Centralized, cross-asset trading on a single platform may avoid compliance and risk nightmares. (Round-up industry story on OTC derivatives quotes CRD Managing Director-Global Tom Driscoll and Product Manager Karl Kutschke. The complete story follows.)
As regulators close the gap between the over-the-counter and exchange-traded markets, order management system and specialist OTC suppliers are gearing up provide the buy side with a single, centralized platform for OTC and listed instruments – a possible Nirvana for the front-office.
Ultimately, the new rules of the road for the nearly $600 trillion OTC market will give the buy side a long “to-do” list.
The vendors may have some breathing space. In the US, the regulatory changes are in a state of flux and are likely to miss their mandated deadlines. The Securities and Exchange Commission and the Commodity Futures Trading Commission are moving to set up swap execution facilities, which are exchange alternatives for OTC instruments; OTC clearing platforms with collateral requirements; and swap data repositories.
The regulators are also likely to issue rules that will lead to changes in back office operations, intended to capture and calculate risk to comply with new, forthcoming margining rules. The driving force behind these changes, the Dodd-Frank Act, also allows OTC trades to be transacted on futures exchanges. European regulators are expected to enact similar reforms later this year, which is when the new rules from US regulators are likely to take effect.
The new regulatory environment will mean new connectivity to SEFs, extra transparency into the risk profile of their counterparties, and more transparency into OTC instruments via additional analytics and risk controls. They will need a broader view of the exposure that OTC instruments pose to portfolios. Some of these steps, however, run counter to the push for platform consolidation.
Step 1: consolidation
Many mid-to-large sized shops are using as many as seven different trading systems to cover cash, foreign exchange, proprietary trading, equities, and fixed income, says Gavin Little-Gill, global head of asset management product strategy for Linedata Services, maker of the Longview OMS. In many cases, the OTC desk is not yet automated.
”How do you run compliance that way? How do you understand what your counterparty risk is? How do you truly measure your exposure?” Little-Gill asks. “In that environment, it’s very difficult to do so.”
One way around this problem is for front-office platforms to do a much better job of capturing the “cleanest possible portfolio data as soon as possible,” Little-Gill says. Users also want the data to be validated to avoid data scrubbing later, he says.
Multiple, isolated systems can arise from firms that have taken a do-it-yourself or a best-of-breed approach, says Robin Strong, director of buy-side market strategy for Fidessa, which offers the LatentZero Minerva OMS/execution management system. These siloed systems have frequently been long and costly implementations. Firms often wind up with a harsh realization that “they can’t actually do pre-trade compliance because half of the trades are in one system and half are in another,” Strong says.
Moving to centralized, cross-asset trading on a single platform could help avoid compliance and risk nightmares. ”I’d say the nightmare is trying to get a consolidated risk picture,” says David Kelly, director, credit products at Quantifi, a provider of analytics, trading and risk management software for the OTC markets. The strengths of OMS platforms are in equity and bond transactions, not OTC, he says. “Throw a CDS at them and forget it,” Kelly says. “What risk system do you overlay on top of these execution/order management systems that allow you to consolidate a picture of your risk?”
To avoid nightmares, user firms have to first organizationally change the siloed mentality, says Sang Lee, co-founder and managing partner at Boston-based market research firm Aite Group. “The best approach to providing cross-asset compliance via OMSs would be to make sure that all transactions across the different asset classes get funneled through the OMS so that the compliance module can keep track from a centralized position,” Lee says.
Converging assets and technologies
In addition, OMS platforms will need more inroads into the OTC environment, says industry analyst Stephen Bruel, an analyst at market research firm TowerGroup. As the OTC market starts to resemble the futures space, “the OMSs will have to make some changes to be able to handle the nuances of the OTC book”, he says.
”At the same time, there are some OTC derivatives providers such as Misys, Calypso and Murex that perform a lot of these front-office trading functions from an OTC perspective and they’re going to need to modify their technology so that they look and act like something that trades futures because that’s how the trading is going to evolve,” says Bruel, adding that the OTC providers lack the real-time data management capabilities that “you see more on the listed side”.
OMS vendors also have to recognize that there will be no “one-size-fits-all” problem set that they can use to model their cross-asset platforms, says Rob Agne, director of product management at ConvergEx’s Eze Castle Software. The North American, European and Asia-Pacific markets will be distinct as will the asset classes. “Different asset classes will be traded on different SEFs,” he says. Counterparties may choose to specialize. Amid the maze of new rules and regulations, customers will need help finding increased levels of liquidity and transparency, not to mention support for new file formats and reporting requirements.
“You can see how this just perpetuates into somewhat of a difficult environment,” Agne says. “We’re not rushing out to connect to everyone. Part of what we’re trying to do is listen to what our clients are asking for.” Agne says he’s hoping for more standardized, extensible APIs that can serve as a kind of insurance against a likely shakeout among the SEFs and related venues. He is also hoping for standardized contracts via the SEFs.
However, Agne cites one key benefit of moving OTC transactions to trading venues – the generation of market data. “As a technology vendor, we’ll need to have adapters to bring in that real-time market data for our clients to take advantage of. As these are traded on exchanges, there will be more data for us to process and that’s something we need to consider. We’re working on it.”
Before vendors launch the single platform for all, they will have to resolve “off the charts” customer demands for compliance and regulatory support, says Chuck Giessen, senior vice president and general manager for the financial markets group of SS&C Technologies, maker of the Antares OMS. “The issue in our industry now is the increasing requirements for transactions,” Giessen says.
A case in point is the 11 million Finra-mandated Order Audit Trail System reports processed per month by the SS&C Antares platform, Giessen says. In addition, Antares supports reporting procedures for exchange-traded equities governed by Mifid in Europe and by regulators in Australia.
“As reporting requirements start to include other asset classes, there is a general issue in the transaction sequencing numbers and how you report them and how things are centralized,” Giessen says. Firms will have to grapple with the issue of principal trading books and how to tie them to their underlying options via time sequencing.
”It’s a massive issue for our clients so we’re doing significant work for them,” Giessen says. “All of which argues for increased spending for IT in an environment where people have less money to spend. And that’s the squeeze. I think that’s the dilemma – everybody knows they need more, but they just aren’t sure how to pay for more.”
Going to market
When they do go to market, the buy side will find the vendor space a lot “more crowded over the next 12 months,” Bruel says. “We may even see some partnership activity.” For the moment, some vendors are skipping the partnership step. Calypso Technology, for instance, is readying an OTC OMS (See “Calypso to build ‘OTC OMS’”, page 32) while Charles River Development has its own analytics.
In fact, Charles River will not be partnering with a specialist OTC provider, says Tom Driscoll, the global managing director at the firm, maker of the IMS platform. “We’ve poured tens of millions, if not more, into the support of these types of instruments,” he says. ”We’re building out our capabilities on analytics and there’s risk management as well,” says Karl Kutschke, product manager, fixed income and derivatives at Charles River. Users will be able to watch a trade’s progression through its lifecycle, including its impact on portfolios.
Providing analytics, risk and compliance support will be differentiators among OMS vendors because the pain points have shifted to pre-trade elements, Driscoll says. “A couple of years ago, pre-trade compliance and risk may have been as ‘nice-to-haves,’ “he says. It’s really more of a must-have now.” Driscoll acknowledges that specialty systems can excel at certain tasks. However, they may miss broader elements such as non-derivative asset classes. “Many of them are good on the risk side but with compliance rules that’s been a challenge,” says Driscoll, who adds that working with a third party contradicts the push for platform consolidation.
Dan Matthies, global head for the Asset and Investment Manager OMS from Bloomberg, says he agrees that pre-trade compliance has become more important for OTC derivatives processing, which is why AIM offers calculations. “If you’re creating a credit default swap on Bloomberg, you’re setting up the deal terms whether they’re captured electronically or created manually,” Matthies says. The deal terms are entered into a calculator before the transaction is sent to AIM.
Quantifi might consider partnerships with OMS vendors, despite the fact that their product scope is “very limited to cash equities and bonds,” Kelly says. “There’s not a whole lot of analytics in the equities space unless you’re doing charting, which we don’t do.” Quantifi may have more interactions with the OMS providers once they start sending OTC instruments to SEFs.
As for the single platform for all, Kelly says it is nonexistent. “I would argue that if there were such a system it would have a monopoly position in the vendor space,” he says. “In my 20 years in the business, I’ve not seen it created – mostly because the spectrum is so broad.” Other vendors express a more qualified support for a centralized platform.
Mattheis says that, while AIM comes very close to being the complete platform, “there’s always going to be something that any system or platform doesn’t do as a result of the market continuing to reinvent itself.” The key is to work with “the biggest community” of diverse firms trading across different asset classes and regions who can then serve as development partners, he says.
“It depends on the requirements of the firm,” Driscoll says. “If you do it across multiple asset classes, finding a system that’s perfect in every asset class is probably not realistic.” However, Driscoll argues that a module that supports 90% of an instrument’s operation and is connected to a unified platform is superior to an isolated system that does 99 percent of the job but costs millions of dollars to integrate. The end users will ultimately decide if they are willing to make that kind of a trade-off for Nirvana.
Source; April 8, 2011; Banking Technology
Filed under: News, Risk Management, Trading Technology, Asset Management, Compliance, CRD Charles River Development, Data Management, Derivatives, Order Routing, Risk Management