The new regulation has spawned an era of innovation but not every product is a bright shiny new invention. Lynn Strongin Dodds assesses the landscape.
Ever since the financial crisis thrust derivatives into the spotlight, technology vendors have been scurrying to find new solutions to meet the new regulatory regime. The landscape is still evolving with some products being an enhanced variation on a theme while others such as Blockchain are set to push the inimitable envelope in the future.
Either way, the technology required is a far cry from the pre-2008 days where the focus was mainly on booking, accurate pricing with familiar analytics such as Libor-based risk-neutral valuation and end-of-day risk parameter/metrics including value at risk (VaR). Systems also churned out robust market data feeds, straight-through processing (STP) for all pricing, risk management, documentation, accounting and post trade life-cycle events management.
Fast forward to today and the industry is grappling with more onerous requirements and dual workflows for cleared and non-cleared trades and industry demands for real-time data as well as risk management. Trade reporting in particular has given rise to many headaches as the data within most firms is unstructured and often poorly managed. Market participants have been dealing with trade reporting under the European Market Infrastructure Regulation (EMIR) since early 2014 but the additional obligations posed by MiFID II will increase the burden. It includes disclosing details of orders sent to trading venues, notifying regulators post-trade and publishing positions in derivatives.
“Some of the infrastructure is over 20 years old and is unwieldy and difficult to change. The new technology uses modern system design to create more efficient integrations and agile modules,” says John Omahen, vice president of Post Trade Solutions at SunGard. “The other big technology shift is in bringing calculations from end of day into real time. In addition to reducing risk, these real-time calculations are increasingly important to meet the regulatory requirements around transparency, trading and accountability.”
Keith Saxton, chairman of the Financial Services and Payments Programme for techUK, the UK trade association for the technology industry, concurs, adding, “We are seeing a lot of vendors developing solutions. The main challenges are creating a holistic view of positions, standardisations, data management, reporting (such as the unique trade and product identifiers) and whether to use internal or external resources or the cloud. There is also a lot of talk about the need to create industry led utilities.”
Saxton notes that in some cases it is not just about implementing new technology but leveraging existing solutions used by exchanges and clearinghouses for other asset classes to the OTC space. In other areas, it requires a cultural shift away from the traditional siloed mentality to create a bigger picture. “Take data technology. It already allows banks to combine structured and unstructured data in a cost efficient and automated way. However, the issues date back to legacy thinking of derivatives in product silos and the need to break down those barriers.”
Justin Llewellyn-Jones, global head of derivatives at Fidessa, also notes, “There is a lot of talk in the industry about what data needs to be added, curated and stored and how different systems can talk to each other. Much of the technology is already there in terms of order management and smart order routing. What we are seeing today is greater use of these tools for derivatives to help meet the new regulations and consolidate workflow.”
One of the biggest challenges, according to his colleague Christian Voigt, senior regulatory adviser, is pulling together the information from all the disparate sources. “Technology is needed to sift through all the data to present a meaningful picture. You need intelligent tools in the front office to correctly capture the information and then the technology in the back and middle office to provide a consolidated view for the audit trail. The visualisation and collation of information has become much more complex, particularly when given the number of exchanges and jurisdictions.”
Fidessa has launched order analytics service which came to the market in June aiming to give firms a better control over algorithmic trading. The system is integrated with its global futures and options trading platform which provides execution, risk management, compliance and reporting tools. Earlier in the year, RBS handed over its futures and options trading flows to the platform while Barclays followed suit in the summer.
Barclays also cut a deal with SunGard, becoming the first client of its post-trade futures and cleared OTC derivatives utility. The bank is also migrating specific futures and OTC derivative clearing operations and technology processes to the utility while several of its employees will transfer to the technology giant.
Launched in March, the utility provides derivatives clearing operations as well as technology services for trade clearing and lifecycle management as well as margin processing, brokerage, reconciliation, data management and regulatory reporting. The goal is not only to improve efficiency but also reduce operational risk and total cost of ownership (TCO) by leveraging economies of scale in middle and back office processing and technology.
“Utilities are the answer to the operational part of the cost equation and scalability is central to their success, says Omahen. “At the same time, processing multiple firms within the same walls means that a utility has a unique ability to see problems across the market that a single participant would not. This can lead to better predictive analysis, operational load balancing and prevention of critical issues before they occur.”
Another utility capturing the limelight is AcadiaSoft, a software company backed by 13 banks, ICAP, EuroClear and the DTCC. It recently made the news with MarginSphere 2, the new version of its electronic margining platform for OTC derivatives, which is replacing the abandoned industry initiative, dubbed Project Colin. The platform which links MarginSphere with ICAP TriOptima’s triResolve OTC trade reconciliation service and the Margin Transit Utility (MTU) to be operated by the DTCC-Euroclear GlobalCollateral joint venture, will create an open, seamless end to end margining hub for non-cleared derivatives.
According to Chris Walsh, ceo of AcadiaSoft, it will automate and centralise the way banks reconcile the amount of margin they should post, as well as creating an audit trail of exposures. “We look at up to 20,000 margin calls being processed every day but it will multiply significantly under the new rules. I think that increased automation across the industry will be necessary in order to absorb these new volumes without a commensurate increase in costs.” he adds.
Despite these grand scale ventures garnering most of the attention, specific areas such as clearing and algos are also being targeted. For example, Cinnober has made the news as the only vendor offering a real-time clearing platform which is a marked change from the historical end-of-day practices. Its TRADExpress system has already been adopted by the Brazil’s BM&F Bovespa bourse and the Johannesburg Stock Exchange while earlier in the year, the platform was chosen by the European Commission to develop a real-time risk margining and multi-asset client clearing system for banks.
The company has also adapted its technology to sell and buy-side firms, enabling them to integrate OTC and exchange-traded flows, access collateral efficiency through cross-asset, real-time risk management, and support a variety of client segregation models. “The pace and speed of trades means that firms need a real time clearing and risk management system,” says Magnus Sandström, head of business development at the Swedish technology provider. “Six years ago this was a non-issue but now firms want to do clearing and trading in real time in the same system.”
Finger on the pulse
Real time has also come to the world of algorithms. Earlier in the year, Euronext decided to mothball its legacy systems and replace them with Horizon Software’s tools to monitor and price derivatives instruments in real-time as well as set trading limits automatically for market participants. “Another requirement in the industry is the need to test algos and scenarios within a platform, as per the German regulator BaFin regulatory framework” says Guillaume Poitevin, business development at Horizon Software. “The Horizon Platform has the capacity to record/replay everything that happened on a market and records all messages to show the regulator if algos have been tested under normal conditions”.
Other firms such as Fincad are offering greater functionality. The firm which offers multi-asset, multi-currency derivative solutions for valuation and risk running from the desktop to the enterprise has developed a flexible hybrid modelling framework that factors in the dynamics and correlations between multiple asset classes. This enables financial institutions to quickly build new models, value complex trades and portfolios, and test various assumptions about underlying risk factors.
An added feature is its “algorithmic differentiation which significantly improves performance and accuracy over bumping, or finite difference, which is the traditional method derivatives firms used for risk management,” says Tony Webb, Director of Analytics at FINCAD. “Bumping is by nature slow, especially when there are many risk factors, and foreknowledge of the important risk factors is needed.”
Looking ahead, all eyes are on Blockchain – the technology that underpins Bitcoin. In its own right though this shared, cryptographically secure ledger of transactions has the potential to revolutionise the industry. Currently, participants use overlapping centralised ledgers which is expensive and time-consuming partly because it relies on human intervention. However, in the derivatives space, if banks and exchanges can see a ledger updated in minutes it could save millions in collateral and settlement costs to third parties. While there are no concrete products at the moment, it is only a matter of time if recent technology developments are anything to go by.
Leanr more about blockchain and bitcoin by listening to a recent DerivSource podcast – “Unlinking Blockchain from Bitcoin” or reading a Q&A on the benefits and implications of blockchain for financial services