Post-trade providers stepping up as passive shift ‘jeopardises entire intermediary infrastructure’

Discussions around data helping illiquid instruments trade more effectively conjure up worries about what the future of passive investing and what it means for post-trade providers.

One of DTCC’s top data experts has issued a stark warning about the potential threat of passive investing on the entire intermediary ecosystem unless custodians and market infrastructures overcome data challenges and show sentiment and liquidity in the markets.

Speaking at Sibos 2018 in Sydney, Tim Lind, managing director, DTCC Data Services, said that while service providers have the historical data to help illiquid instruments trade more effectively and therefore reduce the rapidly growing shift to passive investing, there are rules, privacy concerns and regulations which are placing challenges on post-trade providers.

“These faint signals and the historic data that asset servicers – be it a custodian or market infrastructure – can provide, may show signs of sentiment or liquidity and help tip the balance more towards active management which I think benefits the vibrancy of this entire industry,” explained Lind.

“If the industry goes from active to passive with no expectation of return based on stock selection, and the entire mutual fund and retail industry is based on low-cost – ‘throw it in an index’, the ability of investment managers, hedge funds and others to create fees and value-added products is degraded to such an extent that their business models are challenged.”

“Everyone at this conference, in some way or another, services that [active] business model. When the core investment community can’t prove that they can create return, if companies that actually have innovation and growth cannot be rewarded by having investments allocated to them then the entire intermediary infrastructure that you see today will be jeopardised.”

Custodians and other post-trade service providers have the potential to draw on the historical data they have amassed to create added-value products and services for their clients. However, participants agreed that regulations and individual client use policies may place limits on that data use, even if aggregated.

Tim Grant, founder and CEO of DrumG Technologies echoed Lind’s concerns about the shift towards passive investment but believes rule changes can liberate the data.

“We have got some massive walled gardens, so how can we liberate this data in a secure and private way, provide better information on liquidity and allow us not to fall into the trap of a passive world?” said Grant.

Speakers highlighted that challenges around data persist and are evolving, especially around privacy and ownership, which were only exacerbated by the Facebook-Cambridge Analytica scandal.

Regulations and different rules across jurisdictions mean that service providers are still figuring out how best to deal with these issues, even while liquidity continues to drop in the fixed income markets, which, in principle, could make good use of the insights the data could offer.

HSBC’s global head of custody, John van Verre, explained that “More and more, sophisticated investors have their own data policies. That’s a very good development as it informs us. With post-trade analysis, you want to include as much information as you possibly can.” He noted, however, that, “countries are becoming restrictive about their cross-border data sharing. So there is value in it, but there are limiting factors.”

The value versus privacy debate will rumble on, and Lind argued that post-trade service providers need to understand the nature of the data and how it is used by their clients in order to fashion new data services that are perceived as valuable.