Can we learn from CREST, the real-time securities settlement system for the UK and Ireland that went live twenty years ago this month? Since the project was a glint in the eye of its creators it has proven through its on-going performance to be one of the most important and successful systems introduced in financial markets.
In this vein, a new report titled ‘CREST Revealed: From Paper to Automation’ from B.I.S.S. Research (BISS), a City think tank and benchmarking firm, looks back and has evaluated the history and developments around CREST, which was originated under the Bank of England nearly a quarter century ago. It’s important to note that CREST was created in a crisis.
So what can we learn from these latest findings contained in this 40-page whitepaper? There is a fair bit to get your teeth into given that the study was put together after extensive research and interviews with around twenty participants who contributed their insights and perspectives on the CREST project.
As a former staffer at the London Stock Exchange (LSE) in Old Broad Street within the Regulatory News Service (RNS) when the exchange first demutualized, I must confesss I'm a bit partial to delving back into the history and records around the Stock Exchange Tower.
The list of industry protagonists canvassed includes Scott Dobbie, a former CREST chairman, John Gubert, a Euroclear board member from 2002-2007, Angela Knight, ex-British Bankers’ Association chief executive, Kevin Milne, whose career began at the London Stock Exchange in 1986 months before ‘Big Bang’, and Iain Saville, who set up CRESTCo in 1994 on secondment from the Bank of England.
CREST, which is not in fact an acronym although some have devised the name ‘Certificateless Registry for Electronic Share Transfer’, continues to work seamlessly in the background. But what is somewhat ironic is that many of today’s practitioners, academics and students of the securities industry know so little about this important component of the European post-trade infrastructure. Since 2002 it has been operated by Euroclear.
Oddly enough while the disaster of TAURUS (Transfer and Automated Registration of Uncertified Stock), an IT project started in the 1980s that set out to transfer the London Stock Exchange from paper communications to an automated system and reduce cost and efficiency, failed miserably and received a plethora of news coverage versus that for CREST.
I guess that just shows bad news stories get more column inches over good ones. Taurus eventually cost £75 million (m) and saw 17 proposed systems before being replaced by CREST, and is estimated to have resulted in some £500m of damages.
Today, the on-going changes in the industry and advances in financial technology force companies to focus on current challenges. There is no central archive, for public use, of documents and reports by contemporary witnesses who were directly involved in making history.
With key actors retiring and most material only kept in private archives, it is very difficult to access such information. As such BISS felt it was important to recognize the contribution that CREST made to the financial services industry and the economy - and capture the views of the key players.
CREST’s Economic Value
The report highlights the economic value provided by CREST and the return on investment in it is incalculable. Just take 2014, for example, the annual number of transactions processed through Euroclear, the International Central Securities Depository (ICSD) was around 190 million (m), with a value of €674.7 trillion (trn).
A substantial percentage of this was settled through the CREST system, which settles equity, fixed income (UK government bonds or ‘gilts’) and money market financial instruments.
CREST’s value proposition includes; privatisations and other flotations, corporate actions, and mergers and acquisitions (M&A). And, it remains state of the art in global terms and its architecture has allowed it to be developed and its capacity upgraded over the decades.
The fact CREST still underpins settlement in the UK financial markets is a remarkable fact when one considers the technology available twenty years ago and the near disaster of the settlement crisis and the economic turmoil that existed then. Sounds familiar?
BISS’ study, which was initiated last year, examines the efficiency of the UK securities market since 1996 and how the CREST system came in on time and within budget. But what is also obvious is that the environment of some two decades ago bears some similarities with the events of today.
Global financial markets today are trying to recover from the economic and banking crisis that reared up in 2008. There is also is an on-going threat of new technologies - Blockchain amongst them - that could replace the existing legacy systems and possibly the market structures themselves. The Internet has been a key technology driver since 1996 with the resultant globalization and on-line interaction between financial services firms and their clients.
“As result we have seen the fragmentation of central markets with now a host of choices to trade and settle transactions,” says Gary Wright, CEO and founder of BISS Research.
The ex-head of European settlements at JPMorgan Flemings in London, he adds: “Technologies like Blockchain take the fragmentation a stage further with its distributed ledger technology enabling ‘point-to-point’ communication and settlement moving the middle man intermediaries out of the way.”
This has the potential to restructure the markets and its players in similar fashion to when CREST was first introduced. The CREST design demanded that users invested in new systems to enable their business to flourish. Some processes and systems were made redundant but also replaced with new systems and processes that were required to use CREST. New business processes virtually created a new business.
“Today we see in Blockchain a technology that introduces the potential of new processes and a new business could emerge. Changing market structures is not simple and is expensive,” says Wright.
The financial markets have gone through twenty years of change through regulation and laws, yet twenty years ago change happened through technology innovation and today we are in the beginning of a massive technical innovation.
Was CREST A Disruptive Technology?
Whether a technology is disruptive or not can be assessed by looking at the time period in which change was achieved, and at the degree of the resulting performance improvement. A disruptive effect happens if the time period is rather short and the performance increases dramatically.
“Although the CREST software experienced some teething problems once volumes had increased after its launch, by the end of 1996 the most significant of outstanding issues were rectified,” notes Wright. Overall, the report states that CREST “achieved the transition process in a remarkably short time.”
Let’s look at some of the statistics. In November 1996 CREST was being used by about 1,000 investing institutions, brokers and banks settling over 10,000 transactions per day in 571 securities, which accounted for around 25% of the total market volume of transactions (UK and Ireland) at the time.
Fast forward to July 2001 and CRESTCo announced that the number of transactions had increased to around 300,000 transactions a day with a value of around £200 billion (bn). This means that in five-year period the performance was increased thirtyfold.
Such a performance improvement would not have been possible by traditional paper-based techniques and the TALISMAN system from mid-1970s, which some had described like an “aircraft from the propeller age” and not fit for the jet age. It was fully replaced by CREST in April 1997.
The fact that CREST enabled the processing of much higher numbers of electronic transactions was disruptive for settling trades, predominantly those struck on the London and Irish Stock Exchanges in UK and Irish securities. “It is therefore fair to say that CREST was a truly disruptive technology,” Wright argues.
Why Has CREST Continued To Work Successfully?
Settlement of financial transactions is a complex and difficult field, with historically based relationships that have evolved over many years. New technologies introduced over decades, new laws and regulations have all helped to create the securities markets that we have today.
Typically, nothing was designed by the UK market with market efficiency in mind. Rather it has been reactive. However, CREST provided a unique opportunity to innovate and create a new market model.
“Clearly CREST was designed for purpose in 1993, but it’s a remarkable feat that it has been able to meet all the settlement needs over the intervening years, and it carries on doing so today,” says Wright.
In terms of features, it was multi-currency from the outset. Therefore the introduction of a new currency, such as the euro, held no problems. And, the report notes that CREST is “extremely competitive in terms of speed and low cost, being accepted as a value for money system.”
The corporate structure of CRESTCo was also a key factor in its longevity, as it helped to ensure the on-going use of the CREST system, by its stakeholders. “CREST users have continued to support the system, resulting in total integration to provide the DNA, within modern systems, which have replaced some of the original systems, designed to provide CREST connectivity and settlement functionality,” the report states.
To the extent that CREST has become part of the industry furniture, where it sits almost unquestioned by its users because it is reliable, it works and gives them what they want. Fundamentally the test of a good design and system can be found in its longevity and relevance over time.
It is “highly unlikely that there will be a scenario where CREST will be replaced”, as was the case with Talisman some two decades ago according to the view contained in BISS Research’s study.
“Most likely CREST will continue to be upgraded technically and modernised by its current owners,” contends Wright. Today, CREST operates under the umbrella of Euroclear as an important and high performing component of the European post-trade infrastructure.
Could Anything Have Been Done Better?
CREST was designed to become the single settlement system for the UK and Irish securities market. The achievement of this objective should be regarded as an outstanding success. But the London Stock Exchange was characterised by a broader set of interests, such as international cross-border trading.
Thus settlement of these trades was of still greater importance to the City of London financial markets, its actors and the UK in a wider context. Integration with other European post trading infrastructure providers could have been beneficial.
CREST’s response was to seek to interoperate with other European Central Securities Depositories (CSDs), while leading work for standard protocols and messaging that would permit those CSDs to make one IT investment, reusable with multiple interoperating CSDs.
However, large users of multiple markets argued for cross-border mergers of CSDs, ideally culminating in a single (user owned) European CSD. As a result, interoperability did not succeed. It has however been adopted by Central Clearing Counterparty (CCPs) with much success.
The report further points out that the UK Government could have set a date when all shares (equities) would be held electronically, thereby removing the option for paper certificates to have legal value, or be proof of entitlement. This would have enabled significant cost savings for custodians and sub-custodians.
Lessons Learned
When looking at CREST and its development, the unique historic context has to be considered. That said, the report points to a series of features regarding its project management, which can serve as the basis for lessons learned - no matter what scale of projects.
While the CREST project was not perfect, it was good at developing and propagating design ideas to engage the users, and making workable compromises. The report reveals that there is evidence that most of those involved - users and the core team - positively enjoyed the ride and despite stress at times.
This was said to be down to the friendly tone of the interaction between clients and supplier. And, as such the report states that “this may well be a critical success factor when delivering a complex project.”
The Bank of England and UK Government at the time needed to ensure that the UK retained its global position as one of the three leading financial markets along with New York and Tokyo, and the dominant player in the European time zone. The stakes were very high and pressure to succeed was enormous. Another TAURUS disaster could not be afforded.
Dealing With Complexity
The report cites managing complexity and the requirement for getting top management commitment and strong decisive leadership. “Scaling up for industry projects requires ‘buy-in’ from the various actors at the beginning,” it states.
And adds: “It must be managed throughout to ensure confidence remains high so that the result is never in serious doubt. Marketing the benefits and retaining focus on deliverables will help keep ‘buy in’ secure.” Strong decisive leadership is fundamental in progressing along at a good pace and in meeting the milestones of a project.
In addition it touches on project teams who “must keep responding to the needs of the users” and users not being kept in the dark, to be constructively part of problem solving and making them feel “an important part of delivering the solution.”
On top of that focussing on a successful outcome and meeting the milestones of a project. Whilst it is important to get the balance between all the various points right, granting every wish from users and different actors can be a weakness that can “cause time and focus to be lost” and result - as with TAURUS - project failure.
The $64 billion question remains though. What is the driver for implementation of innovative systems? As Wright posits: “CREST was driven by an industry need, but will Blockchain?” Perhaps in a decade or even sooner we might know the answer.
Note: This BISS Research whitepaper was funded by BT, The Chartered Institute for Securities & Investment (CISI), Euroclear, the SWIFT Institute and 200-year old London-based law firm Travers Smith.
