Utilities in securities finance: taking an old dog for a new walk (Premium Content)

This is no slight on utilities – they are a very good idea to share industry resources with a pay as you go model. Rather, this article looks at the nature of utilities as the silos of securities finance and OTC derivatives get overshadowed by corporate entities with shared services (the Enterprise Cloud model). We start with our article in Securities Finance Monitor Magazine from June 2015 and add some new perspectives.

In our June 2015 article, “The Growth of the Utility Model in Financing, Clearing and Collateral Management,” we five rules of thumb when considering outsourcing to utilities:

  • Commoditization. Is the service sufficiently commoditized as to not add value as a differentiating factor?
  • Shared Service Requirements. Do all utility users have the same problem? Can that problem be defined in its tightest scope to capture most or all services for the target user group?
  • Shared Risk. Is there a problem in the market that puts a group of participants at risk, and can that risk be mitigated through cooperation?
  • High Volume, Low Margin. Can a utility process a large volume of calls, transactions or other metrics where being the industry gorilla results in a lower per unit processing cost than individual firms taking on the same responsibility?
  • Outsourced Technology Infrastructure. Does sharing the cost of technology infrastructure with competitors results in a reliable service with low cost of ownership?

Our more recent reflection on this topic considers whether the utility is meant to solve an industry silo solution or can it work across silos, thereby selling to the central nervous system of an enterprise. Its true that financing business are niche operations, and each market is different. That said, if a utility could work generically for all collateralized products, can it be taken on board by a central processing group? We think this is the next twist in the utility conversation.

We see opportunities for product-agnostic utilities going something like this:

– Calculations for haircut or collateral risk
– OTC processing functionality (interest-rate swap, CLO, repo, etc.)
– Balance sheet calculations (the “capital cost calculator”)

We noted in June that “The utility model has been gaining traction in securities finance, clearing and collateral management in 2015. From derivatives to non-cleared margin calculations, from outsourcing middle office to creating one shared platform for collateral services, it seems that everyone wants to get into the outsourcing game. Is this a fad or the start of a long-lasting shift in the dynamic of who manages what fundamental services in the marketplace?”

We think that the growth of the Enterprise Cloud suggests a movement towards a long-lasting shift in the market. Product specialists will argue that their products are special and need greater customization, but we’re not so sure. The trend of the Enterprise Cloud is to homogenize products to make them look as similar to each other as possible for the easiest processing. This will push opportunities for outsourcing to utilities.

We’re actually sorry to see this trend in motion. The flattening out of diversity in products and markets means that things will be a bit more boring going forward. Safer, probably, and more transparent, but plain vanilla takes away certain opportunities for creativity. Maybe we’ll be proven wrong, but right now it looks like the market is moving towards more of a one-size-fits-all model. That at least will serve utilities well.

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