As systemically important infrastuctures charged with making their markets more attractive to investors, CSDs have to work out how to remain extremely robust while simultaneously cutting costs charged to users and meeting demands for more and better-quality services. Gökçe Iliriş, head of international relations and corporate communications at the Turkish CSD, thinks the best answers to this difficult balancing act lie in expansion of core capabilities into adjacent areas, sales of software products rather than services, assuming a powerful but neutral role in blockchain-based networks and never compromising on the core duties and functions of a CSD.
Central Securities Depositories (CSDs) have a difficult balance to strike. They must retain the absolute confidence of their users in the quality of the systems, processes and procedures of the organization to which investors entrust their cash and securities, and the veracity of the information about assets and transactions that they collect and share. This requires caution and transparency. Yet CSDs must also add new users and augment their revenues by diversifying into new products and services, without jeopardising the safety and resilience of their core functions or running undue regulatory or operational risks.
CSDs must strike a continuous balance between safety and expansion
“The priority for CSDs is to provide stakeholders with a safe and efficient market infrastructure, so they can invest with confidence,” says Gökçe Iliriş, head of international relations and corporate communications at Merkezi Kayit Kurulusu (MKK), the Turkish CSD. “Yet they face many challenges in meeting regulatory requirements, adapting to disruptive technologies, meeting the cost of investing in new technologies, surviving the volatility of flows into and out of emerging markets, and responding to threats to their core revenue streams. Nor is it easy for CSDs to accommodate the multiple requests made by regulators and users. Although many CSDs are non-profit utilities, they still have to get revenues and make a margin purely to survive. CSDs are under pressure to diversify their services, but not in ways that put at risk their safety and efficiency. This is not easy.”
Iliriş lives with these competing priorities every working day. His role encompasses the development of new ways of doing business, as well as new business lines, the formation of links with other CSDs and the sale to other CSDs of the software products MKK develops for the Turkish market. And he has to fulfil this role within the peculiar constraints of being part of a larger trading and clearing stock exchange group.
MKK is a part of Borsa Istanbul Group, which is ultimately owned by the Borsa Istanbul. The major shareholder of MKK is the Takas İstanbul (Takasbank) central counterparty clearing house (CCP), which holds 64.9 per cent, followed by Borsa Istanbul with 30.1 per cent. Borsa Istanbul is a private company with special status – it is 80.59 per cent owned by the Turkish Wealth Fund, the remainder by private institutions, including a 10 per cent stake held by the European Bank for Reconstruction and Development (EBRD) – that owns 64.14 per cent of Takasbank. This gives Borsa Istanbul, directly and indirectly, ownership of 71.3 per cent of the capital of MKK.
“We are regulated by the government and the central bank and the Capital Markets Board (CMB) of Turkey, so we do not have complete freedom to develop new products and services,” says Iliriş. “We cannot simply tap into any sector where we see an opportunity. That would make us a more risky entity in the eyes of the regulatory authorities. They do not want to put the post-trade infrastructure at risk.”
MKK diversification exploits core CSD competences but avoids outright competition with users
MKK is unable, for example, to acquire a banking licence, so it cannot take deposits or lend money. Naturally, this restricts its ability to compete with the custodian banks in the provision of value-added services for buy-side institutions – but Iliriş says that is not a priority for MKK anyway.
“Our aim is to increase the proportion of our revenue which comes from value-added services, as opposed to core CSD functions,” he explains. “Like most CSDs, we are now providing more custody services than we did five years ago, such as asset-servicing. Sometimes our route crosses with that of custodians. Custodians are natural competitors because, like us, they have to invest more in technology and provide new services to retain clients or gain new ones. But in Turkey we have no plans to compete directly with the custodians because we are a monopoly, and the authorities forbid us from exploiting our monopoly. In fact, we always look to reduce the fees we charge for our core CSD functions.”
If the regulators are careful to ensure the MKK monopoly does not become exploitative, they also recognise MKK cannot cut prices without increasing its revenues from sources other than the settlement of transactions and the safekeeping of assets. So they do not place any limits on the areas MK can explore, provided they do not put the core functions at risk. In fact, Turkish regulators place no limits at all on the provision by MKK of software products and software as a service (SaaS), even where these are somewhat removed from the core business of a CSD.
One service, for example, is a dematerialised leasing contract depository developed for the leasing agency, which is a professional organisation whose legal form is that of a public institution. A second converts agricultural produce into digital warehouse receipts. A third, more recent initiative, and one which still awaits approval by the CMB, is a venture to support crowd-funding. “The idea is to treat the crowd-funding projects like listings on the stock exchange,” explains Iliriş. “We will collect the contributions to the crowd-fundings and, if they are successful, we will take them into our systems and treat them as if they are listed securities on the exchange. We will treat the contributors in the same way as we treat shareholders.”
MKK intermediates information exchanges between issuers and investors in Turkey
But the two best-known ancillary services provided by MKK are more than familiar to any CSD. One is an electronic annual general meeting (AGM) broadcast and proxy voting application, initially built to enable companies listed on Borsa Istanbul to meet their legal obligation to provide an on-line voting service to their shareholders. The other service familiar to CSDs everywhere is the role of MKK as the “golden source” of corporate actions information for companies listed on Borsa Istanbul. However, its role stretches beyond accurate events data: MKK provides a digital channel for continuous exchanges of information between issuers and their investors.
The e-voting application in particular has already found a receptive market outside Turkey. Developed from 2012 purely for the domestic market, MKK signed a partnership agreement with Nasdaq OMX in 2015. The subsequent buyers include KSEI, the Indonesian CSD, and the AFRICLEAR Global consortium made up of the African Development Bank (ADB) and the Kenyan and Nigerian CSDs. Its appeal to other CSDs is not hard to discern. As Iliriş notes, having an efficient electronic proxy voting service also helps to attract foreign investors.
Compliance with international regulatory standards meets the expectations of foreign investors
So does compliance with international regulatory standards. Unlike many CSDs in Eurasia and the Middle East, MKK has made considerable efforts to comply with the Principles for financial market infrastructures (PFMI) published in April 2012 by the Committee on Payments and Market Infrastructures (CPMI) and the International Organisation of Securities Commissions (IOSCO). It is currently compliant with all eight applicable principles as a Securities Settlement System (SSS) operator, a trade repository and a CSD.
“Most of the banks and investors which conduct due diligence on MKK check that we are compliant with the PFMIs,” says Iliriş. “Although Turkey is not a member of the European Union (EU) they also ask if we comply with the Central Securities Depositories Regulation (CSDR), and we do comply with the majority of the measures in the CSDR. Complying with both these measures gives foreign investors a higher degree of confidence about coming to the Turkish capital markets and opening accounts at MKK. It definitely provides reassurance to foreign investors and attracts more capital to Turkey.”
In fact, Iliriş sees regulators and regulatory measures in general as benign forces in the evolution of CSDs. “Regulators keep pushing CSDs to get better control over their systems, put better risk mitigations in place and deliver greater transparency for their users,” he says. “This pressure from regulators not only provides a better business environment for the users but also helps the CSDs themselves to work out how to provide more robust systems that will not spring surprises on the users.”
Meeting user expectations is a driver of innovation
This does not mean he sees users as passive recipients of whatever the regulators or the CSD choose to provide. Recalling his work in the securities and fund services department of Citibank in Turkey, Iliriş notes that customers drive innovation too. “During my time in operations, we were keen on enhancing the core systems and increasing STP rates and process automation levels to minimise risks to our customers,” he says. “But sometimes customers asked for a specific functionality in the system, which we did not yet have and did not plan to have until that day. Then, we had to initiate a new project to deliver that specific function and enhance the system to offer that functionality. So change was triggered by the users.”
Another trigger of change, adds Iliriş, is digital technology. “The next ten to 15 years in financial services will be shaped by disruptive technologies, and especially by blockchain, robotics and artificial intelligence (AI),” he says. “CSDs will definitely be affected.” Although he is circumspect about the details of the impact (“I don’t want to give a cliché answer”), Iliriş does predict that technology will prompt changes in core services (such as settlement) and value-added services (such as electronic proxy voting). He also thinks new technology will transform public disclosures by listed companies, how risks are mitigated and managed and how audited reports and accounts are produced.
More powerful digital technologies provide opportunities for CSDs to meet rising expectations
Iliriş does not believe that CSDs can insulate their processes or their revenues from disruption by these new technologies and expects them to drive consolidation. “I believe CSDs will merge or be acquired by other CSDs to remain competitive,” he says. “Like the international CSDs, regional CSDs will be formed and post-trade services regionalised.”
The upside for CSDs, according to Iliriş, is lower costs, as operational costs fall, fewer staff are required and less energy is consumed. But he also believes blockchain in particular presents CSDs with a host of new business opportunities as operators of permissioned blockchain networks. “To run settlement or asset servicing processes on a blockchain, you will need a centralised agent such as the CSD to operate and govern the network,” says Iliriş. “So blockchain will not knock CSDs out of their present role but instead offer them new roles.”
That does not mean he is convinced of the case for CSDs to switch their operating platforms to blockchain technology immediately. “Our users are happy with the existing system,” explains Iliriş. “It is tailor-made for the Turkish market, which runs on the basis of beneficial owner accounts. At the moment we do not have any omnibus accounts in the system, even though we have an exemption from the CMB to enable us to work with the international central securities depositories (ICSDs). However, we aim to on-board at least two or more foreign CSDs which will have omnibus accounts in our system before the end of this year. So we see no need to adopt blockchain technology.”
That said, MKK has not ignored blockchain altogether. “We have working groups in Turkey looking at potential applications of blockchain, to see which processes or sub-processes we can put on to a blockchain, but in most at the moment we see it as too costly to drop the existing technology and replace it with the new,” says Iliriş. “We did investigate whether our e-voting system would work on blockchain, for example. It will, but it will be more costly for the users.”
CSDs can meet rising expectations at lower cost through collaboration
He thinks the foreign sales of the MKK e-voting are a good example of how CSDs can respond effectively to technological challenges. By buying technology from each other, or pooling resources to develop new technology, CSDs can increase efficiency without duplication of investment. “The cost of duplication of processes such as Know Your Client (KYC) can be reduced by joint efforts between CSDs,” says Iliriş. “Investment in new technology such as robotic process automation, artificial intelligence (AI) and machine learning can also be shared.”
One field in which CSDs have sought to co-operate for years, and without conspicuous success, is inter-CSD links. Iliriş, one of whose responsibilities is forging links with other CSDs, has an explanation. “It is easy to open a link between two CSDs, but much harder to persuade market participants to use it,” he says. “We are always in discussion with CSDs in other countries about opening up links. The discussions always start at good pace but then they slow down because the intermediaries and the investors lose their appetite. Opening up a link is easy but making it operational is difficult.”
In other words, CSDs have made the mistake of establishing links with other markets for political reasons, without taking into account the structural and strategic constraints, different visions on either side, unexpectedly high costs and mundane operational mismatches. The negative experience has discouraged CSDs from attempting more links. “CSDs now favour links that can provide an immediate return on investment, or which enable them to provide differentiated products and services to local market participants, or which will appeal to foreign financial institutions,” he explains. “In that respect, CSDs may prefer not to have many operational links, unless they are demonstrably worth it.”
Iliriş nevertheless remains an unapologetic enthusiast for links, especially at the regional level. “In my opinion, it is always to the advantage of the users of the CSDs to have the broadest possible access to other markets,” he says. “For instance if you are an investor or a financial institution based in or operating in Eurasia, you would like to have access to every market in the region because you pretty much speak the same language, have a more or less similar culture in life and in business, and it is much easier to convert local currencies into each other than it is for an investor in another part of the world say, to convert a local currency into Kazakhstan Tenge.”
Expectations of all CSD stakeholders remain perfectly aligned on the issues of safety and efficiency
Whether or not they can be revived on a regional basis, inter-CSD links are for now a clear case of CSD expectations outrunning those of their users. But on one issue, they remain perfectly aligned. “CSDs are expected to provide safe, efficient and reliable post-trade services, to contribute to the maintenance of the safe and stable operation of the capital markets, and to ensure investor protection and asset safety,” explains Iliriş. “These are the expectations of all the stakeholders too. They do not change over time and are accepted as given.”
However, as Iliriş points out, expectations adjust and priorities change, as the different interest groups within a CSD interact with each other. “CSDs, like any other living organism, evolve in time,” he says. “This evolutionary process is based on certain triggers and these triggers stem from the different needs and requirements of different stakeholders. Sometimes the triggers are initiated by regulators and followed by investors, and sometimes vice-versa. It would be wrong to believe that one group of stakeholders always wants change more than any other. All parties – users, regulators, owners and management – have the same level of effect or control over CSDs in terms of pushing them to achieve more or develop more services. All stakeholders are on the same footing. In fact, they are like one foot following the other.”
Wednesday 10 April 2019
Expectations of CSD stakeholders. What have CSDs done to transform and meet expectations since WFC 2017? Have the expectations changed in the last two years and if so how so?
Moderator: Bruce Butterill, Executive director, ACSDA
Nandini Sukumar, CEO, World Federation of Exchanges
John Siena, Association of Global Custodians (AGC)
Gerard Hartsink, Chairman, GLEIF
Nasser Seddiqi, Director, Market and Financial Operations, Moroccan Market Authority
Gokce Iliriş, Head of International Relations and Corporate Communications, MKK, Turkey