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Capital And Credit Management: The Changing Face Of The Regulatory Environment: Thought Piece From Andrew Powell, Chief Operating Officer, Softek

Date 26/10/2016

It is hardly breaking news that regulation is changing the landscape we operate in, whether this be Basel III/IV, MiFID II, EMIR, CRD IV – the list is endless.  Nevertheless, the fact of the matter is it all affects us in some way shape or form. Within this three part series focusing on Prime Brokers, Broker-Dealers and firms operating in the Securities Finance sphere, Andrew Powell, Chief Operating Officer at Softek, gives his account and insight into what these firms are implementing, or looking to implement, in order to cope with the changing market space. This series will serve to report on industry trends and expected future changes - all from a market perspective.

Andrew Powell

Andrew Powell, Chief Operating Officer, Softek


Over the years, we have witnessed the Prime Brokerage industry undergo significant regulatory change and right now Basel III is a key focus. Taking a capital and credit view, this piece of regulation places greater emphasis on understanding the impacts that running a Prime Broking business has on the balance sheet. Firms are now actively looking at and testing different methods/models in order to account for costs such as LCR, NSFR, and internal transfer pricing in order to make sure the true cost of funding is understood. But, for many firms this is not a trivial or easy exercise as it involves analysing and sifting through copious amounts of data from multiple and differing systems in order to generate the information required. All of this must take place before the calculation can even be actioned. As you can imagine the need to gather data from multiple systems comes with its own challenges as each platform has its own format, symbology and field definitions. This means that each firm must create a consistent and normalised data set and although this sounds easy, it should not be underestimated. Nevertheless, it is an essential part in enabling firms to identify costs at an individual client and/or product level ensuring the business can price appropriately. If necessary, it may mean identifying an alternative business and/or funding structure to reduce the cost of capital, liquidity and overall impact on the balance sheet.

Analysis of the business impact of Basel III has resulted in some Prime Broking firms stepping up their intraday monitoring. An initial evaluation which Softek undertook for a number of firms revealed that, at points during the day the banks’ clients were 3 or 4 times over their prescribed leverage limits, suffice it to say this discovery came as an unwelcome shock. In today’s market the start of day view of capital, liquidity and concentration alongside client margin exposures is fast becoming inadequate. The move to intraday monitoring means firms can effectively manage clients against their credit policies, risk limits and take corrective action where necessary. Furthermore, exposures by, for example, concentration, leverage, asset class, holdings, currency, margin calls and unhedged positions can all be assessed in near real-time. Not all Prime Brokers have embraced this move and some may not be able to due to limitations within their current systems.  Regulators are however asking the intraday question so it’s not something that can be ignored for long.

In addition to the intraday move, we have seen Prime Brokers focus on stress testing, especially given the recent economic events. Case in point, the Brexit vote created a mass of uncertainty with high levels of market volatility. During this time Prime Brokers utilised a number of stress test scenarios so they could understand how client positions would impact capital, liquidity and margin under different market conditions. These scenarios were run at the start of day and then at periodic intervals during the day to re-assess potential impacts.

From what we’re seeing, the impact of all this change is driving the need for Prime Brokers to monitor credit and capital not just once a day but on a frequent basis throughout the day. How frequent, depends on the nature of the client and their investment strategies. What we’re seeing is regulators asking firms the question, can you monitor capital and credit exposure on an intraday basis and I know what the answer needs to be.

Finally, with the increasing pressure on capital, we have seen a number of firms exit the Prime Broker business forcing their (ex) clients to seek credit elsewhere.  As a consequence a number of smaller firms are now offering Prime Broking services. This restructuring is a story only partially told and will fully play out over the next 12-18 months.