Why a ripe time for developing market utilities hasn’t bore fruit. Rob Daly reports
After the G20 nations committed to bring more transparency and systemic stability to the global over-the-counter (OTC) derivatives market in 2009, many industry participants believed that new mandated electronically traded market would provide fertile soil for growth of post-trade industry utilities that would help their members meet their new regulatory obligations. Yet, five years on the post-trade utilities field remains fallow.
“Back in the day, we thought that there would be a great opportunity to build a new market infrastructure from scratch using technology, which we did not have 10 years ago,” say Kevin McPartland, principal, market structure and technology at industry research firm Greenwich Associates.
Since market participants do not see their post-trade processes as a competitive advantage, developing and industry utility seems extremely logical, he adds. “Why build it yourself? Why don’t we have everyone put all of their pain points together and we can all move on to focus on more important things.”
However, various market regulators have run from establishing central utilities, which would offer standardization, in favor of approving central counterparties (CCPs) and trade repositories.
“The marketplace thought that having a single trade repository would have been a logical way to avoid data fragmentation, multiple standards and the rest of it,” adds Henry Hunter, managing director and global head of derivatives processing at Markit. “That simply just has not happened.”
Mireille Dyrberg, COO of post-trade service provider TriOptima, sees regulators addressing risk and geographical concerns rather than convenience. “They realize that life would be easier with one CCP utility, but that would create systemic risk for clearinghouses,” she explains. “Similarly it is not realistic to have the all the systems supporting the global market residing in a single jurisdiction.”
Evolution, not revolution
Regulators have taken a pragmatic approach when mandating changes to post-trade processes by relying on existing third-party infrastructure providers rather than creating new utilities from scratch, according to experts.
“Many of the infrastructure services currently in place pre-date the Dodd-Frank Act,” explains TriOptima’s Dyrberg.
“This change was not a ‘big bang,’” agrees Markit’s Hunter. “I was not trading non-reported bilateral OTC swaps one day and a reported centrally cleared and electronically traded swap the next day.”
Dyrberg attributes much of the current massive changes occurring in the back office to historical under-investment by organizations in their back office.
“For ages companies invested in the front-offices processes like getting better pricing and faster execution that would maximize revenue and invested little in the back office where likely there would be faulty and inconsistent manual processes,” she says. “It is like building a Ferrari in the front office and then strapping a horse cart to it. This kept happening as long as the market grew. Once revenues started to shrink, companies turned their focus to their back offices, which were not working as well as they should.”
Firms should not see these back-office investments as a one-time thing, warns Dyrberg, who sees future back offices requiring regular investment.
For smaller firms that may not have the resources necessary to update their post-trade processes, outsourcing provides “the path of least resistance,” says Greenwich’s McPartland. “Future commission merchants (FCMs) are in a place where they can handle much of the dirty work for their clients for a fee. If a firm is a smaller one and relies on a single FCM, this would be something to which they certainly should look.”
Greasing the skids
Although post-trade utilities may not be on the horizon, the International Swaps and Derivatives Association (ISDA), in conjunction with Sapient Global Markets, has been developing its Clearing Connectivity Standard (CCS), which is designed to simplify post-trade system integration and further reconciliation automation between FCMs, CCPs and custodians.
Work on the standard, which was first announced in October 2012, has entered its second phase, according to Phil Matricardi, manager of business consulting at Sapient Global Markets.
This latest phase, which some firms are implementing currently, includes support for various payment reports like upcoming cash flows that will show trade-level cash flows that are up as well as instruction and settlement reports that will tell how clients intend to settle their calls each day.
“It dovetail nicely with the collateral report, which shows cash and non-cash collateral held by clearing brokers,” he adds.
All of this builds on the standard’s initial phase, which supports account summary across clearinghouses in multiple currencies, show the initial margin, margin balance and requirement, all of those related to OTC derivatives and reaches a net and gross call.
What will be included in the standard’s third phase is a bit fluid as the 26-seat steering committee prioritizes the industry’s remaining needs.
Matricardi estimates the next phase may include support for daily trading activity and upcoming cash flow reports. “Phase four will include support for settlement instructions and collateral holdings,” he adds.
According to the Sapient officials, the standard’s 2014 roadmap includes adding CCP support for Eurex, Singapore Exchange (SGX), Tokyo Stock Exchange (TSE) and Hong Kong Exchanges and Clearing Ltd (HKE) to its existing CME Group and LCH.Clearnet’s SwapClear support as well as a transition from a CSV format to the XML-based Financial products Markup Language (FpML).
In the meantime, FCMs like Barclays, Citi, J.P. Morgan, Bank of America Merrill Lynch are already sending messages using the new standard, according to Matricardi. “On the custodian side, J.P. Morgan Worldwide Securities Services (WSS), Northern Trust, Bank of New York Mellon, State Street, SS&C GlobeOp and Citco are requesting CCS-formated files actively, he adds.
Although CCS is an open standard, which is available for download from ISDA’s website, Sapient Global Markets has developed a CCS validator tool, which it has been beta testing with its clients, according to Jim Bennett, a managing director at Sapient Global Markets.
“We plan to roll out the post-beta version of the validator on a client-request basis, which will include an annual subscription,” adds Matricardi.
The standard has a good as chance as any industry standard to gain traction, according to McPartland. “As with all standards, it is hard getting everyone to adopt them as a standard is the hard part. I hope it is successful over time.”
Even if the OTC derivatives market adopts standards like CCS wholesale, it will not replace the role of service providers, according to Markit’s Hunter. “It doesn’t matter how many data standards a firm implement if it needs to create an agreed centrally cleared trade record for transmission for clearing or confirmation. It has to be held somewhere and that is what a central service does.”
