Discussion at BNP Paribas: Enhancing Capital Allocation in Times of Financial Strain
In the rapidly evolving world of finance, equity markets are witnessing a significant shift towards automation, following their electronification. This transformation has resulted in business units that operate with high volume and low margins, necessitating maximum efficiency.
One of the pioneers in this new landscape is BNP Paribas Securities Services, which recently introduced a post-trade service offering in Italy, Germany, and Luxembourg, in partnership with UniCredit. This move aims to streamline operations and provide a more efficient service in the face of increasing market complexity.
The need for efficiency is not limited to Europe. Larger brokers, for instance, have been building platforms to manage risk and optimise capital internally. This internal strengthening has proven beneficial during periods of heightened volatility.
However, the landscape is not without its challenges. Firms in both market-maker and clearing businesses are consolidating due to commercial pressures and heightened sensitivity to the use of capital. This consolidation trend is particularly evident in Asia, where the issue of market complexity and capital management is a significant challenge, exacerbated by jurisdictional fragmentation.
The Asia-Pacific region, represented by markets like Hong Kong, is not immune to these pressures. The Hong Kong cash market, for instance, has seen a reduction in members over the past decade, while its derivatives business has also decreased. The market, however, has shown resilience, with the cash market exceeding HK$240bn (US$31bn) in the first half of the year.
Yet, the market faces risks associated with a more concentrated broker community operating in different jurisdictions in Asia. This concentration increases the risks associated with failed trades, a common issue in over-the-counter (OTC) fixed income markets.
As financial institutions grapple with increased uncertainty and the need for larger capital buffers due to market volatility, effective capital management is becoming a competitive advantage for broker-dealers. A major broker dealer, for example, has observed that using a bank entity to become a clearer is the easiest way to be more capital efficient and reduce capital requirements.
Third-party clearing has been cited as a clear winner for better efficiency for all the dealers in discussion. This shift towards outsourcing clearing functions is driven by the need to reduce costs and manage risks more effectively.
Regulatory and cost pressures are accumulating, limiting business growth and internal liquidity of capital. These pressures are particularly felt in smaller markets like New Zealand, where it is crucial to right-size the market while avoiding excessive additional regulatory and cost given its size.
Awareness of operational constraints is a priority for C-suite decision makers due to the impact under both calm and testing market conditions. Companies are taking more notice of post-trade costs when assessing strategy and feasibility. Post-trade cost reduction could be a gamechanger for companies navigating market complexity.
Regulation creates challenges for market participants, potentially increasing systemic stability. In Asia, regulation is becoming more conservative, with regulators taking a more rigorous approach, including anti-money laundering and sanction practices, which add costs.
Representatives from NZX and HKEX have discussed the pressures their members are facing, with larger global brokers being well-capitalized but local and regional members potentially facing challenges. Despite these challenges, the future of global equity markets remains promising, with innovations in technology and a focus on efficiency set to shape the landscape in the years to come.
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