Mixing Strategy with Practicality – Building a Post-trade Operation for a New OTC Derivatives Landscape
Regulatory uncertainty has thwarted efforts to build a compliant post-trade operation for both bilaterally executed and clearable swaps. SunGard’s Tony Scianna explains how financial institutions can make practical changes to post-trade processes to satisfy current circumstances but also meet future regulatory requirements.
Q. How is regulatory uncertainty affecting how firms are changing their post-trade operation and how can they be preparing despite this uncertainty?
The regulatory uncertainty isn’t allowing financial institutions to make the decisions they need to. However, firms still need to be prepared to deal with what the rules are meant to do. For instance, financial institutions don’t yet know what they need to report on, but they do know that transparency is the intention of the regulatory changes and that they will have to report on all trading activities, in all jurisdictions, and they can prepare for this.
Financial institutions also need to take a longer-term view of all regulatory requirements and their impact on the middle and back office. A firm could look at each new requirement one at a time and solve that problem as it currently stands. Or, the firm can look at the bigger picture and try to prepare for not just one rule but for the ability to address multiple rules that will be introduced over time but share the same intention – to increase transparency and reduce systemic risk.
Q. Let’s drill down into some of the specific post-trade processes that need changing ahead of the new regulation. Data Management: How can financial institutions change data management to support regulatory reporting and other processing changes needed to comply with new rules as they are introduced?
Regardless of the lack of clarity in the regulatory rules, financial institutions of all types will be required to capture and disseminate their trade information. So even though we don’t know what the specific rules are yet, the participants know the intent behind the rules, the specific demands for transparency and the impact on trade reporting. And this requires investment in the back office to capture, standardize and disseminate that information from across the enterprise and the ability to make the data readily accessible for ad hoc and time-sensitive queries.
The challenge that many firms face is that not all back-office applications are in real time, so investment in data capture is essential. Reporting on transactions will be a necessity not just for bilateral contracts and clearable swaps but for all asset classes. So it is even more important that firms ensure that the technology that underpins their connectivity and data capture capability is flexible enough to support multiple asset classes and new mandates as regulations evolve.
The key takeaway here is that firms can make these improvements to data management processes to support future regulatory reporting requirements now and address other areas once there is more clarification.
Q. Connectivity: How can firms set up connectivity to new market structures when these structures haven’t been firmly established yet?
Just like with data capture, the ability to connect to exchanges, swap execution facilities (SEFs), organised trading facilities (OTFs) and swap data repositories (SDRs) will have to be flexible enough to connect as new market structures emerge. The uncertainty about which structure will emerge first – and thus require connectivity first – only reinforces the fact that firms and their systems need to be adaptable. At the same time, they should plan out how they will capture data for reporting to these various structures.
Q. What are the challenges in managing the post-trade processing of clearable swaps, listed trades and bilateral contracts efficiently and perhaps even in tandem?
Some firms are looking at their OTC derivatives processing platforms to see what they can do to support the management of bilateral, centrally cleared OTCs and listed derivatives. For years, bilaterally executed and centrally cleared derivatives have been based on two separate processing applications. If firms are clearing with a CCP, they won’t want to have to deal with two separate sets of books and records for the listed and clearable swaps that they have cleared at a single clearing house. Bilateral contracts will probably remain totally separate, and those applications will need to add the functionality required for execution, matching and reporting requirements.
Additionally, firms face the challenge of managing a range of more complicated instruments for both bilateral contracts and clearable swaps. This is something the back-office operation will have to deal with.
Q. Collateral management will transform with the move to central clearing for clearable swaps. How can firms mix practical with long-term strategy when planning changes?
The new regulation is making a huge impact on the clearing of OTC derivatives and collateral management. The recent MF Global default has brought the topic of collateral management to the fore, and the industry needs clarification on how the regulators and CCPs will change the processes surrounding collateral management and collateral segregation.
Of course, while mandated central clearing and the related new margin requirements present new business opportunities for some banks and custodians, they also complicate collateral management processing internally because firms will have to update their operations infrastructure to support clients for whom they clear and manage collateral. Additionally, firms will have to manage the different margin requirements of each CCP that they deal with, whether the relationship is direct or on behalf of their clients.
In addition, collateral optimization will be crucial for market participants going forward. They need a solution that allows them to select the most efficient type of collateral to meet its collateral obligations. That said, the market requires clarification on what type of collateral will be eligible for use by various CCPs before optimization strategies can be firmly established.
Flexible is key here as well. Financial institutions that are building optimization capabilities will need to be able to take into account the different margin eligibility parameters that will be introduced as this space evolves – both in terms of the CCP margin eligibility and in terms of customer collateral via clearing services.
Q. More on Margin Management: How are firms improving margin management?
As I suggested above, firms do need to prepare for new margin rules with clearable swaps, as CCPs do not use the same margin rules. CCPs are using more of a Value at Risk (VaR) calculation, but the calculations are not, thus far, as accessible as we would like them to be.
As the months pass without additional clarity around the regulations, the compliance challenge is only getting more complicated. Firms that take a flexible approach rather than waiting for the final decisions will be best placed to respond to the latest regulations as well as those that haven’t even been developed yet.
Tony Scianna is deputy head of strategy for SunGard’s capital markets business. He represents SunGard in industry groups and provides market insight to help shape business strategy and product development.
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