DerivSource reporter Lynn Strongin Dodds canvasses the industry to see how new technology is disrupting traditional workflow processes.
FinTech has become the all-encompassing catchword for innovative and disruptive developments in the financial services industry. In the derivatives world, sell and buy-side firms are being encouraged to embrace the full range of new technologies, whether it be in collateral management, utility, cloud-based solutions, data management or blockchain. The challenge is not only keeping pace, but also deciphering the hype from the reality.
“There are so many FinTech projects in the marketplace because firms tend to build their own systems and solutions to address the different problems,” says Robert Palatnick, DTCC Managing Director and Chief Technology Architect. “However, this could lead to fragmentation.”
Palatnick also believes that derivatives have their own set of obstacles due to the many moving parts and participants. “It is a global market that has many different players and regulations involved, as well as a wide array of different solutions and technological components that have to be combined—that is a challenging task,” he says. “The difference with equities is that they started out in domestic markets with straightforward trading patterns and have had decades to grow and mature.”
Another issue is more cultural, and the need to view post-trade operations as a potential driver of profit. Historically, it has taken a backseat to its front-office counterpart and been starved of investment and resources. However, legislation such as the European Market Infrastructure Regulation (EMIR) and the Markets in Financial Instruments Directive (MiFID) II are forcing firms to completely rethink their infrastructure model. As David Pearson, Head of post-trade strategy at Fidessa, puts it, “In the past, if you had a dollar to spend you would spend it in the front office for a new algo, robotics or an OMS. There is now a realisation that more efficient post-trade processes can help sharpen a company’s competitive edge.”
“In the past, if you had a dollar to spend you would spend it in the front office for a new algo, robotics or an OMS. There is now a realisation that more efficient post-trade processes can help sharpen a company’s competitive edge.” David Pearson, Head of post-trade strategy at Fidessa
Pearson believes that one of the biggest obstacles is to “automate the processes across the asset classes a buy-side trades with its brokers. “For example, a clearing broker will hold the client’s positions at a clearinghouse, and is also responsible for the integration of positions and margin calls. However, now the onus is much more on the client to confirm the trade and report the data. To date, the technology lags way behind securities processing, which is relatively automated and electronic. It will happen in derivatives, but will take time for the processes to become normalised and commoditised.”
In the meantime, Fidessa is launching a derivatives module for its post-trade affirmation management solution, which automates the middle and back-office processing for buy-side firms. The technology will now be expanded to include processing for exchange-traded derivatives.
Driven by regulations, data offerings abound
Not surprisingly, there have been a slew of offerings in the data management field, due to the more stringent reporting requirements. The latest version of MiFID alone wants greater light shed onto the transaction as well as the entity and the individual making the decision. Reporting T+1 also means covering 65 fields in a transaction report.
Meanwhile, the recently revised European rules for OTC derivatives reporting, set to become effective on November 1, will require derivatives counterparties to make fundamental changes to database structures, in order to cope with new obligations such as the reporting of additional information on the type of trading model used in each transaction.
“Data is still 90% of all the problems,” says Brian Lynch, CEO of RegTek, which offers Report-it, the control and compliance software for trade and transaction reporting, including Validate.Trade, Reportable.Trade, Load.Trade and Reconcile.Trade. “The issues are not so much with the reporting side, as that is fairly a mechanical exercise, but it is more do with the quality issues. For example, in the past you may have needed ten different pieces of data for interest rate swaps for pricing and risk management, but today that is around 100 pieces that need to be curated and enriched.”
Michael Cooper, CTO, BT Radianz Services, agrees, adding that the focus of technology is on the optimisation of data, including accuracy, availability, reliability and a move to real-time processing. “One of the greatest challenges is to extract more intelligence from data, and to gain a better understanding of what is available and how can strategies be developed to take advantage of the information.”
Overall, Cooper is seeing greater collaboration between industry participants and points to instant messaging provider Symphony Communication as a prime example of firms joining forces to create new solutions. Formed three years ago, Symphony has formed partnerships with a wide range of firms to bring all the services on their platform. The most recent alliance, Ipreo, a provider of market intelligence, data analytics, and workflow solutions joins a long list of others including financial data services like ChartIQ, FactSet, Selerity, Dow Jones and S&P Global Market Intelligence, trade execution management service FlexTrade, IT services like Avaya, FIS MarketMap and Gemalto, and financial back-office services like MarkitSERV.
Blockchain holds promise, but is still in its infancy
Sell and buy-side firms are also coming together to leverage the possibilities of blockchain, which at the moment lacks standards, best practices and interoperability modes. There is also more talk and proof of concepts than projects actually running on the ground. “Blockchain is in development but I think the road is very long and uncertain,” says Sylvain Thieullent, CEO of Horizon Software. “I can see the topic being discussed every year for the next ten years. The technology is innovative and important but will take time to reach its full level of maturity, although one of the issues is cultural, in that people are having trouble agreeing around a table about the next steps.”
“Blockchain is in development but I think the road is very long and uncertain. I can see the topic being discussed every year for the next ten years. The technology is innovative and important but will take time to reach its full level of maturity, although one of the issues is cultural, in that people are having trouble agreeing around a table about the next steps.” Sylvain Thieullent, CEO of Horizon Software. “
This has certainly been the case with R3 CEV, which has lost a few important members such as Goldman Sachs, Morgan Stanley and JP Morgan over the past year. However, the industry consortium is involved along with Axoni and IBM in developing DTCC’s blockchain-driven platform for credit default swaps reporting, which is seen as a crucial test for the industry.
We are leveraging a new technology and applying it to the existing business model,” says Palatnick. “Our objectives are clearly defined because we already have an established business with a network of firms submitting trades.”
Set to go live in the first quarter of 2018, the first phase will see participants face the DTCC directly, through the organisation’s own connection point or “node” followed by DTCC providing nodes on the permissioned ledger to participant firms, enabling them to validate reported data and directly access information. Last but not least, firms will be able to take down their own nodes and replace some of their own internal capabilities with the new technology.
The International Swaps and Derivatives Association (ISDA) is also advocating the use of blockchain as a way to reduce costs and generate extra efficiencies. In its White Paper last year, it explored the possibilities of using smart contracts to help modernise its standard documentation and automatically execute intended lifecycle events.
Smart contracts are agreements whose execution is automatable, mainly by computer and enforceable by legal enforcement or tamper-proof execution.
Cloud partnerships, utilities on the rise
There are also alliances being created in the collateral management space with IHS Markit and CloudMargin launching Collateral Manager, a cloud-based solution for calculating margin, settling margin calls and managing margin disputes. It covers a diverse set of instruments, including cleared and non-cleared OTC derivatives, repos, stock loan, futures and options.
“We have struck a series of partnerships because we believe it provides a better solution for the client,” says Simon Millington, Head of Product Management at CloudMargin. “This is because a single vendor may only be able to solve four of the client’s six problems, but by taking a partnership approach, we can offer a best-of-breed solution. In general, we are seeing a greater push in our industry toward cloud technology, and while this may create more competition for us, it validates the business model we adopted three years ago. There is greater acceptance in the US and UK, and Europe is definitely coming around to the idea.”
Services are not just aimed for the larger global players but also the small to medium sized firms. For example, last year Calypso Technology, a provider of treasury and capital markets (TCM) software, and Sernova Financial, a turnkey post-trade services provider, that formed a bond last year to deliver cloud-based clearing services to regional banks and buy-side firms.
Sernova Financial is a post-trade utility that partners with CCPs and banks to provide its service. The solution recreates the infrastructure of a traditional clearing broker in the cloud, enabling multi asset class self and client clearing across CCPs.
The utility space is gaining momentum with banks such as Barclays and Credit Suisse joining FIS Derivatives Utility. “Our solution is focused on about 80% of a clearing firm’s requirements in the middle-and back-office on a day-to-day basis, and all mandatory project work, upgrades and innovations,” says John Avery, director of client and industry engagement, Derivatives Utility, FIS. “This means that firms only have to focus on the remaining 20% they retain for oversight and differentiating their client service.”
According to Avery, the derivatives utility is based on shared resource architecture, with a mutualised, multi-tenant operating model. “Our model increases efficiency, improves controls, reduces risk and reduces cost by sharing people, processes, technology and projects across clients wherever possible.”
AI used to automate margin processing, reconciliations
Looking ahead, machine learning such as robotic process automation is already being used to automate processes in the margin space, while there are several blueprints on the drawing board to see how best to develop artificial intelligence. “Incorporating future innovations on an on-going basis is an integral part of our offering and value proposition,” says Avery. “Right now, one of our key innovation initiatives is leveraging our FIS centre of excellence in AI to help us pilot machine learning and RPA to augment our team and our technology to increase efficiency and reduce risk in areas such as reconciliations, margin processing and exception management.”
Richard Miller, Product Manager at GFT, also sees most of the gains being delivered in the operations part of the business. “With derivatives, many of the processes are still paper based, especially for OTC, and therefore overdue for all kinds of optimisation, with AI being a large part of that,” he adds. “For example, an automated responder and router for client trade queries could be a neural net with the aim of improving client service and reducing cost.”