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 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
  Abstract

  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
  Abstract

  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
  Abstract

  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
  Abstract

  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
  Abstract

  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
  Abstract

  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
  Abstract

  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