Volume 16, 2023-2024

Each volume of Journal of Securities Operations & Custody consists of four quarterly 100-page issues. The articles published in Volume 16 include:

Volume 16 Number 2

Editorial
Simon Beckett, Publisher
Practice Papers
Digital asset custody deciphered: A primer to navigating the challenges of safeguarding digital assets
Colin Parry, International Securities Services Association

The International Securities Services Association (ISSA), Global Digital Finance and Deloitte have co-authored a report on Digital Asset Custody. This paper gives a synopsis of one element of the report and provides a brief explanation of digital asset custody (DAC) and the key facets that should be considered when looking at a DAC solution. DAC is different from traditional asset custody but it is not totally different. There are complexities that occur uniquely within DAC, and it is imperative that managers understand those aspects and the implications, such as permissioned versus permissionless ledgers, key management, etc. There are also a number of familiar terms used in DAC in a different way from traditional markets and is necessary for managers to challenge the existing wisdom for both DAC and traditional custody. To progress the opportunities that DAC — through distributed ledger technology (DLT) and tokenised assets — offer financial markets, however, the industry should not throw away all the learnings from traditional custody offerings. Custodians (in the widest sense) should merge their knowledge of safekeeping principles with the new abilities offered by DAC to ensure that they can manage the risks of operating in this new environment. An example of a new risk is that DLT evangelists will say ‘Blockchain is instant and immutable and therefore guarantees finality’, but is it true in all or any circumstance? Risk management starts with risk awareness and the purpose of this paper is to explain the risks that occur in the scenarios of providing or purchasing DAC.
Keywords: DLT; custody; digital asset custody; safekeeping
The growing challenge of attracting talent to post-trade and keeping employees’ skills current
Saija Korkala and Björn Welander, SEB

Digital transformation, emergence of modern technologies, regulatory drivers and ever-increasing quest for efficiencies has pushed the financial industry, including the post-trade business, through a tremendous change over the past decade. This change has introduced new requirements for systems and organisations, but most importantly towards staff working in these areas. In this paper, we discuss the implications of the changes in operational landscape for the required skill sets, the challenges and opportunities in attracting and retaining talent, and techniques to build the needed competences for organisations to be equipped for the requirements of the future. This is done by examining the research on general topics and linking that to experience from business and real-life examples related to talent attraction, talent management and competence building in post-trade. Based on that, we see that talent challenge is industry-agnostic, linking to both tight labour markets and changing competence requirements. To address this, companies must ensure that basic talent management practices are well deployed, try out some non-traditional talent pools and new ways of working, as well as bring talent attraction and retention activities to a level that resonates with the new generation (Gen Z and Millennials), who are much quicker in their career moves and are driven by different values and realities compared to their more senior colleagues. We conclude that building talent and skills inhouse is the most important way to approach this challenge, and as a side-effect it will also help in the specific challenge of talent retention. Building talent in-house, however, requires committed leadership and management, investment in learning tools and engaged staff to bring lasting results.
Keywords: talent; competence; post-trade; operations; securities; digitalisation
The role of financial market infrastructures in supporting a sustainable financial transition
Natalia Diaz-Stock, Euroclear SA/NV

This paper aims to describe the role of financial market infrastructures (FMIs), specifically central securities depositories (CSD) and international CSDs (iCSDs), in supporting a sustainable financial transition. It starts by laying out the central role of these FMIs in the centre of the financial value chain, where it plays a critical role in ensuring the smooth and efficient functioning, as well as stability of financial markets. FMIs operate multilateral technology systems and funnel vast amounts of data across multiple markets, including emerging markets and developing economies (EMDEs). The paper then highlights acute challenges in funding sustainability projects in those emerging markets and the need for solutions that help attract private capital and international investors. To help address some of these challenges, a case study is presented of Euroclearability and the establishment of efficient FMIs and secondary markets, drawing lessons from its current impact as a potential solution to bridge EMDE financing gap. A study of the impact of Euroclearability shows an average reduction in sovereign borrowing costs by 28bps, and 14bps for corporate borrowing costs. Additionally, Euroclearability is associated with greater liquidity in domestic sovereign bond markets, leading to higher trading volumes and lower bond yields in secondary markets. Finally, the paper delves briefly into the ways FMIs are well positioned to capture regulatory data flow and sustainability data. With strong track records in managing and quality-assuring data, FMIs can improve the processing of ESG metrics, such as regulatory disclosures, and facilitate the use of these new metrics between market participants.
Keywords: financial market infrastructure; FMI; CSD; sustainable finance transition; sustainability transition; ESG; efficient capital markets; blended finance; emerging markets
The challenges of implementing effective regulatory decision-making provenance
Brock Arnason, Droit Operating Company

Financial institutions face significant challenges in implementing and enforcing regulatory data, specifically in transaction reporting and point-oftrade decision making. The lack of understanding and adherence to correct reporting procedures often leads to compliance breaches and subsequent fines. In this paper, the author provides a comprehensive explanation of regulatory data and how implementation poses challenges such as managing numerous source systems, constructing accurate decision logic, ensuring auditability and handling regulatory changes effectively. The paper also examines the benefits of adopting a best-practice framework, covering examples of transaction reporting and point-of-trade decision making. Finally, the paper underscores the imperative for financial institutions to embrace a best-practice framework for regulatory decision-making provenance which involves automating compliance, reflecting industry consensus and implementing control processes to address regulatory changes. By doing so, companies can ensure compliance, mitigate risks and adapt to the evolving regulatory landscape.
Keywords: AML compliance breaches; transaction reporting; point-oftrade decision making; regulatory decision-making provenance; bestpractice framework for regulatory data management
A proposed mandatory swing pricing regime and the hard close requirement: Practical considerations
Jimena Acuña Smith and Nathan McGuire, Asset Management Group, Ropes & Gray

In November 2022, the U.S. Securities and Exchange Commission (the ‘Commission’) proposed rule amendments that would require, among other things, open-end mutual funds to implement a mandatory swing pricing regime under certain circumstances (the ‘Proposals’). To ensure that funds receive order information with sufficient time to make a swing pricing determination, the Proposals would require funds to set a hard cut-off time for the receipt of purchase and redemption orders. Currently, the vast majority of investments in open-end mutual funds are made through intermediaries and retirement plans, such that investors who submit orders to intermediaries and retirement plans before the time the fund has established for calculating its net asset value (NAV) generally receive the same day’s NAV, even if the fund receives the order information from the intermediary or retirement plan after NAV is calculated. This is how mutual fund pricing has operated in the US for over 50 years. The Proposals would upend current operations. Under the Proposals, an investor’s order would have to be received by the fund — not a financial intermediary or a retirement plan — before the cut-off time set by the fund for calculating NAV in order to be eligible for the same day’s NAV. If adopted as proposed, the Proposals would require extensive changes to mutual fund pricing systems and infrastructure in the US. In this paper, we acknowledge the arguments against the Proposals by an overwhelming majority of industry commenters and, without undercutting those arguments, we explore practical, regulatory and compliance considerations for funds seeking to better understand how the Proposals might affect their day-to-day operations.
Keywords: mutual fund; swing pricing; hard close; operations; dilution; first-mover advantage; systemic risk
Custody in the age of digital assets: The path to building market infrastructure fit for a tokenised economy
Seamus Donoghue, Metaco

This paper charts the dynamic evolution of finance and capital markets amid the digital asset surge. Tracing the historical trajectory from conventional banking to the current digital era, the paper underscores the intertwined narrative of finance and technology. Distributed ledger technology (DLT) and digital assets take centre stage, driving continuous financial operations and reshaping market dynamics. Custody emerges as a pivotal factor in this digital transformation. Established financial institutions strategically invest in digital asset infrastructure, recognising the seismic potential of tokenisation. Research from major companies projects significant tokenisation of assets, prompting global banks to align their strategies accordingly. The paper explores diverse use cases, from custody and trading services for cryptocurrencies to tokenising financial securities and real-world assets. Navigating the regulatory landscape proves crucial, with varying regulations across jurisdictions posing challenges. A unified regulatory framework is advocated for fostering global adoption. The paper delves into the technological nuances of safeguarding digital assets, exploring key management solutions such as multiparty computation (MPC) and hardware security modules (HSMs). The paper anticipates a shift towards recentralisation as the digital asset market matures, with established financial institutions and custodians poised to leverage trust, balance sheets and regulatory compliance to open up commercial opportunities in the digital asset space. In essence, the paper provides a sweeping overview of the current digital asset landscape, offering insights into challenges, opportunities and technological considerations shaping the digital asset custody value chain.
Keywords: digital assets; digital asset custody; DLT adoption; institutional adoption; custody infrastructure; tokenised securities; cryptocurrencies
Sustainability matters: Best practices and challenges on sustainability data and how to integrate ESG and climate risk into your operating model and risk framework
Pat Sharman, Securities Services Veteran and Co-Founder of Everyone Matters

Securities services companies need to respond to changing risks and the impacts they could have on operational resilience. Much of the focus has been on identifying risks relating to asset protection, or factors that can have an impact on revenue, such as falling interest rates. With the potential threat of climate change on asset prices, and the risk more broadly of climate change to financial markets, custodians need to rethink risk, both at an operational level and how they support asset owners and asset managers to help mitigate these risks.
Keywords: ESG; sustainability; climate risk; biodiversity risk; securities services; sustainable governance; governance
Case Study
Reinventing asset servicing with distributed ledger technology
Zhu Kuang Lee, Jing Yu Wong, Rachel Roch, and Xin Yi Tan, HSBC

This paper draws on the hands-on experience of HSBC in implementing distributed ledger technology (DLT)-based solutions through building its own proprietary tokenisation platform, HSBC Orion, and participating in various industry initiatives such the Hong Kong Monetary Authority (HKMA)’s inaugural tokenised green bond issuance. The paper highlights key considerations for building DLT-based solutions and provides a view of the future state of digital assets as the ecosystem continues to grow and evolve.
Keywords: distributed ledger technology; tokenisation; digital assets

Volume 16 Number 1

Editorial
Simon Beckett, Publisher
Papers
Breaking the mould with caution: Promises and risks of crypto-inspired clearing models in traditional central clearing
Aniket Bhanu, NSE Clearing

While numerous crypto exchanges have failed, their innovative clearing models may hold value for the traditional central clearing space. After describing the representative model of traditional clearing and with its strengths and challenges, this paper reviews the external pressures that often dissuade central counterparties (CCPs) from deviating from this archetype. The paper reviews the design innovations in post-trade services in crypto markets and critically examines the potential for implementing certain facets of such alternate models in traditional clearing contexts, taking a view of their promises as well as risks. The paper strongly advocates for a contingency-based approach to CCP design and discusses specific contexts where alternate clearing models could prove valuable for the markets. This journey must preserve the balance of efficiency and safety, anticipation and prudence, in order to maintain the resilience of CCPs while redesigning crucial procedures for improved market services.
Keywords: central counterparty; clearing; alternative clearing models; market infrastructure design
Asset managers and withholding tax: Problems, options and best practices for asset managers on withholding tax processing
Thomas König, Daniel Schneider and Manfred Artmeier, RAQUEST GmbH

This paper presents a detailed analysis of the critical role and complications surrounding withholding tax processing in the asset management industry. The paper first explores the substantial losses incurred by the industry due to a lack of proper attention and expertise in withholding tax matters, demonstrating the urgency of this issue. It then examines the current approach of relying predominantly on custodian banks for managing these issues, highlighting the shortcomings and risks inherent in this practice. The paper further investigates the current state of asset management companies, revealing their limited capabilities in managing withholding tax efficiently due to various factors including cost pressures, technological gaps and lack of awareness. To address these challenges, the paper proposes two primary options for asset managers: increased collaboration with tax advisers, and automation through software solutions. A detailed comparison is made on the pros and cons of these options. Collaborating with tax consultants, while beneficial in many ways, might fall short due to the complexity and volume of the withholding tax challenges. On the other hand, automation can provide significant benefits in terms of efficiency, accuracy, scalability, compliance and cost-effectiveness, although challenges related to implementation and integration exist. The paper concludes with a checklist of critical success factors for selecting, implementing and operating withholding tax processing software, providing practical guidance for asset management companies seeking to improve their handling of withholding tax matters. These findings underline the importance of a proactive approach and the necessity for asset managers to explore the potential of technology-based solutions in this crucial area.
Keywords: withholding tax processing; tax consultants; tax automation; asset managers; tax reclaim; tax relief at source
The transition to T+1: Accelerated settlement cycles and progress so far
Pardeep Cassells, AccessFintech

This paper examines the current momentum driving faster settlements in financial markets, specifically focusing on the shift from trade date + 2 (T+2) to trade date + 1 (T+1) settlement cycles. The U.S. Securities and Exchange Commission (SEC) and the Canadian Capital Markets Association plan to implement it in May 2024. His Majesty’s Treasury in the UK and the Association for Financial Markets in Europe (AFME) have both established taskforces to assess the feasibility of transitioning to T+1 settlement. This paper aims to provide readers with a comprehensive understanding of the accelerated settlement movement and its potential implications for global market participants. It will delve into the reasons behind the simultaneous adoption of this change across various markets, highlight the key changes being introduced in the US market, and explore its impact on market participants within the US. It will also address the consequences of accelerated settlement for international markets, raising critical factors that all market participants need to consider when facing settlement cycle changes. Practical recommendations to prepare for T+1 readiness will be offered. Readers can expect insights into the motivations driving the accelerated settlement movement, the key changes unfolding in major markets and the potential effects on international markets, ensuring preparedness for the forthcoming T+1 settlement era.
Keywords: accelerated settlement; settlement cycle; trade date + 2 (T+2); trade date + 1 (T+1); regulation
Operational challenges with complex assets : Navigating technology solutions for diversified institutional Investment portfolios
Scott Kurland, SS&C Technologies

In recent years, institutional investors have begun diversifying into asset classes previously deemed too complex or high-risk to suit their objectives. While these investments may hold the potential for exceptional returns, they also pose significant challenges from an operations and accounting perspective due to their bespoke nature. This paper explores the diversification trend and investment categories that are attracting attention (and capital) from institutions. It outlines the key operational issues these investments raise, as well as some strategies that can help investors overcome those issues and optimise the benefits of diversification.
Keywords: insurance investment accounting; insurance investment outsourcing; insurance investment operations; institutional investing; private markets; private credit; private debt; commercial real estate debt funds; Schedule BA investments; enterprise risk management
ESG as a key pillar of investment strategy
Eigil Ingebretsen, Storebrand Asset Management AS

In this paper we delve into the importance of environmental, social and governance (ESG) considerations as a cornerstone in investment strategies. The discourse takes the reader through a transformative journey, from understanding key pillars that needs to be addressed to truly succeed in ESG integration from setting the level of strategic ambition to it effectively into investment processes, focusing particularly on process integration and management. We explore key process steps in an investment process, such as strategic allocation, security selection, portfolio construction with a particular emphasis on risk assessment, stress testing and investment compliance. Specific examples are provided to elucidate how ESG considerations can be seamlessly incorporated into these critical steps to achieve fully aligned portfolios. Upon completion of the paper, readers can expect to gain a robust understanding of the ESG landscape, insights on how to integrate ESG considerations into their investment decisions and tools to future-proof their portfolios. The knowledge and skills acquired will be invaluable for asset managers, investors and other finance professionals looking to align their strategies with the emerging realities of the current investment landscape.
Keywords: ESG; data; data models; process integration; investment strategy
Trading operations: Intelligent automation and the T+1 mandate
Laura Ryan, John Almeida and Alan Paris, ServiceNow

As the financial services industry is finalising the adoption and implementation of the shortened settlement cycle on 28th May, 2024, and its implications to procedures, technology and behaviour, this paper lays out the benefits, challenges and best practices to ensure a smooth transition and implementation to all participants. The implications of these changes are enormous and open companies up to a variety of risks. This paper informs best practices to ensure a seamless integration, including operational, risk and communications. In addition, the paper focuses on practical steps to automating processes, centralising data and utilising technology to create a more efficient future. It points out that by utilising technology as a mechanism for continuous improvement, not only will companies be able to meet implementation requirements of this T+1 mandate but also create a mechanism to continue to meet regulatory changes. By utilising technology to create an environment of continuous improvement, powered by work orchestration, a fundamental shift in workforce behaviour can begin. In doing so, companies can ensure that they meet the operational requirements of this mandate, leading to efficiencies throughout their organisation and an improved employee and client experience.
Keywords: work orchestration; post-trade processing; streamlining; technology and automation; continuous improvement; trading operations; T+1; capital markets; asset management; banking; wealth management; trade settlement
Withholding tax relief and recovery: The key to enhancing operational alpha?
Jason Yule and Julia Bricker, WTax Canada

The evolving international tax landscape continues to provide complexities for investors, creating operational challenges, often eroding investment returns. This paper unpacks the withholding tax process along with the key hurdles that investors have to overcome when recovering taxes. While these hurdles have been expanded upon, an effort to quantify the effect on investment performance has been made to help investors understand the true cost of tax inefficiencies. The paper thereafter dives into emerging international tax trends, risk management considerations, and concludes with an analysis of solutions that investors can utilise to enhance their international tax relief and recovery process.
Keywords: withholding tax; international tax; tax recovery; tax reclaims; dividends; foreign tax recovery
Book review
Clearing OTC derivatives in Europe by Bas Zebregs, Victor de Seriere, Rezah Stegeman, and Patrick Pearson
Godfried De Vidts, ICMA ERCC