21 OctHow competing banks need to cooperate properly

How to behave in the club? Last week’s post was about the unique requirement that the banks have to cooperate in order to effectively settle transactions. A Catch-22, because they need to cooperate and ideally not to have a “Heinz 57 varieties” situation with multiple solutions for the same problem, but as the regulators expect the banks to organise themselves, their private actions must not give rise to an anti-trust situation. So, banks are forced to participate in the various industry forums and financial market infrastructures (FMI’s).

How to participate in industry forums properly

The solution is not as obvious as one might think. Over the years I have seen this done well and I have seen this done badly.

On the negative side: many years back, I was quite involved in several CLS Working Groups. As that FMI finally got out of the starting blocks, there was a quiet sensible attempt to look ahead and outwards: “What else can we do with this costly infrastructure?” At the time, CLS settled some seven currencies. More currencies was obvious and already firmly on the radar. At a workshop, one of the senior folks, Jörg Auer from UBS, suggested we look at one way cash flows, i.e. payments. After all, an FX trade, which forms the basis of CLS, is simply two payments. Given the large volume and value of one way payments that flow between the banks, this was a logical thought. That idea was quickly and absolutely shot down by the representative of one of the members with a large transaction banking business. Why? I can only hazard a guess, but perhaps it was some worry about loss of revenue from charging ticket fees for each payment. In any case, the opposition was so vehement that the idea was killed in its tracks. Now, years later, CLS are back in the hunt for a solution for netting payments that are outside the existing reach of their service.

Even further back in time, Goldman Sachs was a bit player in the Swiss securities settlement game. The then big 4 Swiss banks; CS, UBS and the two banks that eventually were acquired or merged, Volksbank and Swiss Bank Corp, were responsible for a system design for SEGA 2.0 that completely ignored the needs of the smaller banks. That group, including Goldman Sachs, was told just four weeks before go live that in the new system the days settlements would be available to those without a direct interface at 18:00 each night. Too late to allocate settlements to clients and move monies. A mutiny amongst the foreign banks was needed to secure the right service for smaller banks. The big boys had simply failed to think about the smaller players, forgetting that they needed us in the boat to settle the trades.

At one large institution I worked with, a true specialist and expert in these infrastructure projects was left sitting in an Investment Banking cost centre. He was heavily involved with SWIFT, CLS and the local CSD. IB just looked at him as a cost; support and sympathy were in short supply and nobody took the long view. He left, which to some extent weakened the bank’s direct involvement in those forums.

Sometimes, even the directors representing their banks as directors of an FMI are less than forthright about intentions. ForexClear was a good example. Testing for NDF clearing was organised and a start date was announced. When push came to shove, given participation was not mandated by the regulators, several large banks simply refused to put trades through the service, objecting to the enforced need to provide collateral that went with that. Other banks, trying to get the service off the ground were left with exaggerated collateral calls from having only one side of a trade “in”. Annoying; with more candour, a better situation for all could have been achieved.

Where I have observed this being done well is one large European bank that created a group executive level position for their “industry Ambassador”. Group level is the right place; at that level you hope people thing strategically. There is of course a danger that people in such roles become detached from reality, like MEP’s and Eurocrats in Brussels.

Lessons to be Learned:  Reflecting on the anecdotal evidence, it immediately strikes me that this is another case of 80:20 in terms of poor vs. good performance. Was it ever thus.

I have had the good fortune to work with one of the greats in terms of contributions to industry efforts, Itzi Klein, who spent many years at CS. I am indebted to him for wise guidance and counsel on many occasion and I think I recall correctly that it was he who once explained to me that in these forums and bodies, the first loyalty was to serve the forum, the industry and do the right thing for the collective good. Secondly, it was fair to then take that knowledge and work with his own institution to make the most of it.

This is actually the same “rules of engagement” that apply to the seven ministers who form the Swiss government. They are members of a party and elected by a parliamentary vote; however, their duty as ministers is to the country first and not the party.

This is a derivative of what I would call the “traditional Goldman Sachs doctrine”, which held that the priorities were the clients, the firm and then you. The corollary for working in these industry forums would be the industry, your clients, your firm.

Perhaps we need more Swiss leading these industry efforts. History would support; Swiss neutrality is renowned and the success at holding together a country with so many diverse regional interests suggests some innate skill in consensus forming.

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