Over the Counter (OTC) derivatives present unique challenges to money managers, institutional brokers, clearing agents, and technology vendors. They also provide relatively high margins, tailored exposure, unique financial solutions and incredible growth opportunities for all of these groups. New TowerGroup research finds that to participate effectively in this market, broker dealers require a trading platform with a wide range of specialized tools, including risk analysis, decision making support, trade entry, execution, and operational support.
TowerGroup predicts that spending by institutional brokers on derivatives trading technology applications will rise by a compound annual growth rate of 9.5% over the next five years, from US$915 million to a total of US$1.3 billion. A graphic illustrating this data point can be viewed and downloaded at: http://www.towergroup.com/research/content/page.jsp?pageId=1822.
There is currently no single system in the OTC derivatives trading space that provides enough structure and processing capabilities to be called a single solution for a broker dealer. With the rise in market electronification and automation, TowerGroup notes that certain "vanilla" OTC derivative products can be handled effectively as they are. However, processing hybrid derivatives in a standardized manner will not produce positive results and will continue to challenge broker dealers.
"While the reality of OTC trading is more advanced than most believe, institutional traders confirm that there are significant areas of inefficiency that dealers need to address," said Stephen Bruel, analyst in the Securities & Capital Markets practice at TowerGroup and author of the research. "Due to the fast moving nature of the OTC derivatives environment, the industry is seeing increased spending on technology as well as increased pressure on technology firms to keep up with derivatives innovation. The successful management of these challenges will enable broker dealers to reap the rewards associated with this high growth, high margin derivatives business."
For firms looking to become major players across all asset classes in this space, TowerGroup recommends implementing a trading system incorporating a well-defined strategy including the following elements:
- Combining the derivatives trading implementation with a service-oriented architecture (SOA) framework to aid in the integration of disparate trading and technology systems.
- Implementing more powerful computational resources. As OTC products become more complex, risk measurement requires more computing strength – putting the use of grid computing high on the solutions list.
- Developing a vendor management system. While trading vendors tend to partner with intuitions to develop new products and workflows, institutions need to ask themselves if they want to participate on the OTC front. If not, they must determine which vendors have developed modules that represent emerging industry standards.
- Removing legacy systems that don’t support new volumes and products.
The TowerGroup report titled, "OTC Derivatives Trading: How to Bolster Front-Office Trading Tools," outlines the key factors to watch in the fast-changing OTC derivatives environment, focuses on the front office requirements of broker dealers, and explores the true state of technology usage and availability in the OTC derivatives trading space.