A recent survey shows that the majority of buy-side firms believe in STP but few have achieved this in their derivatives processing. SimCorp’s Jørgen Vuust Jensen explains how regulatory change is driving firms to finally tackle manual processing in a bid to keep up with market change and speed up time to market for launching new derivatives products.
Since the financial crisis, the spotlight has fallen on how the buy side processes derivatives. There has been intense scrutiny from the regulators and the industry alike on how to manage the concomitant risks that come along with processing derivative instruments, and the new technological demands this brings.
However, a recent survey of 150 capital markets executives in North America, conducted by SimCorp, found that firms are still struggling with workarounds and manual processes when it comes to handling over the counter (OTC) derivatives. It found 79 percent depend heavily on spreadsheets and manual procedures when it comes to processing derivatives. An even greater proportion (84%) rely upon workarounds in their current middle and back office operations.
There is a clear disconnect between the way buy-side firms perceive the best means of handling derivatives, and the reality of business practice. This was shown by the finding that 74% of respondents consider straight through processing (STP) to be extremely important when it comes to derivatives processing – in contrast to the relative minority that seem to have achieved this.
STP and automation are the most appropriate and efficient methods for processing derivatives, hence the strong appetite among firms for their use. They require less resource than manual processes, and thus reduce the chances for human error. Spreadsheets in particular are notoriously error-prone and make effective oversight and compliance very challenging, to the extent that they can create serious business risk. What’s more, automated processes allow for variations in trading volume without the need to adjust headcount. Upswings in volume can be easily accommodated with existing resource, while systems, unlike individuals, can be left idle when trading volumes are depressed.
Historically, firms have been able to get by without implementing the technology needed to support derivatives processing. However, the increasing use of derivatives strategies in asset management has created a pressing need to automate transactions, as growing volumes put an increasing strain on manual processes. This is only likely to become more imperative in the current market conditions. Institutional investors, for example, are becoming increasingly interested in alternative investments which incorporate derivatives as they seek greater returns in the low rate environment.
Worryingly though, 82% of respondents stated that they require at least two months to model and launch new derivatives products, and sometimes significantly more, given the capabilities of their current systems. This is incompatible with rapidly changing market conditions and the need to maintain a competitive edge which requires firms to be fleet of foot with the strategies to deploy.
However, manual processes have been heavily ingrained into investment management for many years, and shifting to the technology needed to accommodate automation can require a change of mindset at board level given the investment required. Many asset managers operate on so-called “legacy systems”, a patchwork of outdated, intertwined technology which has been developed piecemeal over many years to cope with changing market requirements. This architecture was designed before the use of derivatives became commonplace, and struggles to accommodate today’s client and regulatory demands.
Integrating automated processes throughout the firm is near impossible with a legacy system in place. What’s more, the disparate nature of a legacy system means it is difficult to access timely, accurate data on derivatives positions held. Many instruments incorporate leverage and can have a substantial effect on a portfolio through their exposure to different market factors. As a result, having technology in place which streamlines processes and provides a consolidated and updated overview of positions held is crucial.
Changes in the OTC derivative space are increasingly driving the need for front-to-back STP, and it is imperative that operations teams consolidate STP throughout the derivatives lifecycle in order to increase efficiency, reduce processing time, and cease dependency on spreadsheets and manual “systems.” STP assimilation also helps firms to provide transparent audit streams and ensure proper reporting to management.
Increasing regulatory requirements have equally played a part in the impetus for new technology. New rules such as the European Market Infrastructure Regulation (EMIR) have created new derivatives reporting requirements which are challenging to meet without automated processes in place. Now that data management sits at the heart of buy-side technology to meet tougher reporting requirements, spreadsheets have become woefully inadequate at meeting data needs.
Together, these market challenges make the case for STP even stronger. Firms are essentially aware of the significant benefits of STP but seem hesitant to implement the process. As new market requirements continue to emerge, it has become crucial for asset managers to evaluate and update their IT infrastructure to include automation – which in turn will shorten processing cycles and increase efficiency, thus securing a competitive market edge. In a highly competitive industry, a firm with investment management systems characterized by a high degree of automated workflows and processes is in a better position than competitors that still contend with manual processes and workarounds.
