CUBE RegNews: 21st June (2024)

Posted: 2024-06-21

Gary Gensler advocates for shortened settlement cycle to enhance market efficiency

In a speech at the Accelerated Settlement in the UK Conference, Gary Gensler, Chair of the US Securities and Exchange Commission (SEC), spoke aboutthe significant strides the US has made in shortening its securities settlement cycle and advocated for similar changes globally, including in the UK. Gensler's address highlighted the advantages of moving to a T+1 settlement cycle, focusing on the benefits for everyday investors and the broader financial market.

Successful transition to T+1

Gensler reminded the audience that in May 2024, the US successfully transitioned to a T+1 settlement cycle for equities, corporate bonds, and municipal securities. This shift aligns these markets with the existing one-day settlement for Treasuries, options, and mutual funds. For retail investors, this change means transactions are settled faster, enhancing liquidity and reducing risk. For instance, an investor selling stock on a Monday can now expect to receive their cash by Tuesday, rather than waiting until Wednesday. With over half of American households invested in the stock market, this adjustment is poised to have a substantial impact on household financial planning.

Gensler noted that Canada, Mexico, Argentina, and Jamaica have also successfully adopted the T+1 cycle, demonstrating a broader regional commitment to enhancing market efficiency.

Economic and risk benefits

Gensler emphasised that time equates to both money and risk in financial markets. Shortening the settlement cycle reduces the period during which the market is exposed to various risks, including credit and liquidity risks. For institutional investors, the T+1 cycle frees up liquidity that would otherwise be tied up, thus enhancing market fluidity.

The reduction in the settlement cycle also translates into significant financial savings. The amount of margin or collateral required by clearing houses is expected to decrease by an average of 29%, with early reports indicating around $3 billion in savings since the transition. Gensler argued that this decrease in required collateral lowers operational and counterparty risk, as it shortens the time frame in which trade details must be confirmed and affirmed, thereby reducing the likelihood of settlement failures.

Operational adjustments and regulatory requirements

The US transition to T+1 was not without its operational adjustments. Following Memorial Day weekend, brokers were required to adopt new policies and procedures to ensure the timely completion of trade allocations, confirmations, and affirmations. These requirements align with recommendations from the Bank for International Settlements (BIS) and the Committee on Payments and Market Infrastructures (CPMI).

Additionally, registered advisers must now maintain time-stamped records of trade allocations and confirmations, while clearing agencies are required to facilitate straight-through processing of securities transactions, automating the entire trade process from execution to settlement.

Key takeaways for the UK

Gensler shared several critical lessons from the US experience that could guide the UK's transition to a T+1 settlement cycle:

Collaborative effort: The transition to T+1 requires a collaborative approach involving all market participants, including clearing houses, depositories, custodian banks, brokers, investment advisers, self-regulatory organisations, stock exchanges, and industry groups. The SEC's staff played a crucial role in coordinating these efforts, ensuring a smooth transition.
Importance of timely trade affirmations: Ensuring that trade allocations, confirmations, and affirmations are completed as soon as technologically practical—preferably on the same day as the trade (T+0)—is essential. This practice significantly reduces the risk of settlement failures by allowing more time to resolve potential errors.
Firm implementation date: Establishing and adhering to a firm implementation date helps coordinate planning and execution across all market participants. In the US, the process from the final rule adoption to implementation took 15 months, with a total of 27 months from the proposal stage. This timeline allowed for a structured and systematic transition.
Business model adjustments: The transition to T+1 may require changes to existing business models. International investors, for instance, might need to adjust their operations to manage foreign currency risks more efficiently. Additionally, mutual funds and ETFs may need to address potential mismatches between the settlement cycles of fund shares and their underlying portfolios.
Global coordination: Gensler emphasised the importance of global coordination in settlement cycle reforms. Differences in settlement cycles between jurisdictions are manageable, and history shows that markets can adapt to these discrepancies. However, harmonising settlement cycles internationally could yield significant benefits, reducing systemic risk and enhancing market efficiency.

Future considerations

Looking ahead, Gensler suggested several areas for further policy discussions:

BIS updates core principles for effective banking supervision

The Bank for International Settlements (BIS) has published an executive summary outlining the core principles for effective banking supervision.

The core principles, also known as the Basel Core Principles (BCPs), are the minimum global standards for the sound prudential regulation and supervision of banks and banking systems. They have undergone three updates, the latest of which reflects regulatory and supervisory developments (eg the post-Financial Crisis reforms introduced by the Basel Committee on Banking Supervision (BCBS), structural changes in banking (eg the digitalisation of finance) and lessons learnt from prior Financial Sector Assessment Program (FSAP) assessments.

The core principles apply to all banks in all jurisdictions and are used by authorities as a benchmark and to help assesssupervisory frameworks, and by the International Monetary Fund and the World Bank as part of their external assessments of banks supervisory systems.There are 29 principles in total: 1-13 focus on the responsibilities of supervisors, the remainder on the responsibilities of banks.For the 2024 update, five key areas have been identified:

strengthening the effectiveness of supervision,
new and emerging risks,
reinforcing corporate governance and risk management practices,
embedding learnings for mitigating financial risks, and
promoting operational resilience.

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Singapore publishes updated Money Laundering National Risk Assessment

Singapore has unveiled its updated Money Laundering (ML) National Risk Assessment (NRA) which forms a crucial part of the nation’s ongoing commitment to maintain the robustness of its AML regime in the face of an ever-evolving risk landscape.

The updated ML NRA, synthesises data from various supervisory and law enforcement agencies, as well as the Suspicious Transaction Reporting Office (STRO) and feedback from private sector entities and foreign authorities, and offers a comprehensive evaluation of current ML threats. The update follows the last assessment conducted in 2014 and incorporates insights from thematic risk assessments focusing on the misuse of legal entities, virtual assets, and environmental crime-related money laundering.

Key threats

The updated NRA identifies several key ML threats. Foremost among these is fraud, particularly cyber-enabled fraud orchestrated by international criminal syndicates. Other significant threats include foreign predicate crimes such as organised crime, corruption, tax evasion, and trade-based money laundering.

Common ML typologies in Singapore reflect international patterns. These include the inflow of illicit funds through bank accounts, the misuse of shell companies to channel illicit funds, and the placement of these funds in high-value assets.

Sector-specific risks

The banking sector, encompassing wealth management services, poses the highest ML risks. Banks are particularly vulnerable due to their role in facilitating large transaction volumes and serving high-risk clients, including those from jurisdictions with elevated ML risks.

Among Designated Non-Financial Businesses and Professions (DNFBPs), corporate service providers (CSPs) present notable ML risks. CSPs are instrumental in company incorporations, which can be exploited to misuse legal entities. Other high-risk DNFBP sectors include real estate, licensed trust companies, casinos, and the precious stones and metals market.

In the financial sector, digital payment token (DPT) service providers, or virtual assets service providers, have emerged as a high-risk group. Despite DPT activities in Singapore representing a small fraction of global transactions, there has been an uptick in ML cases involving DPTs, prompting heightened scrutiny by Singaporean authorities. Other high-risk sectors include payment institutions providing cross-border money transfer services and external asset managers.

Continued commitment and strategic measures

The findings from the updated ML NRA will inform ongoing efforts to ensure the AML regime adapts to emerging threats. This includes targeted initiatives to educate Financial Institutions (FIs) and DNFBPs about key ML risks and enhancing the capacity of law enforcement and supervisory agencies to detect, disrupt, and enforce actions against illicit activities.

OCC approves new automated valuation model rule

The OCC is one of several regulators adopting the rule to implement the quality control standards mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) for the use of automated valuation models (AVMs) by mortgage originators and secondary market issuers in determining the collateral worth of a mortgage secured by a consumer’s principal dwelling.

Under the final rule, institutions that engage in certain credit decisions or securitisation determinations must adopt policies, practices, procedures, and control systems to ensure that AVMs used in these transactions to determine the value of mortgage collateral adhere to quality control standards designed to:

ensure a high level of confidence in the estimates produced by AVMs;
protect against the manipulation of data;
seek to avoid conflicts of interest;
require random sample testing and reviews; and
comply with applicable non-discrimination laws.

The rule is effective the first day of the calendar quarter12 months after date of publication in the Federal Register.

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EBA concludes roadmap on market and counterparty credit risk approaches with final RTS

The European Banking Authority (EBA) has released the final draft Regulatory Technical Standards (RTS) on the conditions for assessing the materiality of model extensions and changes, as well as changes to the subset of modellable risk factors, applicable under the Fundamental Review of the Trading Book (FRTB) rules.

Some context

The Capital Requirements Regulation 2 (CRR2) implemented in EU legislation the revised requirements to compute own funds requirements (OFR) for market risk of the Basel III package, i.e. the Fundamental Review of the Trading Book (FRTB).

Under the rules, institutions can calculate their own funds requirements for market risk using the alternative internal models approach (IMA), provided that permission from a Competent authority (CA) is granted.

Material changes to the use of the IMA, the extension of the use of the IMA and material changes to the institution's choice of the subset of the modellable risk factors require separate permission from competent authorities. All other extensions and changes to the use of the IMA require notification to the competent authorities.

Key takeaways

The final draft RTS:

Clarify the scope of the materiality assessment of model extensions and changes, and changes to the institution’s choice of the subset of modellable risk factors.
Provide a general methodology for assessing the materiality of model extensions and changes.
Provide a general methodology for assessing the materiality of changes to the institution’s choice of the subset of modellable risk factors.
Provide general provisions for assessing the materiality of model extensions and changes to the institution's choice of the subset of modellable risk factors.

The final draft RTS also includes guiding principles for institutions to follow in the categorisation process, provisions on implementing extensions and changes, and documentation requirements.

Next steps

The draft regulatory technical standards will be submitted to the European Commission for endorsem*nt. Following this, they will be subject to scrutiny by the European Parliament and the Council before being published in the Official Journal of the European Union.

By submitting these final draft RTS to the European Commission, the EBA has now completed its roadmap on market and counterparty credit risk approaches published on 27 June 2019.

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Speech Burkhard Balz: Is CBDC the money of the future?

In a speech at the Central Bank Payments Conference, Burkhard Balz, Member of the Executive Board of the Deutsche Bundesbank considered the future role of central bank digital currencies(CBDCs).

The digital transformation

Balz began by setting the stage within the broader context of digitalisation. The rapid evolution of digital payment solutions, from instant payments to innovative financial technologies, requires the need for central banks to adapt. He stressed that while electronic payments are becoming more prevalent, physical cash remains a vital component of the financial system. Hence, CBDCs should complement cash, not replace it, ensuring continued public access to central bank money in a digital age.

Implications for central banks

The introduction of CBDCs represents a fundamental shift in the financial system. Balz highlighted that central banks worldwide are at various stages of researching and piloting their own digital currencies. The primary goal, he feels, is to integrate CBDCs into existing currency areas, not to introduce a separate currency. This integration is vital for maintaining stability and trust in the monetary system.

A key consideration for central banks is designing a CBDC that aligns with mandates of price stability, financial stability, and secure payment systems. Balz stressed the importance of a well-considered approach to ensure CBDCs enhance rather than disrupt the current monetary framework.

Why a digital Euro?

Balz outlined three key reasons behind the potential introduction of a digital euro by the Eurosystem, which includes the European Central Bank (ECB), the Bundesbank, and other national central banks in the euro area.

Sovereignty in payments: The fragmented European payments landscape lacks a unified payment solution that operates across the euro area on European infrastructure. With geopolitical tensions highlighting the risks of dependency on non-European payment systems, developing a digital euro could strengthen Europe’s resilience and independence in payments.
Trends toward cashless payments: The shift towards cashless payments has accelerated, particularly during the COVID-19 pandemic. Public money, currently represented only by physical cash, is essential for maintaining the financial system’s integrity. A digital euro would ensure continued public access to secure central bank money in a digital world.
Promoting competition and innovation: A digital euro could foster competition and innovation in European payments. By providing a programmable and secure digital infrastructure, CBDCs could enable new financial products and services, such as smart contracts and micropayments, promoting a dynamic and innovative financial ecosystem.

The concept of a digital euro

Balz envisaged the digital euro as more than just a digital replacement for cash. It could be a symbol of Europe’s commitment to innovation and financial inclusion. The digital euro would coexist with cash, offering Europeans an additional electronic payment option. It would be designed to ensure privacy, be free of charge for basic functions, and be usable both online and offline.

The digital euro would be accessible via commercial banks’ mobile banking solutions and a dedicated digital euro app, ensuring widespread usability. This dual approach would facilitate everyday transactions, from retail purchases to peer-to-peer payments and interactions with public authorities.

Current status and next steps

The Eurosystem completed a two-year investigation phase in October 2023, exploring the benefits and implications of a digital euro. This phase clarified the potential design and distribution of the digital currency. However, Balz acknowledged the risks, such as the possibility of financial instability if enterprises and households shift deposits into digital euros. To mitigate these risks, digital euro holdings would not be remunerated, and there would be holding limits.

The ECB’s Governing Council has now moved to the preparation phase, focusing on finalising the digital euro rulebook and selecting providers for the digital euro platform. However, Balz noted that a final decision on the digital euro's introduction would require a stable legal framework, currently under consideration by European co-legislators.

Balz concluded by emphasising that exploring CBDCs is not merely a technical endeavour but a strategic necessity. It presents an opportunity to shape the future of money and payments to benefit both citizens and the economy. The journey towards a CBDC is complex and fraught with challenges, but with diligent planning and collaboration, these challenges can be overcome.