While volume 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 for derivatives. At SunGard’s recent Clearing Panel in London, Challenges in post-trade processes and operations, attendees heard about the difficulties in achieving true end-to-end STP for derivatives.
Panellists
- Matthew Clay, EMEA Senior Research Analyst, Capital Markets, Risk Management and European Banking at Financial Insights (Moderator)
- Frederic Colette, Global Head of Operations, Newedge Group
- Richard Wilkinson, Director of Futures Clearing, Royal Bank of Canada Europe Ltd
- Jérôme Rousseaux, Post-Trade Services Product Line Senior Vice President Product Management, SunGard Global Trading
There are three key issues facing those involved in the post-trade environment in the derivatives world: regulation, transparency and efficiency. These three issues have provided the most intractable problems for participants in both the listed and OTC derivatives markets in the past few years, said Matthew Clay, moderator of SunGard’s Clearing Panel on post-trade operations and processes in derivatives.
The issues are also dominating in a market where volumes are rebounding and are likely to continue to grow during the coming year. At the same time algorithmic trading strategies are proliferating as are new contract types in the listed markets. The increase in volumes, speed and complexity is putting pressure on post-trade processes.
Regulation
As regulators worldwide respond to the financial crisis, regulatory scrutiny will become much more intense and all derivatives market participants will be working within the boundaries set by regulators. Risk is no longer an independently controlled element, said Clay, but something that everyone within an organisation must consider.
“The regulatory environment is much tighter and regulations are being enforced more strongly than in the past,” said Frederic Colette, Global Head of Operations, Newedge Group. “Regulators and buy side firms want to bring OTC derivatives into the clearing house environment, but we are seeing some pushback from the industry, which is not yet ready for this.”
Richard Wilkinson, Director of Futures Clearing, Royal Bank of Canada Europe Ltd agreed: “It is important for the industry to push back on regulators to ensure that clearing is not seen as a panacea for all types of risk. Clearing houses mitigate risk, but in the case of a default we must ensure that there is enough liquidity and transparency in the products they are holding to get out without an impact on the default fund. The risk of contagion will become greater if all products have been centralised in a clearing house. For this reason I believe some products should remain OTC.”
With such a variety of initiatives in derivatives clearing at present that involve different processes and margining strategies, Wilkinson and Colette agreed that “backing the right horse” was difficult and costly. The result is a type of clearing limbo, in which most participants are waiting to see which way the market will move.
Asked whether regulation or business imperatives drove developments in post-trade derivatives processing, both Wilkinson and Colette said regulation was the more significant driver. “Changes in regulation supersede all of our plans and have a huge impact on the way we do business,” said Colette. For Wilkinson, the focus on risk management, post-Lehman, means that regulations will change quickly and institutions need to be flexible in the way they respond to those changes.
Transparency
There is now a push to deliver transparency through more real-time and granular information, said Clay. “Transparency is all about the clarity of information and giving institutions an understanding of their processes and positions. It comes down to managing risk appropriately.”
A multi-asset environment makes transparency more difficult to achieve, said Colette. “It is important to have real-time information so you can monitor the transactions you are processing and react quickly so you are not at risk.”
Wilkinson suggested that transparency and efficiency are intertwined. The key is certainty – of trades, positions and margin calls. Royal Bank of Canada is implementing an intraday system to monitor risk in “quasi real-time”, he added, giving the bank the ability to monitor exactly where risks are.
But how difficult is it to achieve real-time in derivatives processing? “In the cleared world of exchange-traded derivatives, real-time processing is relatively straightforward,” said Wilkinson. “But as we move into new asset classes and into OTC clearing, it comes down to having a system that can look across product silos, providing a layer that can pick up all the information, number crunch and come up with a result.”
When volumes are soaring and markets are volatile, said Colette, clearing houses often struggle and it is then that institutions need clarity. He called for financial institutions to work more closely with CCPs in order to automate margin calls. “At the moment we bear the risk in part and this can’t last. For the past three years there have been more and more margin calls made by CCPs. Institutions need to act.” Wilkinson agreed that intraday margin calls will become more frequent and that if processes are in real time, or near it, an institution will have more certainty and be able to pass on the liability rather than funding the margin call itself.
Jérôme Rousseaux, Post-Trade Services Product Line Senior Vice President Product Management, SunGard Global Trading said real-time is linked to counterparty risk management. “A few years ago the back office was the poor relation within financial institutions. Now they require real-time information on demand, enabling them to allocate on the fly and validate what is received to answer the question ‘do we accept all trades from this counterparty?’.”
Efficiency
Any discussion about efficiency will inevitably focus on straight through processing (STP). Newedge’s Colette said the more STP an institution had, the greater the danger of underestimating the number of people needed in the back office. “Such an attitude does not take into account market volatility, when exception queues go up. If you have very few people in the back office to deal with the queue, you will have a problem,” he said.
While this raised the issue of redundant capacity, he said it was a price to pay to be safe from any further financial market crisis. Wilkinson added that convincing senior management of the need for additional capacity in case of a crisis is difficult.
The idea that there could be such a thing as “too much” STP was also discussed. Colette said there was a risk that institutions could lose the knowledge of how to process manually, something quite dangerous during a crisis. Rousseaux agreed, saying that retaining the knowledge of how to process manually was important.
Asked where the greatest improvements in process efficiency would come in the next year, Wilkinson cited static data mapping as an area needing progress. “You can have up to six different identifier codes for the same product, therefore it is important to have good data mapping that gives certainty on the exchange code. On the client side, it looks like regulators might move to imposing IBANs [International Bank Account Numbers] on institutional customers. This will enable regulators to investigate particular customers and will make it easier for brokers to supply that information.”
Challenges ahead
Getting the mix right as to which derivatives products are cleared through a CCP and which aren’t is a top priority for the market, said Wilkinson. “I think we need to ensure that we don’t end up with products in the clearing system that shouldn’t be there. If an OTC option, for example, doesn’t have sufficient liquidity, it shouldn’t be there.”
As to how many clearing houses are appropriate, the panellists agreed that there was a trade-off between having more CCPs to spread the risk versus the concentration risks of having products going through a single CCP. “The industry needs to consider the impact of an event in a particular asset class that is cleared at only one CCP,” said Wilkinson.
SunGard can help clearers face many challenges that were descirbed above thanks to Stream Clearvision. Stream Clearvision is an automated real-time middle-office matching and clearing system for derivatives providing straight-through processing between front-office, exchange and back-office systems. Click here for more information.
Social Media
View All Social Media