Volume 17, 2024-2025

Each volume of Journal of Securities Operations & Custody consists of four quarterly 100-page issues. The articles published to date in Volume 17 are:

Volume 17 Number 2

Editorial
Simon Beckett, Publishing Editor, Journal of Securities Operations & Custody
Practice Papers
Key themes of resiliency, outsourcing and third-party risk management regimes
Mike Pierides, Partner, and James Mulligan, Associate, Morgan, Lewis & Bockius UK LLP

Throughout 2024, European Union (EU)-based financial entities have been analysing their thirdparty and intra-group technology contracts against compliance with the EU Digital Operational Resilience Act (DORA), and renegotiating with vendors where necessary, in order to comply from 17th January, 2025. McKinsey estimates that EU institutions typically earmarked €5−15m for DORA programme strategy, planning and design, although full implementation costs may be five to ten times that range.1 The DORA analysis is also highlighting that certain companies are not compliant with existing regulatory expectations. Financial regulators and global standard-setting bodies have published high-level principles and also detailed expectations to ensure that companies have in place prudent third-party risk management controls, both at an enterprise level and for managing individual third-party arrangements. As securities markets participants become increasingly reliant on third-party service providers for tasks that they had not previously undertaken, leveraging technology and artificial intelligence (AI), supervisory focus is extending to operational resilience across third-party services relationships, not just outsourcing. In this paper, we explore key themes of existing outsourcing and third-party risk management regimes that apply to financial entities and their service providers. We note key differences between regulatory expectations on resiliency and outsourcing, highlight key best practices and challenges to implementing these expectations and, finally, consider the impact of AI solutions on such regulatory expectations.
Keywords: operational resilience; artificial intelligence; outsourcing; digitisation; financial regulation
Crossing the chasm: Why post-trade FMIs are key to scaling blockchain adoption
Qian Jiang, Director of Capital Markets Strategy, Swift

There is a growing industry consensus that blockchain presents an exciting insight into the future of next-generation operational technology. As blockchain brings a new way of organising the underlying ledgers and communication, often we see industry leaders launching an on-chain version of their core business and operating both in parallel, such as J. P. Morgan’s Onyx and Euroclear’s D-FMI. Therefore, the question on the minds of many is what mass adoption would look like, as participants balance the needs of modernising existing systems versus migrating to new ones. This paper seeks to unwrap the key challenges and delve deeper into this multifaceted technology, to show that a trusted bridging solution that has footing in both traditional and new ecosystems is instrumental to enable the industry to move towards adoption and convergence. The author argues that post-trade financial market infrastructures (FMIs) have a key role to play in helping industry participants amplify the benefits of adoption, while crossing the various associated chasms of costs, scalability, risks and uncertainty.
Keywords: digital assets; blockchain; DLT; adoption; scaling; FMI; post-trade
Integrating private assets in a total portfolio approach
Thomas Meyer, Director, SimCorp Luxembourg

In a total portfolio approach (TPA) asset owners use their entire capital to maximise the net impact of their investments by diversifying over risk factors. The focus is on allocation to risk exposures rather than asset classes, as in the traditional strategic asset allocation (SAA). Compared to the SAA, the TPA leads to better quality of decision making by using a factor lens that embraces the continuum between equity and debt as well as across public and private markets. The increasing adoption of the TPA coincides with what has even been termed ‘hypergrowth’ of investing in private markets. Many asset owners may be overestimating their liquidity needs and thus be foregoing valuable opportunities for investing in private assets and harvesting an illiquidity premium. As the costs of illiquidity do not depend on the asset but the specific state of a portfolio, TPA requires frequently generated cash flow forecasts for investments in these illiquid assets. By following the TPA and by treating private assets on an equal footing to liquid asset classes, asset owners can construct their portfolios in a new and innovative way that has the potential to sustainably generate higher returns. Newer risk factor models in combination with highly automated cash flow forecasting tools create a unifying framework whereby risks are measured more realistically, and a private asset’s illiquidity is not penalised if no liquidity is needed within the portfolio’s context.
Keywords: total portfolio approach; strategic asset allocation; private assets; risks factors; liquidity risk; cash flow forecasting
Capital markets need a new operating model: Built on data, delivered by people
James Maxfield, Chief Product Officer, Duco

Capital markets companies are in the midst of a series of challenges that they cannot solve with revenue growth. This has increased the impetus for companies to look inwards and think about efficiencies and cost savings. The operating model that serves capital markets — and the legacy technology that powers it — is struggling to keep up, but change has historically been fraught with risk and the chance of failure looms large. This paper explores the need for a ‘next-generation’ operating model, the transformation pitfalls companies need to avoid when delivering one, the technology that enables it, and why people and data must be at the heart of any change.
Keywords: data; automation; operating model; transformation
Reimagining post-trade: A blueprint to upgrade today’s markets?
Bill Meenaghan, Chief Executive Officer and Founder, SSImple

There has been significant excitement surrounding the potential of distributed ledger technology (DLT) in revolutionising the world’s financial services markets in recent years. The aspiration of achieving a flawless method for trading, matching and settling security transactions is a far-reaching objective that all industry participants strive for. Financial services professionals do not begin their day aiming to create transaction failures. Such failures result in financial losses, including fines, staff expenses and overdraft charges across the industry. Despite decades of efforts to achieve a 100 per cent settlement rate, success has remained elusive. This paper delves into the evolution of our existing settlement framework, examines the risks it has brought about and speculates on potential improvements by enhancing our current systems and processes with necessary technological advancements.
Keywords: post-trade; T+1; settlement efficiency; SSIs; DLT
The cloud computing dilemma for financial services institutions
Nathalie Zeghmouli

This paper explores the current state of cloud computing in the financial industry. While the potential benefits of cloud adoption — agility, scalability and innovation — are acknowledged, the paper highlights the challenges that remain. These challenges include a lack of clear and consistent regulations across jurisdictions, concerns about data security and residency and the complexity of navigating a hybrid cloud environment. The paper argues that to unlock the full potential of cloud computing in finance, a collaborative effort is needed. Regulators are expected to establish clear global standards for security, data residency, reporting and service level agreements (SLAs). Financial institutions should prioritise security and sustainability when choosing cloud providers and advocate for clearer regulations. Finally, cloud service providers (CSPs) themselves need to collaborate with regulators and financial institutions to develop standardised security frameworks and reporting formats. By working together, the paper concludes, all stakeholders can build a more secure, sustainable and prosperous cloud future for the financial industry. Readers will gain an understanding of the current challenges and opportunities surrounding cloud computing in finance, along with the key actions needed to move forward. They will also be introduced to key concepts such as data residency and hybrid cloud strategies.
Keywords: cloud computing, banking; security; regulations; standards; cloud service providers; CSPs
Driving growth in asset management through data: Data as a revenue driver
Ryan Cuthbertson, Global Head of Custody Services, Trustee and Depositary Product, BNY Mellon

The asset management industry is dealing with a variety of challenges, ranging from difficult market conditions, higher operating costs, declining fees, intensifying competition from passive funds, right through to the introduction of new and complex regulations. At the same time, asset managers are also looking for innovative ways to diversify their businesses, either by launching private fund strategies aimed at the retail market or integrating environmental, social and governance (ESG) standards into their decision-making processes, to name just a few. All these dynamics are forcing asset managers to rethink their historic operating models. If companies are to adapt, however, then they will need access to excellent data. The problem is that many asset managers do not possess this data themselves, or if they do, it is often unstructured and unusable. This is where their global custodians are well positioned to help them. With many global custodians sitting on mountains of data, leading providers are now sanitising this information and turning it into useful insights and analytics for their institutional clients. From this, asset managers will be able to enhance their asset allocation processes, streamline operations, better comply with regulations and ESG requirements and bolster their retail distribution capabilities. In today’s highly crowded market, the ability to successfully make use of data could be the difference between winning and losing lucrative mandates.
Keywords: resilience; data; operations; custody and efficiency

Volume 17 Number 1

Editorial
Simon Beckett, Publishing Editor, Journal of Securities Operations & Custody
Case Studies
How to test AI: A case study of a machine learning-based trading system
Olga Lewandowska, Senior Consultant, and Edgar Mai, Chief Executive Officer, Mainstay

The rapid evolution of artificial intelligence (AI) and especially machine learning (ML) has significantly transformed the technological landscape, influencing diverse sectors and making notable inroads into the realm of finance. This paper delves into the challenges posed by ML models, known for their black-box nature, non-deterministic behaviour, reliance on big data and inherent complexity, often lacking clear specifications. These characteristics present novel testing challenges compared to traditional software. In addressing these challenges, the authors introduce a conceptual framework tailored for testing ML-based systems, with a specific focus on financial applications. Theoretical concepts are exemplified through a real-world case study of the implementation of an ML-based bond trading system within a banking context. As the AI technologies become increasingly integrated into critical financial systems, a deeper understanding of their testing strategies will be essential for mitigating risks and harnessing their full potential. The heightened significance of in-depth testing knowledge, propelled by AI-driven progress, holds relevance for both testers and managers in navigating the complexities of the technological changes.
Keywords: artificial intelligence (AI); machine learning (ML); digital banking; innovation; testing; software testing; software quality; test automation
Innovation in self-regulatory organisations in the Brazilian capital markets: The BSM Market Supervision case
André Eduardo Demarco, Chief Executive Officer, BSM Supervisao de Mercados

The capital market plays an important part in Brazil’s economic development. It meets a large part of companies’ financing requirements and protects against market fluctuations. BSM is the main self-regulator of the Brazilian capital market. It performs self-regulation, supervision and inspection for organised markets managed by B3 — Brasil, Bolsa, Balcao — one of the world’s largest financial market infrastructure companies, providing trading services in an exchange and over-the-counter (OTC) environment. Pursuant to these goals, BSM monitors operations, orders and trades executed in this trading environments, supervises market participants and, if necessary, applies penalties against those who violate regulations. In this paper, the author shares how, in his current role, he verified the need for strategic mapping of BSM’s self-regulatory agenda. The paper aims to map opportunities for creating and updating legal standards that govern the capital market, to establish incentives for economic agents to reduce cost of compliance and make their regulation more efficient and effective. Several key drivers for BSM developments are: autonomy and empowerment, collaborative culture, agility and adaptability, and technology and digital transformation. BSM is adopting innovations in several areas, including trading technology with advanced analytical tools for monitoring electronic trading platforms, risk management systems and advanced analytical tools, as well as market surveillance monitoring: artificial intelligence (AI), machine learning (ML) and other technologies to detect abusive trading activities. Furthermore, it is promoting education and research: workshops, executive education courses and partnerships with universities and market schools and other initiatives to strengthen market understanding and improve trading analysis practices. All these tools bring to self-regulatory organisations (SROs) significant benefits, including greater transparency and efficiency.
Keywords: innovation; self-regulatory organisation (SRO); capital markets; BSM Market Supervision
Practice Papers
Adapting custody services for modern asset managers and asset owners
Bruce Russell, Senior Partner, Harry Coombes, Partner, and Jaibeer Singh, Manager, Alpha FMC

Custodian banks have long been the unsung supporters of the investment industry, ensuring the smooth operation of transactions, servicing large institutions and infrastructure to support significant amounts of money management. As modern asset managers and asset owners continue to grow, however, they will demand more from their custodian- partners. The demand for services will come from more sophisticated, technology-reliant functions, and as such, the role of custodians will undergo a profound transformation. What has helped custodians be successful so far — reliance on people and process to deliver services — will not continue to help them in the future. This paper explores considerations for custodians and the adaptations required in their service models to meet contemporary challenges. We conclude that a fundamental shift is required away from traditional mindsets to ensure custodians remain central to supporting the needs of asset managers and asset owners.
Keywords: custodian; investment data; operating model transformation; data-as-a-service
Settlement of digital assets and wholesale CBDC: Solutions and interoperability approaches explored by the ECB
Maja Schwarz, Managing Consultant, NTT Data DACH

Although the adoption of distributed ledger technology (DLT) is still in a very early phase, its application to the issuance and custody of digital securities is making progress and various platforms and solutions based on a blockchain/DLT infrastructure are emerging. The cash leg of settlement, however, is still not properly solved for this type of infrastructure. For the settlement of digital assets, traditional payment rails are still often used, which hinders the technology from reaching its full potential in areas such as efficiency gains, both in respect of costs and time. To support and prepare for a potentially wider adoption of digital assets, the European Central Bank (ECB) is exploring in 2024 new technologies for wholesale central bank money settlement together with interested market participants. Central bank money systems have centralised architectures designed for single issuers and operators. As central bank money is traditionally used to support the settlement of securities, the question of how to bring it to newly emerging decentralised DLT platforms in an interoperable and efficient manner requires an answer. The ECB, together with three national banks as solution providers, is exploring three different approaches and will likely shed light on several important considerations: is wholesale central bank money necessary on-chain in a tokenised form? What are the advantages and disadvantages of alternative approaches? This paper provides a comparative overview of the explored solutions and describes the assumed interoperability mechanisms between the digital asset and payment systems.
Keywords: DLT; digital assets; settlement in central bank money; interoperability; ECB exploratory work
Streamlining cross-border withholding tax procedures in the EU : EU FASTER and Germany’s MiKaDiv regulation
Wolfgang Göb, Business Development Consultant, Software Daten Service Gesellschaft

With the recent adoption of the European Union (EU) FASTER directive, the EU intends to act against the practical hurdles for a proper taxation of cross-border income payments. At the same time, Germany is implementing the Act to Modernize the Relief from Withholding Tax and the Certification of Capital Gains Tax (ABzStEntModG) and with this, the Mitteilungsverfahren Kapitalertragsteuer auf Dividenden und Hinterlegungsscheine (MiKaDiv) reporting regulation, which aims at both the modernisation of withholding tax procedures and at anti-abuse measures, as a result of the experience with cum/cum and cum/ex tax fraud. Both regulations will have a significant impact on the processing of cross-border income payments by financial intermediaries. EU FASTER requires the implementation of new reporting regimes and will potentially change the way income payments are processed, and requires certain intermediaries to offer new services for tax relief or refund.
Keywords: withholding tax; EU FASTER; cross-border taxation
The benefits of CUSIP non-permanence: Reverse splits
Cynthia Meyn, Chief Operating Officer, Zircon & Company

The unique identification of securities is the basic building block of financial markets. It is impossible to trust anything else about a security without first knowing what is being bought and who is selling it. Security identifiers provide that critical function almost invisibly, allowing trades to be executed, cleared, settled and tracked in a standardised, consistent manner across the countless individual portfolios and security master files that make up the global financial system. This concept is so fundamental and critical to the efficient operation of our financial markets that it is often taken for granted. Two recent trends, however, have forced a closer look at the underlying governance structure of security identifiers as a potential source of trade settlement failure and confusion among market participants. The rise in popularity of reverse stock splits and the introduction of alternative securities identifiers that use a different approach to cataloguing these types of corporate actions has created a scenario in which market participants using different securities identification taxonomies will see the same underlying security two different ways. The phenomenon puts a spotlight on the issue of securities identifier permanence and raises serious questions about when an identifier needs to change to address corporate actions. This paper argues that the approach utilised in the governance of the Committee on Uniform Securities Identification Procedures (CUSIP) and International Security Identification Number (ISIN) identifiers, whereby identifiers change in response to corporate actions, is critical to the maintenance of efficient financial markets.
Keywords: CUSIP; ISIN; FIGI; securities identifiers; reverse split; corporate actions; permanence; ABA; FactSet; Bloomberg
Will tokenisation deliver efficiency? And what kind?
Udo Milkau, Digital Counsellor

This paper attempts to provide a careful and balanced look at some of the benefits and challenges of tokenisation of securities. A fundamental problem is the lack of consistency in how ‘tokenisation’ should be defined. According to a report by McKinsey & Company in 2023, ‘Tokenization adoption was poised for success six years ago, but progress was limited … the path could be different this time’. In the past, tokenisation was: (1) limited to a process of creating a representation of financial, intellectual or physical assets on a blockchain (ie distributed ledger technology [DLT]); and (2) discussed as a narrative of disintermediation and programmability as a basis for efficiency gains. As it became clear that DLT, with its basic game-theoretical approach, comes with high costs and opaque governance, traditional platforms with high efficiency such as the European TARGET2-Security (T2S) with atomic settlement and delivery-versus-payment (DvP) show up as blueprints for efficiency. A proposal of the Bank for International Settlement (BIS) for a unified ledger, Project Guardian of the Monetary Authority of Singapore (MAS), both in 2023, and an announcement of the U.S. Securities Industry and Financial Markets Association (SIFMA) in 2024 about ‘settlement on a common regulated venue … [of] tokenized assets’ can be regarded as paradigms for a new and pragmatic approach, with coordination and synchronisation as key objectives in the context of financial market infrastructures.
Keywords: tokenisation; distributed ledger technology; platforms; operational efficiency; synchronisation