Increasing efficiency has been a constant theme in the history of financial markets. The fallout from the subprime crisis has increased the need to keep a tight lid on costs, but not at the expense of business expansion.

After a decade of unprecedented growth, the exchange-traded derivatives (ETD) industry  was subject to a sharp correction during the global financial crisis. Volatility increased and contract volumes plunged. Now though, the future is already looking much brighter, even if there is, as Kevin White, lead partner for financial services at Ineum Consulting UK, claimed a ‘do more for less’ challenge facing everyone.

White made his assertion while moderating a panel session on ETD post-trade processes. In his opening remarks he stated that many believe the future will see increased growth. White listed some reasons for this, including: an increase in the number of exchanges; 24-hour, round the week trading; higher volumes flowing from algorithmic trading; and the continued switch of over-the-counter (OTC) business securities processes to the central counterparty (CCP) model.

White asked the panel to first state what they regarded as their key operational challenges. Kim Lennen, global head of futures and options post-trade technology at JP Morgan, said it was “keeping the boat afloat while steering ahead” at a time of focus on capacity during an upsurge in volumes while accommodating new controls.

Didier Dos Santos, derivatives business development manager at BNP Paribas Securities Services spoke of the “tremendous switch and increase in emphasis to risk management” and concerns on the matching side, due to the higher level of volatility, and a shift to close-to-real-time matching from overnight. These he said, were producing a “major stress on our systems and people.”

Mark Mills, director of futures and options at Merrill Lynch, echoed this, and noted the enormous upsurge in interest and scrutiny aimed at the ETD market following the 2008 financial crisis.  “Everybody wants your expertise on how exchanges and their margin calls works now”, he claimed.

Patrick Tessier, head of European ETD operations at UBS, said that, “contract volumes may be down, but transaction volumes have not tailed off by as much.” He marvelled at the novelty of being asked to help clients with risk management and straight-through-processing [STP] developments, as they reassessed broker relationships and credit.

White then focussed attention on risk management issues. Tessier began with the perennial problem of brokerage being impacted by volatility, and the industry not being fully geared to intraday settlement, which requires real-time position monitoring.

Intraday margining

Mills added that the frequency of exchange margin calls had risen, and brokers were no longer happy or able to ‘swallow’ these overnight anymore. Instead they want to clear and match margin calls with their clients intraday. Lennen agreed: “The demand now is how fast can you recompute margin and cash exposure intraday…it’s almost moving from a T+1 to T+0 basis, and that’s a challenging environment,” he said. This requires the full end-to-end process, “from execution to books and records”, to be completed in minutes. Dos Santos concurred and added that collecting margin and collateral from clients was a key challenge, but at least do-able because of industry automation.

He added: “Operationally speaking, the biggest area of risk has always been around deliveries and options exercise.” As a result, this had been identified by BNP Paribas Securities Services as a key area for investment as it sought further automation.

Mills picked up on the communication issues involved in this: “STP from client to exchange around expiration is going to be extremely beneficial for us…to mitigate risk issues”. Tessier agreed but mentioned a major stumbling block. “Interaction with exchanges is still often too manual on big expiration dates, when thousands of trades need attention all at the same time,” he pointed out. Add to this the new flex products now cleared through CCPs, and all this puts the human links between clients, brokers and exchange systems under immense pressure, he claimed

Dos Santos said that he could not agree more, and questioned how can you deal effectively and manage the risks with clients that give you manual instructions right up to the time limit for action? It may be fine with one client, but, “how do you deal with it if you have 20 different clients with 20 strategies in the market, and all waiting to process within a minute of the deadlines? At the moment the answer is to throw human resources at it, but that isn’t either efficient or risk-less,” he stressed. His answer is to work with IT vendors and exchanges to prompt fuller automation of the investor side of the business.

White then asked the panel to move on to considering the general outlook in the ETD world now; noting that in 2008 there was a widespread general media and public perception that derivatives were bad and dangerous things.

More products and more regulation

Tessier noted that the steady move from OTC to CCP/exchange models for many derivatives means that there is inevitably more regulatory oversight, which further increases back office workloads. Mills added that since the SocGen rogue trader issue, the amazing Volkswagen stock volatility and the Lehman’s collapse there have been massive additions to workload and pressures to monitor positions and activity. “Data has to be there, correct and timely,” he said.

Mills thought the market had reacted well to the problems, and that the derivatives industry does not get the full credit it deserves for the way it functioned and applied necessary changes. However, Dos Santos partly disagreed: “The Lehman crisis saw the whole market move in 24 to 48 hours, and the [ETD] model already in place was proved to be right.”

The panel finished up considering technology development issues, with first listing known current areas of concern: the effect of new asset classes moving on to exchanges; the surge in volumes; the break up of silos and a move to horizontal operating models. All require infrastructure re-engineering from end to end, said White, but getting funding currently is a massive challenge.

Tessier thought IT vendors are meeting many of these challenges, and added that there was additional regulatory and political pressure on the street-side to move more processes from OTC to more easily monitored exchanges. He also called for a move away from processing futures and swaps separately – as greater inter-operability was required between units to benefit both the clients and brokers treasuries.

The panel was split down the middle on their immediate IT wish list. Mills and Dos Santos wanted more automation of option management systems, whilst Lennen and Tessier both called for extra automation of the intraday process. But Lennen added a telling caution: “No matter what the sell-side houses do, if clients are poorly automated it will still mean problems in managing expiry, margin and risk,” he warned.

So there was much cautious optimism to be drawn from the session. ETD post trade processing teams had faced up to the immediate operational challenges of the 2008 crisis, and according to the panellists, they coped rather well. Intraday processing has developed into a major concern for end-to-end automation and data processing, as has the remaining manual parts of the STP chain and risks around major expiration dates. But with improved automation from clients to exchanges, these are issues the industry is confident it can overcome.

Number of Trades in equity shares (in thousands), by region

The makeable trend of 2009 is the growth of the volume of trades of the Asian Markets, 39% increase in the average monthly volume of trades compared to 2008.

Domestic Market Capitalization

The Domestic Market Capitalization decreased for all the regions in 2009, the highest drop of the average DMC compared to 2008 was at the level of the EMEA (-27%) and Americas (-22%) while Asia-Pacific was less affected (-11%).

Value of Shares Trading

The overall regions average value of shares traded decreased by 28% compared to 2008, this trend is driven by two regions, the Americas (-33%) and the EMEA -MTF Markets included- (-33 %). Exceptionally, the Asia-Pacific valuation of shares increased in 2009 by 12%.

Graphs on traded derivatives

Turnover in Number of Contracts in Millions

The Asian markets kept a positive growth in the turnover of the futures and options contracts during 2009 with 3% increase compared to 2008. North America decreased by 25% and Europe decreased by 17%. The other markets slowed down because of the financial crisis with (-9%) between 2009 and 2008.

Turnover in Notional Principal in Billions of US Dollars

Notional value: The total value of a leveraged position’s assets. This term is commonly used in the options, futures and currency markets because a very small amount of invested money can control a large position (and have a large consequence for the trader).

The North American Markets are the most important in turnover of notional value, but they decreased by 31% between 2009 and 2008. Europe, the second region after the US in derivatives turnover of notional principal, has undergone the same trend and recorded a 21% decrease. For Asia, despite the growing trend in the turnover of the volume of contracts, the notional principal value deteriorated by 27%. For the other markets the decrease between 2009 and 2008 was by 21%.

Two trends will continue develop in South East Asia in 2010: more cross-asset and more cross-border trading. Watch Hui Yew Ping, managing director of OCBC Securities -one of the largest stock broking firms in Singapore-describe the trends impacting South East Asia, the company’s focus and its experience  working with SunGard Global Trading.

Brokers increasingly want to offer multi-market and multi-asset products to their clients. Such offerings have been facilitated by the development of electronic trading generally and direct market access (DMA) specifically in the region. As clients’ and investors’ demands become more sophisticated, local brokerages will look for new technologies and access to new markets to support multi-asset and multi-trading strategies.

At the same time, cross-border trading is becoming more important for Asian exchanges, especially within ASEAN countries. The stock exchanges of Singapore, Malaysia, Thailand, Indonesia, and Philippines have agreed to form an ASEAN electronic trading link. This will allow cross-border trading through a single access point and, should help to further attract international funds. The member exchanges expect the e-trading link to be operative in 2010. Brokers will then be able to trade in ASEAN-listed securities through a single link on behalf of both local and international investors.

Hui Yew Ping, managing director, OCBC Securities

Consolidating a trading platform for global multi-market trading

OCBC Securities, one of the largest stock broking firms in Singapore, relies on SunGard’s GL Stream and GL Net solutions to stay ahead of industry trends. Watch this video to gain insight about the trends impacting Singapore’s brokers and how GL Stream and GL Net can help to facilitate and enable the multi-market trading strategy.

Global brokers face technology optimization and rationalization challenges in delivering advanced trading services. Watch Leslie Sutphen, Global Head of eSolutions at Newedge, explain how targeted investment has helped expand the firm’s business and deliver efficiency in global listed derivatives trading.

Global brokers need to deliver increasingly sophisticated trading services while controlling their technology costs. Working with global vendors, such as SunGard, can facilitate optimization by integrating tailored solutions to focus on strategic objectives, such as multi-market trading and risk management. At the same time the operation and support of many infrastructure components, such as market connectivity gateways, can be outsourced.

Competition at the front end has not, so far, been matched in the post-trade arena, and that is hampering many firms’ abilities to actually trade on the venues they may wish to.

When the Markets in Financial Instruments Directive (MiFID) was unleashed by the European Commission back in November 2007, one of its main aims was to increase competition across the European Economic Area financial markets. While there has been a migration of some traditional cash equities business from exchanges to the new multilateral trading facilities (MTFs) as a consequence, there remain a number of separate national clearing houses and settlement depositories across Europe.

Why this is the case was discussed by a panel moderated by Bob Currie, editorial director at Financial Services Research. Industry experts considered what major changes have been seen from a post-trade perspective and the main issues that are arising. They began by considering what and who was driving the movement of liquidity from exchanges to MTFs.

Trevor Gatfield, head of securities operations at Investec, thought this migration was broker-led rather than client driven, as the former were striving to access all pools of liquidity in order to offer best execution. The panel noted one of the unintended consequences is that many clients cannot afford to develop the IT required to connect directly to all the pools of liquidity now. As a result, they need to partner with an IT routing specialist instead, and as Philippe Ruault, head of financial intermediary solutions at BNP Paribas Securities Services, pointed out, over the last two years there have been many new developments to assist connections to MTFs as well as cover new investment products.

Fragmented and shallow, not integrated and liquid

Lauren Vis, managing director at Kas Bank, reminded the audience the Lisbon Summit in 2000 proposed European market efficiencies, calling for financial markets to be deeper and more integrated, and set 2010 as the target to achieve that. Somewhat disappointedly, here we are in 2009, still striving for this goal, with the liquidity pools in Europe, “now more fragmented than ever”.

Though there was not much surprise expressed about this fragmentation, Trevor Spanner chief operating officer at EuroCCP, said he felt the various central counterparties (CCPs) had a clear role to play in reducing back-end clearing costs. Gareth Bevan of SunGard stated his belief that this interim fragmentation will eventually stop and there would be consolidation. But for the moment, the ongoing front office innovations had not abated. Indeed, “the back office needs to enable that [innovation], not stop it,” said Bevan.

Gatfield talked about the small impact MTFs have had on Investec so far. He believes the biggest current impact on costs is the reduced size of trades. “Doing more trades for less value needs increased automation to cover that cost gap,” he pointed out.

Ruault felt that many of the leading counterparties were going global using MTFs. Vis said this would not necessarily continue, as switching flow to an MTF had to be viable on a cost ground. He noted that the clearing and settlement for MTFs is still done by the major central depositories, which presents absolutely no economies of scale for the back office. Vis thought this was a key point, as direct trading costs now represented only about 10% of expenses, whereas margin management, post-trade settlements, regulatory and client reporting accounted for the remaining 90% of the costs.

Spanner thought the developed US model was an interesting comparison: trading activity had shifted to MTFs, but there was still only one CCP, which helps to reduce risks and costs. Vis thought the European post-trade model could benefit from similar competition, but that smart order routing needs to be extended to cover post-trade work. As the exchanges are unlikely to develop such links themselves,Vis believes it is still up to the exchanges to open up their IT connections to competent technology providers.

The interoperability dream

This led the discussion into the desire for interoperability. Ruault mentioned that a code of conduct for CCP interoperability is in place, but he questioned whether CCPs would really work together for the benefit of their clients. Gatfield felt that more competition between CCPs had perversely introduced more cost for the clients and brokers: even though trade unit costs are down, connectivity costs had gone up. Spanner thought some European CCPs were in favour of interoperability, and it could break through the barriers to access currently ‘closed shop’ markets as such as France and Germany. But he went on to caution that not all CCPs were keen to foster interoperations. For instance, he claimed, LCH.Clearnet would be ‘mad’ to embrace interoperability, because it charges about five times the rates of its European equivalents.

Vis picked up on this theme. In Europe, “there are still seven exchanges and seven CCPs now …if CCPs embrace interoperability, some of them will lose their business,” he stated.

A question from the floor was asked whether the European Central Bank’s (ECB) Target 2-Securities (T2S) initiative would influence the CCP landscape at all. Ruault answered with a flat no, as T2S is aimed at simplifying European settlements rather than clearing. But Spanner felt that directly navigating the 15 European markets was already very difficult and required an effective “agent bank” model – whereas T2S will promote direct access, and increasing investment opportunities. He did, however, acknowledge this was a ECB project in development with a future timeline for completion – maybe 2012 – with no certainty of adoption, rather than currently available. Vis also expressed some scepticism, saying he believed that T2S is a complex and expensive answer to cross-border settlement costs. He thinks it could only work under the auspices of a pan-European securities law that would allow securities firms to continue to legally reside in their home territory.

Change is not cheap

Currie rounded off the session by asking the panel their primary desires for immediate future clearing and settlement developments. Ruault requested more CCP interoperability, and clearer rules for firms to act as CCPs across Europe. Vis wanted to see the exchanges open up to multiple CCPs first, and also for margin processing to be standardised between the CCPs to avoid the current arbitrage possibilities.

Spanner thought that the high back office costs had now been fully exposed by lowering trading costs, with particularly more attention on clearing and settlement costs – and that true competition between the exchanges and CCPs was required to drive these costs down. Bevan said that, from a technology perspective, it was crucial to design systems that have the agility to accept market developments built in, and provide good operations accounting functions.

Finally, Gatfield cautioned that any major developments cost money – and questioned whether the many mooted changes would actually benefit clients, who would effectively have to foot the bill. However, he agreed that there is currently a window of opportunity to make major changes in the European securities back office landscape, before the markets get back to normal levels of business.

BRIC and emerging marketplaces have suffered from the financial crisis; but there are now signs once again that they offer real opportunities.

 In the run up to the ongoing financial crisis and during its initial unfolding, many emerging markets showed such a surprising degree of resilience that there was considerable talk that they had decoupled from the mature markets. But this perception was soon shown to be false as the crisis took hold. Now though, with risk appetite seemingly on the increase, the emerging, or perhaps more accurately the alternative markets, are once again offering new investment opportunities to a broad range of investors.

As Matthew Clay, senior research analyst at IDC Financial Insights pointed out in a panel he moderated at the SunGard London City Day, there has been plenty of talk about a flight to quality and a desire by investors to seek less complexity. But the fact is that emerging markets have strongly outperformed in 2009. At the end of September, the FTSE 100 stood 16.35% higher than it had done at the start of 2009; similarly, the S&P 500 had risen by 18.64%. In contrast, the MSCI Bara Emerging Market Index had soared by 62.7%.

“I think it’s true to say that after the credit crisis there was a flight to quality. You saw emerging market funds closing up or moving to less risky sets. But now that we are emerging from various recessions, people will want to see greater returns,” said Howard Snell, an emerging market veteran and director of Otkritie Securities, a large Russian broker and provider of direct market access (DMA) to the country.

According to Snell, investors are likely to come to the conclusion that blue chip investments in major markets may soon not offer sufficient returns to entice them. “Emerging markets still have a long way to go. If you look at the FTSE and the Dow, they went down but the FTSE is almost back to where it was. Whereas, the RTS and MSCI Index aren’t even at 50% of where they were…so there is still plenty of opportunity in emerging markets. Price/earnings are much better than in a mature market. In Russia, it’s the lowest you can get at just over seven, against an emerging market average of 12,” he argued.

Milan Procházka, head of capital markets at Prague-based Wood & Company, which runs membership on nine exchanges in Eastern Europe and Dubai, contended that the emerging markets had effectively been ‘over punished’. “It was not the emerging markets which triggered the fall out, unlike Russia in 1997 or Mexico and Argentina on other occasions. Still, the biggest hit was on Russian equities and bonds. There was no safe harbour in the emerging world – if anything had emerging in its name, it was like a stigma.”

However, there are real signs that things are turning around. “I think though that going forwards, I’m a big believer in the emerging markets…We are now seeing these markets being very efficient and high growth. The population in these markets is very young and adaptable,” he continued.

And meeting the needs of those populations will potentially be another growth factor for the emerging markets. Cathy Lyall, an independent consultant working for Brazil’s BM&FBovespa, used some statistics to highlight the attraction of the country. Not only is it huge – Brazil is the fifth largest country in the world – it has a large educated population, a strong agrarian economy and an extremely attractive tax regime. “BM&FBovespa is actually the second largest exchange in the Americas, right behind the CME Group. It’s the fourth largest in the world on market cap…which a lot of people don’t realise,” Lyall pointed out.

As importantly, Brazil is seeking to make itself an attractive location for investment. It has overhauled its trading systems and is overhauling its banking and regulatory regimes. This is something that is also happening elsewhere. “What is important for people going into emerging markets is the regulatory backing and transparency. For Eastern Europe, all these countries are members of the European Union and are adopting MiFID. There rules are similar to those in Germany, France and the UK…you do have investor protection, but when things start moving things can still fall off the edge of a cliff,” said Procházka.

Snell agreed that pitfalls do remain. “I wouldn’t go as far to say they’re (emerging markets) safe havens, because there hasn’t been a decoupling from the mature markets. If we see a massive fall in the mature markets, the emerging markets are going to fall as well. Where there is a relative ability for them to be safe havens is by picking the right stocks in the right markets,” he said.

Another factor was that strength in the domestic economy naturally stimulated stability and lessened the impact of speculative or fickle investors. “The sway of hedge funds will diminish, because the populations of the countries will be much more involved in their stock markets. Russia is a case in point; people don’t have pensions, but they are starting to build them through personal investment funds,” Snell reasoned.

The financial crisis has presented an opportunity to bring global rules and regulations more closely together. If regulatory standardisation is achieved, it will boost confidence in investing in emerging markets. “I think we’re a long way from there (standardisation) yet, but you are seeing more unanimity between governments, regulators and central banks about how they are going to go forward,” said Snell.

Another change is that investment on a broad basis along the lines of, “China is booming, let’s buy it’” may no longer work. “You can’t just blanket invest anymore…now it’s much more about picking the right stocks at the right time,” argued Snell, just as it is in ‘traditional investing’.

In other words, investors should do their own research, but as they do that, they may come to rely on local expertise. “Understanding of how the individual markets work is key. Every market behaves in a different manner. I think you need local partners or brokers to help you out,” concluded Procházka.

A surge of foreign investment has forced the Brazilian authorities to take action to prevent a bubble developing. So, does Brazil remain a land of opportunities?

Ostensibly, the decision by Brazil on October 20 to set a 2% tax on fresh capital inflows investing in equities and bonds had exactly the impact people will have expected. Once, such an event would have undoubtedly caused a mass exodus of investment from the country, but although the knee-jerk reaction was to sell anything denominated in Brazilian real, the dust soon settled.

It would seem that the international investment community believes that the country’s growth story is one built on strong foundations. The fact that Brazil decided to take such a measure, which was designed primarily to slow the appreciation of the real against the globally weak US dollar, is a solid illustration of just how far the country’s economy has emerged.

The new tax may have slowed down foreign investment, but it did not cause an exodus. Brazil still saw a net inflow of around $500 million into its equity markets in October, strongly supporting the now common claim that the country is really starting to capitalize on its undoubted potential. As Cathy Lyall, an independent exchanges consultant who is currently working for BM&BOVESPA, points out, Brazil is the fifth largest country in the world and it has an extremely large and strong agrarian country.

Such a fact would always have attracted some niche investors. But wholesale changes to the country’s investment rules & regulations, as well as to its trading infrastructure, have opened it up to a far wider audience. At a micro level, the creation of

BM&FBOVESPA is extremely significant. Formed in 2008 by the merger of Brazilian Mercantile & Futures Exchange (BM&F) and the São Paulo Stock Exchange (Bovespa), BM&FBOVESPA is one of the largest exchange groups in the world. “It’s the fourth largest exchange in the world by market capitalisation, which a lot of people don’t realise,” says Lyall.

As importantly, the technology that the exchange has deployed is becoming seen as one of its strengths. “BM&FBOVESPA is vertically integrated, multi-asset exchange. It has built is technology from the ground up and it provides a centralised exchange for multiple assets with robust clearing and settlement. Its infrastructure allows regulators to know who the beneficial owner of every transaction is.” Few would disagree that this has proved important as a means of installing faith in the country’s markets.

Brazil has been wary about opening up its markets too quickly. In particular, foreign banks and brokers have not been able to fully write to BM&FBOVESPA’s post-trade systems, which has perhaps limited their control of risk. The country’s regulators have insisted that foreign firms need to operate under their jurisdictions, but at the same time has made it clear that foreign-owned subsidiaries are more than welcome to establish a local presence. This is seen not just as a way of retaining control for its own sake, but as another important policy to help maintain the confidence both foreign and domestic investors now have in its markets. As part of this approach, Brazil is fully encouraging foreign ISVs, such as SunGard global trading business, to provide richer connectivity.

“Brazil had the opportunity to completely restructure its markets from both a regulatory and technological perspective. It basically ripped everything out and started again, doing things properly,” says Lyall. “Even if the world hadn’t changed over the past decade, Brazil still would have been a good story. But the way it has gone about restructuring its markets means that it has become the potential hub for all investments into Latin America. The easiest way to access Brazil, for both investors and ISVs, is to work with local firms. That is already happening and Brazil is now introducing the same sort of services seen in the mature markets. For instance, colocation went live for derivatives in July and is expected to go live for equities by the end of 2009. This will increase the interest from the high-frequency trading community and add to its attractions,” she adds.

Importantly, the exchange has been steadily allowing ISVs to write to its systems. SunGard global trading has provided access to Brazil’s markets for over a decade and it now has 29 clients, as well as a further 10 GL Net order-collector brokers who will be keen to cater further for the demands of a growing international investor base.