With regulatory scrutiny set to intensify through 2010 whilst volumes and execution speeds continue to increase, financial institutions, clearing houses and exchanges are under pressure to deliver a more timely, transparent and operationally efficient post-trade landscape. However, realizing these imperatives is no easy task, given the inherent difficulties of achieving real-time position monitoring and true end-to-end straight-through processing (STP) for derivatives. SunGard recently concluded Clearing Panel in Singapore where industry experts discussed the ongoing challenges that confront market participants in the post-trade derivatives processing environment.
Moderator:
Steve Edge, Principal, Asia Etrading.com
Panelists:
Todd Keenan, UBS, Director, Regional Head of ETD Operations
Emma Larkham, Morgan Stanley, Executive Director, Asia Regional Head of Listed Derivatives Operations
Thomas McMahon, Singapore Mercantile Exchange, Chief Executive Officer
Philip Joslin, Eurex Group, Head of Representative Office in Singapore
There are three key challenges in the post-trade derivatives and processing environment: regulations, transparency and efficiency. All three are crucial in the face of a fast-evolving trading landscape, especially in Asia, which saw 6.8 billion contracts traded in 2009, not including over-the-counter trades (OTCs). What were small markets 10 years ago are now global leaders. Also, with an increasing number of new contract types and product innovations on derivatives exchanges, there is perhaps a need for OTC standardization. Infrastructure upgrade is also vital so that all parties can keep up with the rapid changes.
Regulations
Asia has always been a highly regulated protectionist environment, but it is slowly opening up, said Edge. For example, the Singapore Exchange and Chi-X Global have joined forces to create ChiEast, the first multi-regional dark venue in Asia, and the Singapore Mercantile Exchange has been given a licence to operate directly against the Singapore Commodity Exchange. Australia and Japan have also mandated exchange competition. In terms of evolving a trial regulatory framework, Asia has the added advantage of observing and learning from the problems and successes of the West – for example, the European Union’s Markets in Financial Instruments Directive (MiFID). MiFID, Edge added, would be the “Holy Grail’’ for Asia, even though he acknowledged that it is still a long way away from happening.
Said Thomas McMahon, Chief Executive Officer of the Singapore Mercantile Exchange: “Singapore enjoys a very good regulatory environment. The Monetary Authority of Singapore is very forward- thinking in its ability to change. The greater question is the impact of Washington and coordination with the United States. But ultimately, the regulations will be beneficial as long as there is a concept of building a universal front across Asia, and not silos.’’
He also struck a note of caution against the standardization of products: “It’s easy to say you can stuff all the OTCs in one bag. But OTCs are unique and that’s why they’ve never been in one bag. While customization has inherent risks, trying to make them all standardized is not easy. You can do that maybe with energy products. But it’s difficult with financial products. So this needs a step-by-step approach and not a reactionary process.’’
Emma Larkham, Morgan Stanley’s Executive Director, Asia Regional Head of Listed Derivatives Operations, said that her firm was already seeing more interest from clients in OTCs, and it is working with other exchanges to observe disparate solutions. “So even while regulations are still being deliberated and a decision probably would not be made till end of 2011 or in 2012, we anticipate a rapid uptake once it does happen, so we need to be give our clients a heads-up and be prepared to support it.’’
Transparency
Risk management and visibility of risk dominate priorities in the post-trade environment, said Edge, citing how Lehman Brothers traded on a Friday and went bankrupt over the weekend, leaving clearing houses on the hook. “No one wants this to happen again. So there is a need to deliver transparency in real time or, at the very least, intra-day.’’
Risk implications needs to be understood at any given moment in time. One also needs to manage sheer volumes effectively to allow them to work more nimbly. Liquidity has to be found when needed, in order to mitigate risk, he added.
Philip Joslin, Eurex Group, Head of Representative Office in Singapore, said his company has come up with an Enhanced Risk Solution which provides margin statements to clients every 10 minutes. “This is so they can drill down more effectively into positions, which is vital to business and clients. The more data they have, the more control they have over their internal systems.’’
As for the impact of a CCP for OTCs, Larkham felt this would be a positive thing, from a risk perspective. “As a clearing broker, we are keen to see clients manage their risks. In terms of members of the CCP, however, we would recommend that they should be people who have a deep understanding of OTCs and capital derivatives in terms of actual clearing numbers. They need to be able to manage and handle default situations.’’
She also expressed a hope that OTCs will use existing trade tools available in the market to get trade information, so as to minimise risks intra-day.
However, McMahon cautioned that a concentration of risk was something to be wary of. “A clearing house can be too large. There is nothing wrong with having separate clearing venues. Asia has a 1000-year legacy in commodities trading, but for the most part, they have existed as silos. Japanese exchanges dealt in Japanese products, for example. In recent years, China and India have re-emerged rapidly but they too are largely closed markets. The issue here is to benchmark the trades, to shift risk, pricing and clearing – not to fragment centres – to Asia. There are a lot of business models that can be extended to Asia.’’
Todd Keenan, UBS, Director, Regional Head of ETD Operations, said however, that he saw commodities and OTCs as more of a growth area of the future. “Our bread and butter are still index futures and we see that market increasing there.’’
Efficiency
Edge said that straight-through processing (STP) is the goal when it comes to achieving efficiency, which, in a post trade environment, is a challenge. Some 2/3 of trade risk is borne by the back office, he noted. However, one of the hurdles to achieving true STP is that there is no messaging standard implemented across markets. “The businesses using STP are using different messaging standards. The issue of intraoperability between service providers has not been effectively explored.’’
Larkham said: “We are all very batch-driven, looking at batch processing overnight. It is currently quite difficult to see and capture which clients are making their positions intra-day.’’ She added that her company is trying to function more in real time, by giving real time statements and real time calculations around margins. “That’s going to be fundamental platform change from where we are today. Risk managers need to have tools to see what’s going on day to day. It’s still a manual process at the moment so that’s definitely a challenge.’’
The benefits of STP are many, according to Edge. These include a short settlement cycle and turnaround time; increased transparency; reduction in operational risks and errors; and faster data capturing, processing and report generation.’
However, initial challenges exist. Larkham pointed out that some work still needs to be done, particularly around margins and methodology around standards.
Keenan agreed: “We have tools in place but we have clients in Asia that have very specific demands. They expect perfection but they may not be willing to use the tools they have so we need to get them onto the tools that are already in place.’’
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