12 OctCatch-22 for the banks. Cursed to cooperate.  

Banking is not special, it is an industry like any other. Whilst I would stand by the first statement, there is something unique about banking. The need to cooperate.

Today, in southern Germany, the senior execs of Porsche, Mercedes and BMW might be interested in what their rivals are up to, but they do not have to work extensively together. I think they might have to agree on the height of the car bumpers, but that is about it. Banks, both locally and globally are dealt an entirely different hand.

The general public’s view of banking might be summarised, albeit simply, as understanding three things. There are those trading rooms they see on TV when there is news about the markets, with lots of people on phones and looking at lots of screens. Right now, they probably don’t trust bankers and they might think of fat cats and people being paid too much. Behind the scenes, it is the day-to-day operations of banks that ensure that what has been agreed either between banks, or between banks and their customers, be those retail or institutional, actually happens.

“Ensuring” means that securities sold are actually delivered and the corresponding money received, one currency is exchanged for another or even that the dividend on the shares owned is actually received. Those exchanges and events take place in payments systems, central counterparts and securities depositories, which are often given the collective name of Financial Market Infrastructure, or FMI’s.

Creating and operating those FMI’s takes cooperation between the banks. For the most part, this work is not organised by the regulators, although it is often encouraged. The need to create and operate FMI’s is something unique to banking.

The path to creating them is often tricky; years ago, there was an effort to improve securities settlement, particularly in the US, that becomes the GSTPA, the Global Straight Through Processing Association. Goldman Sachs was involved in the very early discussions. I was sent to talk about some details with a senior manager from Merrill Lynch, another early sponsor. As I left, my boss warned me: “Consider that anything you say, do, or write could be considered as an antitrust issue”, in other word cartel-like or even illegal behaviour.

This is not just the twisted world view of litigation happy Americans. I was very involved in the initial set-up of CLS, the system for settling FX trades. At a trade event, I commented on how unfortunate it was that there was no regulation to mandate usage and how the banks, having been “encouraged” by the regulators to create CLS, now had the burden of dealing with the liquidity issues of having some trades in CLS and others outside CLS. A senior staffer from the EZB was in the room. He suggested that those of us inside CLS simply get together and simply refuse to deal with banks who did not use CLS. From the perspective of a central banker, that was a rational comment. I thanked him for it, agreeing that as an operations guy, I would love to have only one system, but suggested that what might please the regulators would certainly upset some of his colleagues from the EU Competition Commission, who would likely find ways to send me on a new career sewing mailbags.

Lessons to be Learned:  Sorting banking matters out takes cooperation that other industries do not have to practice. Given the regulatory bias for letting the industry evolve the FMI’s, there  is a real catch 22. If we do get together and force a monopoly, the actions might be construed as anti-trust. If we don’t get together and force a monopoly, we have a mess. In the end, we end up with multiple solutions to the same problem. The trade reporting around derivatives is a great example; as the regulators did not create just one, there are several and the banks have to deal with all of them.

Sympathy for banks is in shorter supply than new silverware in the Arsenal trophy cupboard. For those in the infrastructure end of banks, a small morsel of sympathy for the challenge of cooperation is well deserved.

There is some irony here. In guidance from the BCBS on FX Settlement Risk, which comes into effect from Jan 1 2015, there is now a regulatory burden if banks do not use CLS or net. My thanks to those regulators who forced that through; better late than never.

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