to banks or utilities.

Shorter settlement cyclesThe post-trade regulatory drive in CSDR towards reducing settlement risk means that settlement cycles are getting shorter. Most European countries have moved from a T+3 to a T+2 settlement cycle as part of CSDR, apart from Spain, which is due to transition in June 2016. The US and several Asian markets will look to move in 2017. This move could mean changes to liquidity management and operational processes, and potential technology upgrades. It could also have the positive benefit of a reduction in settlement exposure risk.

Knowing your customer With the heightened regulatory focus on segregated accounts, regulators are asking securities services providers to show that they know their customer and potentially their customer’s customer. As providers operate omnibus accounts with certain clients, they will know their direct client, but not always their client’s client.

However, the International Securities Services Association has proposed an industry-driven solution – the Financial Crime Compliance Principles. These principles, once implemented in 2016, should allow intermediaries – wherever they sit in the chain – to request information on the beneficial owners who hold assets further up or down the chain. “We keep the omnibus structure but we can see who owns the assets if and when required,” explains Fletcher.

A move towards market infrastructuresIn a bid to protect investors’ assets from potential default scenarios, and to enhance risk transparency and the overall safety of the system, EMIR, CSDR and Markets in Financial Instruments Regulations

are pushing trading activity towards infrastructures including trading venues, clearing houses and CSDs. “There are clearly good reasons post-crisis why regulators have driven activity towards infrastructures,” says Fletcher. “For securities services providers and users, this affects business and risk models and can place restrictions on collateral processes,” says Fletcher.

“Moreover, all participants, be they direct or indirect, will need to consider their market connectivity options and the opportunities, risks and costs associated with that. For example, what obligations might they have towards an infrastructure’s risk waterfall (particularly pertinent to clearing house relationships)? What say do they have as part of the infrastructure governance? What control do they have over the infrastructure fees that they will need to pay?”

Disruptive digital The disruptive potential of new technologies such as blockchain could meet the requirements for a safer and more efficient settlement system. “So far, the technology has raised many questions: Could you replace current clearing processes and change the intermediary roles that exist today in the market with a more efficient model? What would be the business standards required for a world of multiple co-existing blockchains, and how will that work?,” says Fletcher. “The infrastructure and regulatory landscape is built on current processes and players, so how does the regime today suit the new technology? If

There are good reasons why regulators have driven activity towards infrastructures

we have one set of securities and financial providers on the old system and another on the blockchain, how do we manage the interface between the two? We need to introduce blockchain properly, and ensure that it starts to deliver on its efficiency and cost reduction potential from the outset.”

With evolving regulation set to have implications for all parties in the securities industry value chain, some participants could take on more investment and liability than others in order to comply. To what extent that liability, and the need for increased investment, transforms business and cost models throughout the post-trade value chain remains to be seen. Things should become clearer as the full impact of the burgeoning regulatory landscape and emerging digital initiatives are realised, likely in the next few years.

The more we segregate, the fewer efficiencies there are in the model

Seven key changes

1 Increased transparency and investor protection costs

2 Increased liability risk costs

3 Increased regulatory reporting costs

4 Shorter settlement cycles

5 Increased KYC regulation

6 A move toward market infrastructures

7 Increased digital disruption

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SECURITIES SERVICES

A sharper focus on client relationships In this period of uncertainty across the banking sector, certain key practices will keep securities services thriving. Janet Du Chenne speaks to Satvinder Singh, Head of Global Securities Services (GSS), Global Transaction Banking at Deutsche Bank, about maintaining the client focus

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the “backbone of Deutsche Bank”. This commitment not only covers clients but also includes further investment in GTB’s technology. And the corporate/investment banking integration enables an even easier connectivity across the Bank, allowing a client coverage to be truly joined up.

“We are now easier to navigate and simpler to get,” says Singh. “Due to our strong network in the developed markets of both the USA and Europe, as well as a strong local presence in Asian markets, Deutsche Bank can partner with clients to power the flow of global capital.”

Digital focusThe commitment to investing in technology will also help GTB respond to regulatory trends. Singh describes GSS as an intrinsically technology-driven business, with specific value-added services layered on top. “Given the nature of the business, there are some themes that will shape the digitisation agenda,” he says.

“The bank is giving clients a chance to cherry-pick services to suit their evolving buying behaviour, which in turn brings opportunities for us to improve our delivery model, allowing us to provide best-in-class services.

“In essence,” says Singh, “we are maintaining our ability to operate in an open-architecture fashion, which provides clients with a plug-and-play service model and a choice of services. We also continue to invest in front-to-back automation, reducing operational risk, service turnaround times, and the cost to serve clients.”

As the industry draws near to the eye ofthe storm, the three principles of client centricity, investing in technology and commitment to the business will steer the success of Deutsche Bank’s GTB and the wider securities services industry towards clearer skies.

the next 12 months. The Foreign Account Tax Compliance Act, the Volcker Rule, the Alternative Investment Fund Managers Directive and the TARGET2-Securities initiative are all coming into effect, driving structural change among industry participants in order to comply.

“What impact the overlapping requirements of these initiatives will have is uncertain,” says Singh. “But the industry landscape will continue to be shaped by the ability of market players to adapt as they re-evaluate their needs and business models over the next 12 months.”

As competitiveness in the industry changes, there will be new and different conversations between clients and service providers. This beckons service providers to move from a one-size-fits-all approach to a more client-focused way of doing things, where they partner with clients on solutions that best suit their needs. “This shift in our industry has led us to adopt a more client-centric approach – listening to what clients need, engaging them and collaborating on how we can help,” says Singh.

“Clients want long-term solutions for the future to address regulatory change, and they have therefore adopted strong solutions-oriented approaches that best meet their needs and help them navigate the changes.” Specifically, regulations aimed at protecting investors, as well as the complexity of international business, imply that clients increasingly need multi-market end-to-end solutions.

“Additionally, we should work together with other providers and infrastructures towards greater efficiencies in the post-trade segment,” says Singh.

Commitment to the causeDeutsche Bank’s commitment to Transaction Banking was reinforced by CEO John Cryan, who referred to GTB as

While the perfect storm continues to engulf the securities industry, Deutsche Bank’s Global

Transaction Banking (GTB) arm remains firmly anchored, growing from strength to strength. The business continues to invest, and new ways of managing client relationships have evolved to meet the challenges clients face.

All the while, securities industry regulations are morphing within an uncertain geopolitical and macroeconomic environment. “Given the uncertainty and volatility in the operating environment, it is very important for us to keep engaging with our clients on how we can help them adapt to the changes,” says Satvinder Singh, Head of Global Securities Services (GSS) within Deutsche Bank’s GTB business.

Feedback to this approach has been positive. Clients appreciate what GTB brings to the table and they are keen to do more with the Bank, says Singh. The recent integration of GTB with the Corporate and Investment Banking business makes the ‘more’ possible, but the bank’s approach goes beyond cross-sell opportunities. “This is about positioning Deutsche Bank as a trusted advisor to our clients and enhancing its ability to ‘deliver the whole bank’ to meet their needs,” says Singh. “That said, we are sharpening our focus on client relationships, which enables us to concentrate on the revenue, countries and products we want.”

Compliant revenues This sharper focus has also prompted the bank’s review of high-risk markets and certain client groups. “While this may mean fewer clients, it will mean the right clients,” adds Singh. “This approach, combined with driving compliance, governance and robust operational controls, allows us to truly focus on ‘compliant revenues’.”

Several unprecedented regulatory initiatives will likely dominate clients’ agendas in

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Sharpening our focus on clients enables us to concentrate on the revenue, countries and products we want

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Hedging is only part of the story, however. FX is an integral part of GTB’s Cash Management offering to clients. This really comes to the fore around cross-currency payments and collections. Paying beneficiaries in their operating currency, while leaving FX conversion to the beneficiary’s bank, and paying in local currencies through individual currency accounts can be inefficient for our clients from a cost perspective. “FX4Cash provides another way – paying beneficiaries in local currencies and funding payments from a single operating currency account.”

FX4Cash brings many benefits to the client, not least improved treasury and risk management in FX transactions. It also consolidates accounts and eliminates the need for minor currency accounts. Corporate and financial institution clients that are attracted by its flexibility gain innovation and efficiency.

A clear distinctionRobert Wade, Head of Electronic FX Sales at Deutsche Bank, says there is a marked difference between the needs of the two client bases. “Institutions are more concerned with execution capabilities, while corporates are more focused on workflow and treasury solutions. We can provide exactly what both sets of clients need.”

Clients can also benefit from the expanding partnership between GTB and the Sales & Trading FX business. “These departments can really leverage this client-focused joint venture to good effect,” insists Wade.

Mueller adds that the interaction between GTB and the FX business continues to grow and reap rewards for both the bank and its customers. “Our FX franchise is world class and enables our clients to manage risk, while also meeting the growing requirement from treasurers to execute cross-currency and cross-border payments,” he says. “These are both major priorities for our clients and we have the tools and expertise that they require.”

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Hedging, quite naturally, features among these requirements and the FX team has developed a product that is ticking many boxes for clients – Deutsche Bank Automated Rolling Collars, or ‘dbARC’. This tool, explained below, is especially useful in emerging markets (EMs), says Jeremy Monnier, Global Head of FX Structuring, Deutsche Bank. “Hedging EM exposures is a necessary exercise but can be costly if done through traditional hedging instruments such as forwards,” he explains. “However, a collar-based strategy – which restricts certain market activities – can allow clients to hedge risks without locking in the cost of the carry.”

Given local interest rates in emerging markets, this cost of carry – the difference between the cost of holding an asset for a specific timeframe and the financial benefit of doing so – can be high. It affects both forward and cross-currency swaps pricing, which weighs on profit and loss in the longer term. EM currencies can also have wild mood swings, appreciating steadily, before depreciating very rapidly when things go wrong.

Attractive featuresThis has prompted some corporates to turn to collar-based solutions such as dbARC. “It combines all the necessary ingredients of a hedge – collar-based, rolling short-term hedges and preset collar strikes at trade inception,” explains Monnier. “But the difference between dbARC and other dynamic collars is that it locks in all market parameters to a given maturity.”

The benefits for clients are manifold. First, they can lock liquidity rather than be at the mercy of prevailing market liquidity. Second, clients can lock market levels regardless of how the market develops, an attractive feature, as the carry can materially worsen in EMs in times of crisis.

Providing an antidoteSo, which clients benefit from this hedging tool? Mueller explains: “Trade finance and structured trade export finance business relies on FX hedging, especially in markets where risks can surface quickly. The introduction of dbARC has proven to be a win-win for our clients in this space.”

An example of how dbARC can be used as an antidote to volatile markets came earlier this year when heightened concerns around China, and the possibility of contagion, troubled the global economy.

MACRO & MARKETS

New tools, new rulesA new platform for hedging foreign currency exposure risk is reducing the historically high costs of doing so and opening up the market, writes Neil Fredrik Jensen

Deutsche Bank has long been among the world’s leading Foreign Exchange (FX) houses and, for nine consecutive

years, was voted No.1 in Euromoney’s prestigious FX poll.

Having stood astride the market for so long, the bank’s stance has modified, turning its attention to more structured and integrated transactions. No longer does it strive to be a market behemoth that devotes its energy to the accumulation of volume and mass – instead, it has a more focused approach that homes in on big deals and sizeable clients.

Furthermore, Deutsche Bank has developed a broad offering for its target clients, leveraging its renowned FX4Cash platform and developing solutions that address a

wide range of issues for both corporates and financial institutions.

Optimising FX flowsThe Bank’s Global Transaction Banking (GTB) arm provides its clients, across cash management for corporates and institutions, trade finance and investor and issuer services, with access to the bank’s market-leading FX franchise. “Closer connectivity is key to ensuring we really leverage what is a powerful business,” says Eric Mueller, Head of GTB FX, Deutsche Bank. “As business becomes more global, international corporates and financial institutions have a broad range of FX needs, including structured products. Our aim is to deliver the solutions they need to optimise their foreign currency flows.”

Hedging EM exposures is necessary but can be costly

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LANDMARKS

Time for a changeIn a bold statement of forward-looking, pared-down banking, Switzerland has introduced an entirely new interbank payment system (SIC). In April, the nation waved goodbye to its current system, which had been in operation for 30 years, and embarked on an ISO 20022-based messaging standard alternative, which will provide a variety of new services to corporate firms and institutions.

Market operator SIX worked with the Swiss National Bank and the Swiss financial centre to transform the system, which, with the ISO 20022 technology, will reduce the number of interfaces between users. This way, says SIX, it will simplify the payments platform, which had become highly complex over three decades.

SIC boasts 350 participants and processed more than 440 million large value and retail transactions in 2015. The amount handled in these transactions is equivalent to about 75% of yearly GDP.

2726

The world is drowning in oil. That’s what is being reported by news publications the world over – and, for

the moment, proving hard to challenge. Oil behemoth Russia, together with members of the Saudi-led Organization of the Petroleum Exporting Countries (OPEC), is resisting calls to cut production levels to remedy the current chronic oversupply. These nations are pumping oil at record rates and major banks are predicting varying but altogether worrying price estimates – some dipping to as low as USD 10 per barrel (bbl)[1]. That’s despite the recent uptick in oil prices to around USD 40 bbl[2]. But research by Deutsche Bank posits that placing any long-term certainty on either the sudden turnaround in the oil price or the underlying low level seen throughout the first months of the year is misguided. While there could

be a further slump in the price of oil and with it steel, nickel and others, Deutsche Bank analysts say there’s just as much evidence to suggest prices will sustainably rebound in the near-ish future.

Radical response Although there is a great deal of surplus oil floating around, when looking at barrel numbers, the widely advertised oversupply looks rather more modest. Global production in 2016 is 96.44 million barrels per day (bpd)[2]. But the world struggles to guzzle more than 94.85 million bpd[1], resulting in a surplus 1 million bpd. In 2015, though, there was an overhang of 1.2 million bpd, so this year’s figure is an improvement.

As for steel, the recent and severe rebalancing in the real-estate sector and investments in China triggered a 3.5%

TRADE FINANCE

Playing the long gameWhile recent upticks in commodities prices may not be the recovery institutions are waiting for, the longer-term picture is less flooded with oil and steel. Joanna Lewin explores the commodities landscape

decline[3] in demand by Chinese construction and manufacturing firms in late 2015. Let’s not forget, China accounts for about half of the world’s steel supply. It has the capacity to produce 1.1 billion tonnes[4] of metal per year. China has sold its resulting surplus to nations around the globe for a markedly cheaper price than many other steel exporters could possibly afford.

It doesn’t take an economist to conclude that the reverberations of this situation for the world’s primary steel producers are fairly catastrophic.

Analysts see few signs of the oversupply abating without a radical response from the world’s commodities suppliers, or, if they don’t play ball, more severe tariffs on commodities imports, such as those imposed by the US, of around 260%.

1mThe number of surplus barrels of oil produced

each day[1]

Sources: [1] The Telegraph, Jan. 16, 2016; [2] US Energy Information Administration, March 9, 2016; [3] World Steel Association, March 10, 2016; [4] HKTDC

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their research, global demand is healthy, especially when the price is low. The excess supply should therefore drain off within the next few years.

Absorbing supply Pointing to the US’s tight oil production, for example, the pair cite encouraging figures that indicate supply absorption. Output is already well below its mid-2015 peak of 5.5 million bpd and will likely fall to 4.2 million bpd by the end of the year. This has allowed them to forecast medium-term prices rising towards USD 50-55 bbl by next year, more than the amount needed for many US producers to break even.

If oil prices really do fall to lows of USD 10 bbl, Sporre and Hsueh say that, for example, planned capital expenditure (capex) might be “ratcheted so low as to engender a greater likelihood of a V-shaped recovery in prices over three to five years”. Before it even got to firms shelving capex, OPEC nations would get involved, they add.

EIU analysts agree with this logic. The group’s central scenario is for a sustained pick-up in the oil price as soon as the second half, and particularly the final quarter, of 2016. And Marlier thinks that Russian production is bound to drop at some point. “Russian producers will have trouble sustaining their current production levels. Dwindling investment and growing cash restraints have made it difficult.”

The Brent Crude price is currently around USD 40 bbl – a step in the right direction. However, Marlier believes this current upturn will be short-lived, given the

The EU, so far, has not imposed tariffs. Efforts are being made to impose anti-steel dumping laws on China, but these are taking time to materialise.

Sebastien Marlier, Senior Commodities Editor at the Economist Intelligence Unit (EIU), says that a material response is necessary before any plateau in oil and other commodity prices can be reached. And as yet, that hasn’t been forthcoming. “It seems major suppliers are still pumping out record amounts of oil and producing significant amounts of metal,” says Marlier.

A March 2016 meeting for oil makers to discuss a production freeze was mooted, but then called off once it became apparent Iran would likely not agree to a deal. And an OPEC meeting in April ended without a deal.

Resisting calls to cutMaintaining market share is one big reason why OPEC countries seem to be turning a deaf ear to suggestions of cutting oil production, and why China isn’t responding to appeals to lower its metal output. But there’s a more fundamental reason too, believes Marlier. “Cutting production is costly. You might need to close down a whole operation.”

There is also the effect on employment to consider. “Closing down aluminium smelters in China has a strong impact on jobs and on local government revenue, so you see local and even central government being very wary of pushing for closures.”

The World Trade Organization states that countries have the right to protect their businesses’ interests and many Chinese firms are benefiting from the lower prices – an argument put forward by the Chinese Minister of Commerce, Gao Hucheng. He added that the steel situation was “purely market behaviour, not the behaviour of the Chinese or EU governments”. So, until there is a substantial and sustained response from suppliers, there will continue to be substantial oversupply.

But as Grant Sporre, Head of Metals Research, and Michael Hsueh, Head of European Natural Gas and Thermal Coal Research at Deutsche Bank, point out in

broader prevailing conditions. “When you consider that shale oil producers have been so slow to reduce production, the recent recovery isn’t really what we mean by a material recovery – we are expecting that later on in the year,” he says.

So there is good and bad news. The price increases seen of late are unlikely to last, but a more meaningful recovery is on its way. “While it’s too soon to say ‘we’ve seen the worst’ we can already say, ‘it could be worse’,” says John MacNamara, Global Head of Structured Commodity Trade Finance at Deutsche Bank. He notes that Brent Crude and West Texas Intermediate were both about USD 27 bbl back in the depths of last winter – and are now pushing USD 40. Iron ore has been floating around the USD 50s when at the start of 2016 it was in the USD 30s, and zinc is now heading towards USD 1,800 per metric ton, up from USD 1,500.

Efficiency gains While financial institutions are taking a broadly doom-and-gloom attitude and gravitating to low commodities price estimates, corporates are far more upbeat.

On a recent trip to the US, MacNamara was struck by a comment made by someone at a Houston oil corporation. “We’ve never been this efficient,” they said. MacNamara explains this stance: “When oil is USD 100 bbl, everyone focuses on growth and the ample cost-base cover means no one looks too closely at the bills. At below USD 30 bbl, they check every nickel and dime to be sure they don’t spend what they don’t have.”

In any case, for many European corporates, the advantages of low commodity prices actually outweigh the disadvantages. A price recovery may offset some of these benefits.“For the majority of European

corporates, energy and oil are a cost, rather than a revenue, consideration,” says Marlier. “At the end of the day, the benefits will likely exceed the costs.”

But there are also risks for corporates. “Stock prices and market sentiment have moved in line with oil prices, which could affect corporates negatively. So, for those who were expecting a boost to European markets as a result of lower oil prices, this hasn’t really been as clear as in previous commodity cycles.”

As for financial institutions, Marlier says: “The exposure for European financial institutions is far less than for US ones. And even for them, they have very diversified portfolios and relatively limited exposure to the energy sector.”

Uncertainty reigns During all of this discussion, commodity prices are still fluctuating. Oil prices are likely to continue to yo-yo as short-term factors cause short-lived spikes. But what is clear is that the response from OPEC nations and Russia will be key to oil prices settling, and Chinese economic stability will underlie metal prices rising.

With Russia likely to be forced to cut production due to cash considerations, further OPEC discussions to freeze output will probably be slated. And if prices really do dip to levels predicted by some of the big banks, then OPEC is likely to impose a freeze anyway.

While it wouldn’t be wise to say with any certainty that prices have hit a floor and can only go up, it is fair to predict that the oil price is far more likely to rise. And as oil is the great driver in market sentiment for metal prices, and therefore inescapably tied, it’s looking all right for them too.

It’s too soon to say ‘we’ve seen the worst’ but we can say, ‘it could be worse’

1.1bnChina’s yearly steel production capacity

in tonnes

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The world’s top 5 oil producing nations

1 US: 13,973,000 bbl/day

2 Saudi Arabia: 11,624,000 bbl/day

3 Russia: 10,853,000 bbl/day

4 China: 4,572,000 bbl/day

5 Canada: 4,383,000 bbl/day[5]

Source: [5] U.S. Energy Information Administration, 12 September 2015

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TECHNOLOGY

The age of financial innovation is upon us Banks and FinTech firms are taking tentative steps to partner up. Neil Fredrik Jensen takes a look at some of the highlights from Deutsche Bank’s white paper on the topic

What is driving the FinTech market phenomenon? What are the possibilities of partnerships

between banks and FinTech firms? And how can innovation be applied in the real world? The paper, ‘FinTech 2.0: Creating new opportunities through strategic alliance’, sets out to answer all this and more.

The banking industry has become accustomed to dealing with competition, so it realises it has to be more innovative, flexible and nimble in order to retain its market-leading position among new market entrants. Many FinTechs have focused on the payments industry, often homing in on a niche element of the transaction process. Invariably, this has resulted in more efficient and user-friendly alternatives to traditional bank products. Needless to say, these new players have not only created some anxiety, but also revitalised the spirit of innovation within the banking community.

Bank technology officers talk constantly about the need to collaborate rather than compete. While recognising these new market entrants bring something different to the table – at a time when the traditional structure of financial services is being questioned – banks are acknowledging they also bring a vast pool of expertise to any budding relationship with a FinTech firm.

For FinTechs themselves, entering into equal partnerships with traditional banking providers is a simple way to address a lack of payments-market experience or regulatory expertise, leveraging synergies and creating a stronger proposition by fusing the core competencies of both sides.

Successful implementation Banks and FinTechs have different attributes to bring to a relationship. FinTechs have the skills, mindset and regulatory freedom to be innovative. They also contribute technological expertise and are not hamstrung by siloed thinking or legacy system issues. This enables them to be relatively fleet-footed and quick to market with new ideas.

Banks, however, bring experience of compliance and long-established infrastructure. Banks also have the operational power needed to excel in clearing, settlement, straight-through-processing, liquidity and FX functions. Major banks also have the global reach that many FinTechs have yet to build.

Partnerships are already being formed, but the most successful ones will be those that centre on well-balanced mutualism – two parties bringing complementary core competencies and resources together to

innovate and offer a new value proposition that benefits both, while addressing a clear market need.

Key to any partnership involving banks and FinTechs has to be mindset alignment. Although it is important that both sides adopt an adaptable attitude, banks will need to accept that a new business paradigm is taking root and that time and resources need to be invested. After accepting that the rise of FinTechs is at the forefront of this market shift, banks will gradually see that digitalisation can become a key differentiator for them. Existing business models will need to change and could even be cannibalised through new alliances with FinTechs. There will be failure in some areas, but also the opportunity for success to offset any shortcomings.

Culturally, banks will possibly have to change their view on their own structures. Leadership and talent will become more important than management, although senior management will need a strong vision to lead the transformation into the digital age. Selecting the ideas that are worth pursuing will be of paramount importance and empowering staff to be innovative should be a priority. Decision-making, often hampered by bureaucracy and organisational structures, will also need to improve. Above all, banks must focus on execution capabilities – solution delivery will have to be faster than ever.

Potential obstacles It would be misguided to believe there are not hurdles in the way of innovation. Regulation is weighing heavily on the banking industry and can be seen as both a burden and a protective force. Some regulation has resulted in circumstances more conducive to innovation, such as the Single Euro Payments Area, which has advanced technological developments and encouraged other points of differentiation.

For banks, the post-crisis cultural mindset has also, to some extent, stymied innovation. Banks have developed a lack of tolerance towards failure, a crucial ingredient for creativity and innovation. FinTechs, by contrast, have evolved in a more creative environment, free of bank regulation and expensive legacy systems. Two of the greatest difficulties FinTechs face – particularly in the B2B market – are access to a sufficient client base and the ability to successfully scale up a functioning solution for mass use.

Technical compatibility will be one of the biggest obstacles to overcome when establishing a partnership. While most banks use outdated communication protocols, going forward, they will need to embrace application programme interfaces in the treasury and corporate space. But banks are only in the early stages of this process. Ultimately, they will need to convert their data from being unstructured to structured in order to leverage the potential of Big Data, an area in which many FinTechs are way ahead of banks.

Partnerships between banks and FinTechs The industry has seen a number of micro-payment services that have sprung up from collaborations between technology companies and established banks, such as Cringle-DKB, Simple-BBVA and Earthport-Bank of America Merrill Lynch. There is already momentum in this direction, but as digital structures change, they will transform almost every industry. The treasurer’s world will also shift towards a more transparent, interlinked and real-time manageable system.

There’s no denying that market players that want to safeguard their position have to develop a strategic plan that enables them to remain competitive. At the same time, this plan must adhere to a rapidly changing regulatory environment.

So, banks have some challenges, but so too do FinTechs, which have to find a way to meet regulatory, investment and risk needs.

The combination, however, of banks plus FinTechs has the rousing potential to create a more dynamic payments industry, and, ultimately, this will position financial institutions at the forefont of the digital age. What’s more, it should also create a win-win scenario for banks’ customers, who will derive multiple benefits from the pooled expertise of all parties involved.

Banks have a lack of tolerance towards failure, a crucial ingredient for creativity

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Eight years on, the banking industry is still feeling the after-effects of the global financial crisis. Ben Poole examines two pieces of this year’s regulatory pie – PSD2 and Basel III

REGULATION

The never-ending story

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that it uses to verify the identity of the payer. These factors could be knowledge, possession and inherence.

“Part of the authentication discussion, and a broader trend beyond Europe, is around the levels of protection of client data and the security levels that banks are required to implement as part of their systems,” says Fletcher.

“This will mean changes to risk processes and, potentially, to systems and exception-handling that PSPs are going to have to look at introducing.”

PSD2 allows payment initiation service providers and account information service providers access to customer bank accounts for different reasons. Some providers will be able to initiate payments, while others will be able to provide their customers a ‘virtual wallet’, allowing them to see a history of their payments.

“This is good for customers. They should get access to more innovative services,” says Fletcher. For banks, however, this creates concern about how they ensure that the third-party providers linking to accounts have the correct authorisation. If fraudulent transactions occur, then the bank is liable for refunding the customer.

“This shifts the liability somewhat,” says Fletcher. “It remains on the bank, but this opens the process up to a new set of parties that banks will have to manage.” This change in the rules should make new types of products and services available to the customer. For banks, however, an increased workload and new risks could potentially arise.

PSD2: What’s new?Following the Payment Services Directive (PSD), PSD2 came into force in January 2016. EU member states have two years to implement its provisions. PSD2 contains notable additions, including changes to geographical scope and currency. It also addresses business requirements such as authentification of payments and the granting of access to customers’ bank accounts to third-party payment providers.

The change covers transparency of terms and conditions and information requirements that payment services providers (PSPs) will need to provide for their transactions. The original PSD demanded levels of transparency when both PSPs were in the EU.

Now, PSD2 demands the same level of transparency even when only one PSP is in the EU. This also applies to all currencies where those payments are being made as they arrive in the European Union.

“This is a significant move and, from a customer point of view, it is probably quite a good thing,” says Angus Fletcher, Head of Market Advocacy, Global Transaction Banking at Deutsche Bank. “They will get to see greater levels of transparency around the payments they make.”

PSD2 also calls for two-factor customer authentication. This requires banks to look at the payments that are being made, determine whether they are comfortable with those payments and confirm the payments aren’t fraudulent.

The key here is that a bank can combine different elements to form two factors

Basel III: Overcoming implementation issues While PSD2 only came into force this year, the Basel III standards have been a talking point for much longer. As they are standards, they must be enshrined in national or jurisdictional law. This implementation process is undergoing phased rollout, which began in 2015 and is planned to run through to 2018.

“I think we will see adjustments and national interpretations go beyond 2018,” says Fletcher. “The phased-in process is all about tweaking and changing the different ratios to get the best fit. On the one hand, banks need to be as safe as they possibly can. On the other, it is important that these ratios are not introducing burdens on organisations that force them to stop doing certain business, or create unintended risks to banking services.”

Another concern for banks continues to be the treatment of deposits, especially non-operational (those deposits not attached to business/payment flows). These have a significant balance-sheet effect under Basel III, as they must be held at central banks. Many corporate and institutional customers, however, want to be able to hold large balances with banks and have the ability to take those out at any point.

“It’s important for banks and their clients to really understand each other’s models, and to try to come up with something that works for all,” says Fletcher. There are several ways of doing this, for example through offering certain balance sheet efficient deposit products, such as call and/or rolling time deposits. Offering off-balance sheet products is another option for banks – products such as money market

funds, which allow cash to be stored in a relatively safe place for customers. Reverse repurchasing agreements (repos) are also a possibility. The client can usually make a return on the cash as well, despite negative interest rates. However, there is still a capital effect felt when using reverse repo products, which may negate any return.

Basel III also affects trade finance. Banks use a number of core trade finance products, such as guarantees and letters of credit. These are off-balance sheet items – so-called contingent liabilities. This means that they will only be called on in certain agreed circumstances.

“Under some of the Basel consultations being carried out this year, in particular those focused on the net stable funding ratio and the leverage ratio, these products are being effected,” says Fletcher. “The end rules could change these tools and therefore affect the ability of banks globally to support what we see as real-world economy activities.”

Of course, the ongoing implementation of Basel III presents an opportunity for banks and their clients to understand how their strategies affect each other.

When a corporate requires services such as deposits or a line of credit, knowing how and when this will affect a bank’s balance sheet is important, as it will highlight possible overpricing or availability challenges, for example. For multinational corporates, it presents an opportunity to examine ways of making internal processes, account structures and balance sheet moves more efficient and cost-effective. Im

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It’s important for banks and their clients to understand each other’s models, and come up with something that works for all

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the initiative to go fully live at the end of 2016, although not all banks may be ready by then. Overall, the GPII is intended to “dramatically improve” the cross-border payments experience for banks’ corporate clients, and bring significant efficiencies and reductions in cost.

Geert Matthys, Head of Digital Product Development at Deutsche Bank’s Global Transaction Banking arm, says of the Bank’s involvement: “We envisage a smart integration of GPII whereby we make it easy for our clients to do business.”

Matthys says that Deutsche Bank aims to provide corporates certainty of the status

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experiencing the irksome inefficiencies in tracking and transparency – on a frequent basis.

Future proofing paymentsThis is where GPII aims to bridge the gap – to bring the cross-border payments business fully in line with current customer expectations, and also to build it out in such a way that future expectations are also easier to fulfil.

Essentially, GPII will look to build on existing correspondent banking foundations and provide an overlay of new global business rules. The initiative will be built on a strong basis of compliance, global reach, co-operation and proven standards. Together with the industry, SWIFT is creating a new service level agreement (SLA) rulebook for cross-border payments, which will deliver a range of benefits (see box out).

Dramatic improvementPiloting the SWIFT system are 21 banks, with 51 due to take part overall. The results will be announced at the Sibos conference in September 2016. “Banks are not just piloting to test the system,” says Wim Raymakers, Global Head of the Banking Market and Project Lead for the initiative at SWIFT. “They are really starting to develop a plan to automate things.” The aim is for

Cross-border payments between corporations are what make international trade go round. For

these payments to be efficient, businesses rely on the services of their banking partners. But some banks may not necessarily have a presence in any given country and so they, in turn, depend on the services of their correspondents.

These interbank relationships – collectively termed ‘correspondent banking’ – are supported by embedded technology, processes and controls. Much of this is currently contingent on SWIFT messaging. SWIFT stands for the Society for Worldwide Interbank Financial Telecommunication, and supplies secure messaging services and interface software to wholesale financial entities. The correspondent banking process is based on an infrastructure that has been built up over the course of the past 40 years and has proven to be stable and resilient.

But the model is increasingly coming under pressure. Transaction banks are already facing persistently low interest rates and stuttering global growth, as well as regulatory demands around capital requirements, anti-money laundering and new non-traditional competition – for example, as a result of the latest Directive on Payment Services 2 changes.

Additionally, society as a whole is becoming more demanding – unsurprisingly, given the incredible speed at which technology advances. With the increasing use of smartphones and mobile technology, people expect real-time services, transparency and utmost convenience as a given. These expectations are now spilling over into wholesale commerce.

Expectation gapThere is currently a mismatch of expectations when it comes to individual demands, or commercial activities, and cross-border payment capabilities. This mismatch can be understood using the following simple example.

Suppose you live in Oxford, UK, and you go on holiday to Los Angeles. You have booked a rental car, but when you arrive at the customer counter you realise you’ve left your driver’s licence at home. You call UPS, and ask them how long it will take to deliver your licence. At the same time, you call your neighbour and inform him that UPS is coming to your house to pick up the troublesome licence. UPS promises to deliver door-to-door within 36 hours. Not only do you know the exact price to pay, you also know exactly where your license is. UPS provides you with tracking that allows you to see your licence’s journey from Oxford, via New York, to Los Angeles.

Compare that clearly efficient process to a dollar-denominated payment made by a corporate, again from Oxford to Los Angeles. Although the firm may know the price it has to pay (but not necessarily), and despite the clearing of the payment taking seconds, there may be an issue with one correspondent further down the chain. The firm does not have full transparency on the payment or the ability to track the payment. It may be the case that the beneficiary does not receive the payment for several days.

In our technology-driven world, these inadequacies are simply no longer acceptable. Yet corporate treasurers are

PAYMENTS

Swift and sureLike many other aspects of transaction banking, the cross-border payments business is changing. The Global Payments Innovation Initiative (GPII), which aims to streamline the payments process, is due to go live at the end of 2016. Hannah Tautz explores its potential

of payments and details of the cost of transactions at any point in time, in a way that is easy to implement and use.

To this end, Matthys’s team is looking to integrate an array of technology. This will include application programming interfaces to support service and status requests; digital documents and digital signatures; data visualisation to provide insight and foresight; and, potentially, blockchain technology. Existing popular Deutsche Bank payment applications, such as the autobahn cash inquiry app, will also be in the mix.

Multiple benefits“We love the fact that there is a global payments innovation initiative because we believe that it will create benefits for many parties in the cross-border payments ecosystem,” says Matthys. However, he cautions that, as things stand, many corporates are unaware of what GPII can do. He says banks need to fully understand the problems facing corporates and ensure that these are properly addressed.

Raymakers is also optimistic about what GPII can do to support global trade. “This initiative creates a great experience for payments,” he says. “Ultimately, it may mean that we will no longer need such a big network of [correspondent] banks.”

Four ways cross-border payments will change

SWIFT’s new SLA rulebook for cross-border payments will aim to deliver the following:

1 Same-day availability of funds

2 Transparency and predictability of fees

3 End-to-end payments tracking

4 Transfer of rich payment information

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51Banks are due to take part in the new SWIFT system

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&

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Q Why have central banks cut interest rates to below zero?

A Generally speaking, it is standard procedure for central banks to cut

interest rates when economies face times of low inflation. That in itself is nothing unusual. What is new though is the decision by several countries to cut rates below zero almost simultaneously, catapulting financial markets into a new environment and challenging the architecture of those markets, despite not fundamentally being in crisis. To interpret the full implications of these actions, it is important to understand the different reasons for taking the unknown path into the negative interest rate territory. For the eurozone and Sweden, the main rationale was to raise inflation and boost the economy. In Denmark and Switzerland, the primary objective has been to prevent a steep currency increase. Japan and Hungary also recently joined the ‘negative interest rates club’.

Q What are the implications for transaction banking?

A The banking sector, with its underlying payment system architecture, is

clearly affected as negative interest has a fundamental impact on underlying transaction flows. Commercial banks normally hold deposits at their central banks as settlement balances for clearing purposes in order to facilitate payments on behalf of their clients. They now face costs for holding balances with their central banks overnight to follow up with their operational behaviour. But why does the move from close to zero to below zero rates make such a big difference? In a ‘normal’ positive market environment, central banks pay interest on excess deposits above minimum reserves. Financial institutions usually minimised these excess levels as central bank deposit rates were typically below market rates – there was no incentive to hold excessive cash balances with central banks as investing funds in the market was more profitable. This changed in the low interest environment as the spread between rates diminished and arbitrage opportunities increased due to risk aversion. As soon as official interest rates hit zero, one of the main ways in which banks make money – net interest margins – gets squeezed.

Q How widespread are the effects?

A It is evident that more and more banking businesses are placing the

negative interest rate topic on their agenda and attempting to analyse its impact. It is not only transaction banking’s core activity that is affected. The official cut in rates also affects money markets, with fewer investment opportunities for their market participants. The pension and insurance industry, for example, may struggle to meet their long-term liabilities offered at fixed nominal rates. Furthermore, there are differences in how market participants are affected. Financial institutions have to absorb the cost or at least have to find ways to share the costs with their depositors. This is no trivial decision. At the same time, liquidity is fundamental as it is imperative for financial institutions to execute on their transaction flows to enable global economic business. Global bank deposit levels have not fundamentally changed. However, in the long run, interest margins will diminish. This has not been fully apparent so far as the decrease in interest margins was partially offset by the decrease in risk provisions. But this may change in the near future. Therefore, financial institutions will have to find new ways to offset declining interest revenues with higher lending volumes. This too may become limited when interest rates further decrease – something banks cannot actively manage.

Q How low can central banks go?

ACurrently, most rates are in the range of between zero and -1%. If central

banks push rates too far into negative territory, there is a danger that the financial sector could face a new type of systemic risk. This could lead to a situation in which banks increase their lending rates to limit their profit and loss downside. The idea of storing cash in vaults and reducing fiat money to limit and avoid negative interest rates would also contradict the intention of the European Central Bank. This would question the constitution and sense of financial markets. The uncertainty about actual implications has reinforced the need for tighter communication among market participants and the need for forecasting cash flows to enable a smooth transaction flow and a cost-limited use of funds.

MACRO & MARKETS

Moving below zeroNegative interest rates have gone from being a theoretical curiosity to being enshrined in major global economies’ central bank procedure. Negative Interest Rate policy is bringing nominal target interest rates below zero. Anne-Katrin Brehm from Institutional Cash Management at Deutsche Bank answers some important questions

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Collaboration among central bodies, commercial banks and their clients will be key to handling the new situation that the entire financial market finds itself in. It is not only a question of analysing and understanding the implications of macroeconomic and financial market fundamentals. It is also a question of validating the technical plumbing of systems and banking products, to see whether they are compatible with negative rates. Contractual arrangements as well as practice and investment guidelines may also have to be adjusted under the new lens of negative interest rates. The scope of the implications on the transaction banking business have not yet been fully explored as the negative interest rate environment is not a business cycle expression – it’s a structural one.

Anne-Katrin Brehm ispart of the Institutional Cash Management business at Deutsche Bank AG in Frankfurt. Brehm focuses on Liquidity, Interest Rate and Balance Sheet Management, as well

as Intraday Liquidity Management. Prior to her current role, she worked in Deutsche Bank’s Asset & Liability Management team in Singapore

The negative interest rate environment is not a business cycle expression – it’s a structural one

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Intraday exposures, and the intraday limits that banks provide their clients, play a crucial role in keeping global payments

flowing efficiently. For the uninitiated, intraday (put simply, within the day) limits are placed on a dealer’s currency positions by their bank to reduce the risk of exposure.

They permit the dealer to make payments without necessarily holding the funds needed to fully cover the payment. For a client to be given one of these limits, they first have to fulfil certain risk criteria set out by the bank.

Koral Araskin, Institutional Cash and Liquidity Management at Deutsche Bank, has a pleasant way of looking at it: “If you imagine the payments landscape is an engine, the liquidity is the fuel for that engine and intraday limits act as the oil that keeps it running smoothly,” he says.

Without intraday limits, a payment could only be made if a client has the funds to match it fully. This might not sound like a big issue. But it would cause significant obstacles that would slow down the entire payments landscape. For example, in institutional cash management businesses, banks carry out payments on behalf of other banks’ clients. Often, an initial payment will be made on the basis that a second payment will be made later. The cash required to make the second payment, however, may stem from a transaction that has not yet happened, but is due to be carried out later in the day.

The institutional client knows that these two transactions will balance out over the course of the day. But without an intraday limit, the client would not be able to make the initial payment. Instead, it would have to wait until the funds arrive later. Multiply this scenario across the whole payments landscape and the process would become hugely inefficient.

“The intraday limits in place today are on an uncommitted and unadvised basis, but they are really essential for keeping payment flows running efficiently,” says Araskin.

Risk considerationsOne could say that a risk develops if the exposure balance has not cleared by the end of the day. But this is generally not an issue, as most payments will settle within a few hours and so the flow of payments remains uninterrupted. There are, however, times when this wouldn’t be the case, which is why banks often have overdraft positions with clients at the end of the day.

“The client may do a great job of managing their account, but they may have unforeseen expenses or make unexpected inflows,” says Araskin. “That is why they will have either credit or debit benefits on their account. The client may never be able to square these off completely by close of business, even though in theory it would be their aim to do so. You need to expect the unexpected.”

Things can be made more complicated when corporates and institutional clients have international business, meaning they are bound to the opening and closing times of a variety of currencies. “This is a sensitive consideration for many banks in terms of their foreign exchange settlements,” explains Araskin. “Banks have to process urgent payments in the early hours when an international market comes online, but they’ve not had the opportunity to raise funds from other sources up until that time.”

So, intraday exposures are crucial for commercial payment flows and have so far not attracted any risk-weighted assets, unless they have not been settled at the end of the day. To avoid disturbing the payment and settlement processes, the Basel Committee on Banking Supervision (BCBS) has published, in the supervisory framework for measuring and controlling large exposures (BCBS 248), that intraday interbank exposures are not subject to the large exposures framework, either for reporting purposes or for application of the large exposure limit.

Transparency requirements from regulatorsIn today’s payments climate, however, there is a trend towards increased

INSTITUTIONAL CASH MANAGEMENT

Oiling the payments engineThe exemption of intraday exposures from general exposure calculations is vital for maintaining global payments market efficiency, writes Ben Poole

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regulatory control and making payments less risky. If the perceived risk of intraday exposures leads regulators to require banks to hold additional capital against this risk, the result would likely be far higher costs. It could also affect the efficiency of bank services. “We talk about real-time payments becoming more efficient and getting even cheaper,” says Araskin. “Well, this would go in the opposite direction of becoming more expensive and less efficient.”

What’s more, without the possibility of intraday exposures, it would be far more difficult to manage payments in – or close to – real time, keeping in mind the interconnectedness of the payments landscape. “In this scenario, you would need to prefund any payment you make,” says Araskin. “This would slow down the system and make the payment landscape cumbersome. It would probably also increase costs – any inefficiencies will naturally increase the cost of a certain service as they require more resources and capacities, from a balance-sheet and operational perspective.”

The BCBS’s current recommendation is that regulators and central banks increase the intraday reporting required by banks in their main currencies (BCBS 248). When this eventually comes into law, it will mean that major banks have to give intraday reports on their liquidity position and, for example, the biggest users of this liquidity.

This would provide regulators with transparency, allowing them to see clearly

which banks and corporates are dependent on which for certain lines of financing.

“In market stress situations, regulators could see the different behaviour patterns of certain client participants and attempt to avoid a bigger impact by isolating a single participant at a very early stage,” says Araskin. “This is something we won’t see this year, but perhaps in 5-10 years.”

A more transparent approach to intraday liquidity could mean regulators have a comprehensive view of intraday exposures. Understanding the interconnected nature of the global payments landscape is vital if this landscape is to retain, and indeed enhance, the levels of operational efficiency.

Technology and industry collaborationNone of the major regulators have yet published exactly what they want to see in terms of transparency on intraday exposures, but financial institutions are preparing. All of the major banks, as well as euro and dollar providers, are either working on a solution or have a solution at hand to provide their clients transparency on their liquidity positions.

On the other side of the coin, banks are also working on ways to best provide regulators with this information.

“Providing information about liquidity levels on an intraday basis in certain currencies is, from a technology perspective, something that is relatively easy for us. To a large extent, this is information that we already

have,” says Araskin. “But it would become more complicated if we have to provide our institutional clients, for example a bank that holds a variety of currencies with us, the transparency the regulators desire on an intraday basis.

“What’s more, that bank’s regulator will then ask them for their intraday reports, which might include details of their highest usage or lowest overdraft position and how they ensure they have the appropriate funding. It becomes very complex. This cannot be something that just Deutsche Bank thinks about and provides to its clients, it has to be an industry-wide shift.”

Of course, the industry could benefit from a standard to ensure that future potential regulation is interpreted the same way among all banks. Corporates and institutional clients receive services from a mixed portfolio of providers, from a risk and diversification perspective.

If banks and corporates can achieve true intraday transparency through reports or a system that allows access to different

organisations’ intraday positions, it should mean that organisations are able to provide this information directly to the regulator without any additional work. But it is currently difficult for banks to build a system to report on intraday positions independently for their clients, as any such solution would need to be relevant to how others in the market move.

“Right now, there is a lot of industry consultation on this subject,” says Araskin. “It is being discussed at association level and in working groups from a technical perspective, in terms of how intraday transparency can be made as a standard. In one working group, Deutsche Bank is working with the Society for Worldwide Interbank Financial Telecommunication (SWIFT) to build a common technical standard and ensure that transparency can be provided through the SWIFT platform.”

Where to go from hereIn the supervisory framework for exposures, the regulators have explicitly exempted intraday exposures from the calculation of overall risk-weighted asset exposures. This is positive for both corporate firms and institutions, as it removes additional costs to payment flows.

In order to fully unlock the potential of more transparent intraday liquidity flows, Araskin concludes: “As an industry, we must continue collaboration to make individual intraday liquidity solutions and metrics an industry standard on how to measure and report intraday liquidity.” Im

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As an industry, we must continue collaboration to arrive at an industry standard for reporting intraday liquidity

Liquidity is the fuel for the engine and intraday limits act as the oil

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42

The beauty of the market is in its inception as the perfect way for us to meet human need – and thus

create prosperity. As the Scottish philosopher Adam Smith first argued: I have a need and you have what I need. How can I persuade you that meeting my need is in your self-interest?

At its philosophical core, the market is a human endeavour. We invented it and it reflects us as accurately as any work of art. Across the financial world, however, markets are becoming increasingly inhuman – robots dealing with robots, thousands of trades per second, trades faster than thought, hedging positions taken. One third of all European and US stocks were traded by algorithms in 2006, with estimates of 60% in 2015[1].

And it seems there’s a strong future in artificial intelligence-run algorithm trading. FinTech firms are offering a suite of robotic services – from algorithms that monitor banks’ liquidity to apps that allow high-net-worth individuals to day trade from their smartphones.

On the one hand, what’s not to like? Democratisation of the financial markets, increased hedging and machine learning. Robots don’t get drunk, deal on wild adrenaline jags or – in theory – take and then defend unsustainable positions in a market. These machines can shore up a bank’s balance sheet while the C-suite sleep. You still need to keep an eye on things, though.

For a start, it’s an arms race out there. If your robots fall behind, you’re the sucker at the table. So invest. But do a little more than just kick the tyres on innovation.

Algorithmic market-makers, for instance, strive to balance supply and demand. They move buy-and-sell quotes up by a cent when someone buys and down by a cent each time someone sells. Each time it moves price, it cancels all buy/sell orders and submits new ones. Add in the feast of other data flooding into these bots and an alarming number of orders can end up being cancelled.

Interestingly, the legal defences mounted in recent spoofing prosecutions, including

British stock market trader Navinder Singh Sarao’s arrest last year over the 2010 flash crash, are essentially: “It wasn’t me, it was the machine.”

The point is that any market traded solely by machines isn’t the market as we know it. It’s not even a version of it. It’s something entirely new. It might, in principle, work by our rules, but it works without any inbuilt human need.

In this world of hair-trigger regulation – the next US election will almost certainly usher in fresh ultra-high frequency trading rules – it’s useful for senior staff at large financial institutions to understand these differences ahead of treasury departments.

It might be cheaper to hire robots, but as Warren Buffett once said: “Never invest in a business you can’t understand.”[2]

Stephen Armstrong writes for The Sunday Times,

Wired and The Daily Telegraph and appears on

Radio 4 occasionally

last word

Are we robot ready?Stephen Armstrong reckons we need to get our heads around artificial intelligence in our business lives, and fast

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Sources: [1] PlusAtForex, August 5, 2015; [2] Forbes Magazine

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