In a Q&A, Omgeo’s Ted Leveroni explores the importance of trade matching for exchange-traded derivatives amidst regulatory reform, market change and previous success in automating this process for other asset classes.
Q. Why is trading matching for ETD important now? What are the drivers and motivations for this trend?
A. Increasing volumes for futures and listed products has the inevitable consequence of increased risk. Post-trade matching of exchange-traded derivatives (ETDs) provides timely data, which enables participants to locate trades, identify the counterparty and the owner of the trades, which is essential for regulatory and internal risk reporting calculations. In order to properly calculate your positions and manage risk effectively you need to be aware of all the trades held on your books. When you overlay the process of post-trade matching with a non-standard manual process alarm bells ring. If the markets were fully standardized and fully automated, it wouldn’t be such a concern. Futurization of swaps and the shift away from OTC derivatives due to market regulation have pushed this need for automated ETD traded matching.
Q. What challenges do financial institutions face in automating this process? What are the benefits?
A. There are different parties communicating in a post-trade world; brokers, asset managers and exchanges are all communicating daily and the way to streamline communication is to agree on a standard. Once you have a standard workflow you can create a standard messaging convention/hub that will solve the problem when communicating with multiple entities. The real challenge is selling a standard when you are one of the early adopters. Firms want to stand on the outside of the pool and not jump in until they can quantify how much benefit they can get, yet it is difficult to recognize the benefit when building the community. Standardization and automation will benefit all industry participants.
Q. In terms of trade matching what do participants currently use? What are the different methods of communication?
A. Brokers have individual portals through which they communicate with their clients and to give notices of execution, allocate trades and receive give-ups. Each broker has a different portal so if a buy-side firm wants to automate they have to create different automated links or connecting points, otherwise it is a manual process logging on and loading spreadsheets.
The broker’s data is only as timely as the investment manager interfacing with that portal and this can be a slow and manual process. Also, brokers though automated, may get untimely and inaccurate information from their clients who are not yet automated. If the buy-side firm wants a new broker, it is time-consuming and costly process of interfacing with a new broker portal and likewise, if the brokers want to onboard a new client it is costly to set up and maintain.
Q. How much time would the buy side save by onboarding to a new broker if they were to use a standard for different broker portals?
A. It depends upon what they are trying to accomplish. If your new broker has adopted a community based standard like Omgeo it is not difficult to switch. In fact, it is near instantaneous and you can start communicating with it once you are integrated. Conversely, if the buy-side firm wants to manually interface with a broker via a two-way feed to a broker portal, the time it takes to do this really depends on existing systems and how the broker works. To avoid entering information manually into a broker portal, an asset manager would have to become more automated. And in terms of estimating the time to market, the firm would need to be able to evaluate where they are today, where they want to be and estimate how long that will take.
Q. When dealing with inaccurate data how would adopting a messaging standard help the buy side?
A. Ideally it would be straight-through processing (STP); they would need to have the flows from execution all the way from trade order management into Central Trade Manager (Omgeo CTM), to match all the information and give ups, which informs the broker which trades they will hold on to and which they will give up to the clearing broker. The data flows seamlessly from the order management system where all the information is captured/ generated initially, but if they don’t have that level of automation and enter the information manually into the broker portals they may use wrong identifiers, wrong account numbers and codes, which creates inaccurate give ups and may cause exceptions and delay the final allocation of the trade.
Q. Is the benefit for the buy side reduction in operational risk, STP and improved processing time?
A. Yes, and it also benefits the sell side, as they want to have accurate and timely information as to the position of trades. If they are supposed to give up a trade to another broker they want to make sure they give it to the right broker. If they are sticking with a trade they have to post margin for that trade.
There are rules for brokers to accurately measure pre-trade risk before they execute transactions on behalf of clients and they need to know all the trades the client has executed. This provides them with timely information as to whether clients have breached their limits and whether brokers have executed too many trades.
Q. Are there any other benefits for the sell and buy side?
A. It is cheaper to live in an automated environment and currently there are real margin pressures on the brokers. While there is an initial implementation phase when adopting a new standard and automated operation, standardization can save money and resources in the long run. Finding fails and correcting errors will be a more efficient and cost effective process for the broker community. And if they off load some of the operational burdens from their portals to a third party they don’t have to deal with the cost of maintaining such processes.
Q. CTM is used for various asset classes, what are some of the lessons learned from automating trade matching for other asset classes that the ETD market can take on board?
A. Omgeo was created by an industry need to automate this process in the equities world and the industry is familiar with full automation within the equities space. If you ask what it was like before our community was built in the equity space few can remember those times of manual processing. It is hard to conceptualize what it was like before as several issues have disappeared with market standardization. Having a standardized automated environment makes sense in terms of handling volumes, cutting costs and reducing risk.
Q. What’s next for trade matching and the exchange-traded derivatives space?
A. In the post-trade space we will see a snowball effect, as clients come on and trade they are going to realize the benefits. Once the basic processes are standardized the new opportunities for efficiencies will emerge such as commissions matching, and data cross referencing. Automation of these aspects of the lifecycle will further reduce breaks, risk, and will make the entire process more efficient. The key point is that once you adopt a standard you only need one solution to fix an industry problem and the value of the product will grow exponentially.
In general, I believe that in the ETD space we are going to see some significant increases in volumes due to futurization of swaps and mandatory clearing of OTC derivatives. Lots of firms do not have swap clearing brokers and they don’t want to incur margin and capital costs when trading OTC derivatives. Exchanges are launching futurized products and I think this is going to have an impact on the volumes. In the next 12-18 months you are going to see a lot of these products traded, and the increased volumes will exacerbate these issues and create further demands for a standardized process.
