The world’s capital markets infrastructure (CMI) has demonstrated impressive resilience during the period of COVID-19—induced volatility. Recent insights from BNY Mellon, with contributions and data from SWIFT, demonstrate how capital markets infrastructure withstood volatility and offer CMI providers four lessons for the future. </p> The COVID-19 pandemic, and the government-imposed lockdowns introduced to stem its spread, created unprecedented disruption to people’s lives and jobs, and to global economic activity. Capital markets responded in an agile manner, even as market participants moved to remote working. The pandemic ended the 11-year U.S. stock market bull run and prompted the quickest drawdown on record. As volatility significantly increased in financial markets, there was a brief spike in redemptions while investors sold stocks and piled into cash or fixed income markets.</p> Overall, the period was the most extreme stress event since the 2007–09 global financial crisis. But despite sharply increased trading volumes, the industry—including exchanges, clearinghouses, central depositories, alternative exchange venues, inter-broker dealers/banks, custodians, collateral management and information providers—all functioned well. While large margin calls impacted clearing member banks’ liquidity, default rates at clearinghouses were low compared with the 2007–09 global financial crisis. </p> The resilience of capital markets infrastructure indicates that the post-crisis reforms of the financial markets worked as intended. And while CMI service providers can be proud of the industry response during a time of great pressure, there are lessons that can be drawn from the COVID-19 crisis that can help CMI and capital markets to be optimally prepared for further shocks. Four key themes should drive CMI focus and development as market volatility may reemerge in the coming period.</p> A. Streamlined Communication</strong></p> The COVID-19 crisis has shown the value of speed when it comes to communications. Transparent, frequent and flexible client and regulatory communications, outside of traditional reporting cycles, are likely to become a prerequisite for market participants to a greater extent. At the same time, many asset managers, custodians and vendors will focus on front-to-back offerings, using post-trade information in new ways, including improving reporting and generating insights.</p> Further harmonization and standardization of data and messaging between institutions and CMI providers are critical to enhance markets’ responsiveness in times of heightened volatility. There are no magic bullets. But recent advancements in community APIs to enable better and timelier communication, in areas such as the net asset value of a fund and status reports, are advancing the industry toward streamlined and faster communications.</p> Further increasing digitization of markets—for example, in corporate bonds and repo—will help to streamline the interaction among market players. Although significant volumes in such markets remain OTC because of limited liquidity, new technology deployed by CMI players has the potential to overcome these challenges by lowering cost and enhancing communication flows.</p> B. Enhanced Collaboration</strong></p> The intrusive volatility shocks during the COVID-19 crisis brought credit, collateral and liquidity management to the fore for asset managers, banks, brokers, dealers, advisors and insurance firms, as demonstrated by the criticality of meeting margin calls, at times on tight deadlines.</p> Collateral and liquidity management efficiency are offered in the market by specialized CMI players such as BNY Mellon, providing access to a wide and global ecosystem of collateral takers and givers and vast pools of collateral. Further broadening the reach and depth of these ecosystems, as well as offering institutions an aggregated view of their exposures, positions and allocation optimization, enhances collateral and liquidity at market level and hence resilience in times of heightened volatility.</p> Corresponding operating models are evolving, seeking to enhance connectivity between ecosystems and overall collateral mobility, further strengthening the overall collateral and liquidity environment to withstand times of volatility. There should be an increased focus on building partnerships between CMI providers and key institutions, broadening collaboration, introducing micro-service technology (single-function modules with well-defined interfaces and operations) and open business architecture. By combining forces, CMI providers can give clients additional flexibility and improve overall market efficiency.</p> C. Standardized data and information</strong></p> High-quality standardized data has a key role in driving efficiency in CMI flows as digitization progresses, while timely and granular multi-asset data is essential to optimally defining investment strategies, e.g., incorporating environmental, social and governance (ESG) criteria. Standardized qualitative data also powers deployment of newer technologies such as artificial intelligence and machine learning, facilitating predictive and prescriptive analytics. Such data also fuels the various platforms that aggregate information and optimally direct flows, while providing additional value-added services such as collateral management, billing reconciliation and analytical insights gleaned from those flows, so that market participants can make faster and better-informed decisions.</p> Emerging innovations such as distributed ledger technology (DLT) and tokenization, underpinned by qualitative data, will allow multiple parties to see the same record on a real-time basis, eliminating the need for labor-intensive data reconciliation. Current core systems and new technology ecosystems such as DLT will require agreed-upon data definitions to be interoperable. Such common data dictionaries endorsed by the industry can help foster technological innovation.</p> D. Business and market resiliency</strong></p> The COVID-19 crisis has reinforced various fundamental trends taking place across financial services segments, which are likely to further encourage many firms to reassess their existing operational setups and processes. Firms may seek to stress test their operating and outsourcing models to specialists beyond current stretched scenarios, in areas such as remote working capabilities, digitalization and cloud-enabled infrastructure, and asset diversification toward alternatives and passives. Risk management models will need to incorporate new and emerging investment factors, such as the rate of COVID-19 infections.</p> Systems access rights and remote working made it difficult for the financial industry to manage nonautomated processes in particular. Where regulation permits, adoption of cloud and hosted solutions, including SWIFT’s Alliance Cloud, seems certain to increase. Going forward, collaboration between CMI providers and the asset management industry will help enhance business continuity by advancing cloud and hosted solutions and appropriate backups. In addition, CMI providers can help market players to apply best practices in cyber and fraud prevention, which has become increasingly important given remote working.</p> Similarly, the COVID-19 crisis may accelerate the outsourcing of post-trade activities: Asset managers and asset owners increasingly see the benefit of outsourcing middle- and back-office operations, which do not create value and can be done more efficiently by dedicated players while freeing up the buy side for its core activity. Advisory services are a potential next step in this continuum. Once market participants recognize the value of outsourcing non-core functions to dedicated service providers, it is easier for CMI players to develop and provide market services such as balance sheet optimization, risk and performance analytics, and strategic advice regarding “new normal” investment strategies to asset owners, and advisory for holistic end-client service models to insurance firms, for example. </p> Looking to the Future</strong></p> As financial markets further evolve, considerations of safety and resiliency of market participants and the broader financial system will continue to determine the strategic focus of the CMI community. Safeguarding clients, continued awareness of their challenges, and standing by them during tough times are the hallmarks of successful CMI businesses. CMI players’ resilience and maturity bode well as we move toward a post-COVID-19 “new normal.”</p> BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may be used to reference the corporation as a whole and/or its various subsidiaries generally. This material does not constitute a recommendation by BNY Mellon of any kind. The information herein is not intended to provide tax, legal, investment, accounting, financial or other professional advice on any matter, and should not be used or relied upon as such. The views expressed within this material are those of the contributors and not necessarily those of BNY Mellon. BNY Mellon has not independently verified the information contained in this material and makes no representation as to the accuracy, completeness, timeliness, merchantability or fitness for a specific purpose of the information provided in this material. BNY Mellon assumes no direct or consequential liability for any errors in or reliance upon this material.</em></p>