The FT published a great special section this past Monday on the state of OTC derivatives reform. Coverage ranged from the impact of MF Global on margin and segregation rules to technology innovation driven by the new rules. What these stories all reaffirm is how much the details of the final rules will impact liquidity, product selection, the growth of electronic trading and what set of tools will ultimatey be most valuable in helping market participants come out on top.
“As volatility alone can cause rapid intra-day deterioration of major counterparty credit quality, a move
towards near-time or realtime clearing is inevitable anyway,” said Kevin
McPartland, fixed income analyst at Tabb Group, in a report last year.
“Some of the most contentious rule proposals are those that will impact
liquidity fragmentation the most,” says Kevin McPartland, [Principal] at Tabb Group.
A few months back we put out a research piece on clearing technology, and how despite a lot of work over the past few years, a big investment is still needed to bring OTC clearing to where it needs to be. And thankfully for those that sell clearing technology, regulations and continued fear of counterparty risk will ensure that investment will in fact happen. The subtitle to the aforementioned report explains the shift in mindset: "Bringing the Back Office to the Forefront".
But one problem is that while the industry knows clearing and transaction volumes will grow, it is unclear by much. Kevin McPartland, an analyst at Tabb Group, the US capital markets consultancy, estimates transaction volumes could increase twentyfold, and market data volumes up to 3-4 times above the current levels.
“As volatility alone can cause rapid intraday deterioration of major counterparty credit quality, a move towards near-time or real-time clearing is inevitable anyway,” said Mr McPartland in a recent report. “OTC derivatives transactions that once took days to clear and settle will be finalised in minutes, if not seconds.”
A few weeks ago I had the privilege of sitting down with CFTC Commissioner O’Malia. In this clip, we talk about how important technology is to both participating in and overseeing the swaps market and financial markets as a whole.
The FT did a great job covering TABB Group’s new research piece looking at the technology challenges facing clearinghouses and dealers as they prepare for central clearing mandates. Read the full story here.
And the press release:
TABB Says Dealers and Clearinghouses Need to Make Huge Investments and Upgrades to Current Clearing Technology
NEW YORK & LONDON, Sep 29, 2011 (BUSINESS WIRE) — Global regulators focusing on the clearing of OTC derivatives have started a technology revolution, says TABB Group in new research published today, “OTC Derivatives Clearing Technology: Bringing the Back Office to the Forefront.”
“OTC derivatives reforms are causing headaches all over Wall Street, the City and beyond,” say Kevin McPartland, a TABB principal, director of fixed income research and co-author with senior contributing analyst Finn Christensen. “Unfortunately, current clearing infrastructures are neither scalable nor flexible enough to handle the changes ahead, a fact driving a wholesale change from overnight (or longer) processing to near real-time clearing expected to occur during the next three to five years.”
Anticipating an increase in transaction volumes is a key component to the clearing technology roadmap, and using listed-derivatives markets as a guide, TABB estimates that as new trading and clearing mandates are implemented, transaction volumes could increase twentyfold with market data volumes rising three to four times above current levels. “Not only must clearing infrastructures be scaled up but upgraded in such a way that they can scale further if transactional growth exceeds current estimates,” McPartland says.
Despite the fully staffed IT teams and eight-figure budgets at big global dealers and some clearinghouses, the authors explain, building out this infrastructure will be difficult without third-party assistance. “Technology providers have already stepped in to revamp legacy systems and build new technology that solves many of the issues born from expected regulations. The biggest market participants will take a best-of-breed approach, utilizing the best off-the-shelf products they can buy and tightly integrating them with systems that are built by in-house staff.” They add that most buy-side firms expect swaps dealers and their service providers to provide the necessary connectivity and interfaces.
Real-time clearing of a broad range of OTC products will happen, McPartland says, as market participants and regulators demand it and innovative technologists guarantee it. “These improvements will come in phases, paralleling regulatory rollout and growth in clearing volumes. The first phases are underway and clearinghouses and dealers understand the winners will be those who can consume and disseminate data elements critical to trading, clearing and reporting in the least amount of time. But technology is the key catalyst behind the elimination of existing inefficiencies, reduction of expensive manual resources and lowering of operational risk.”
Based on conversations with clearinghouses, swap dealers, technology providers and buy-side clearing specialists, the 21-page TABB report with 8 exhibits examines the impact new OTC derivative regulations will have on clearing technology for both sell side firms and clearinghouses; the cost of implementing the technology needed to handle real-time clearing and intra-day margin calls; and a view of the new clearing workflow.
The report is available for download by TABB Group Research Alliance Derivatives clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx . For an executive summary or to purchase the report, visit http://www.tabbgroup.com or write to firstname.lastname@example.org.
This is further coverage of my recent research report. Regulations are causing a headache for much of the industry, but the flip side will be all of the resulting business for consultants, tech firms, lawyers, etc.
“The OTC derivatives market is in for revolutionary rather than evolutionary change,” said analyst and author Kevin McPartland.
The top 15 banks will spend a further $290 million on technology to ensure more efficient workflow processes to replace existing systems, the report revealed.
This story talks about Citi’s foray into visualization to help with risk management. My comments:
“Before all of the mess started, we were in a place where companies with household names were perceived as having zero risk,” says Kevin McPartland, senior analyst with Tabb Group. “There was no chance that a major bank would ever disappear, so the thought of a bank disappearing didn’t go into their calculations of risk. But the crisis did bring a good thing to the market-it made people more aware and more conscious of the risks they take and how they manage those risks.”
I moderated a recent event put on by Telx discussing the challenges faced by financial services firms when creating low latency, highly reliable infrastructures. The event saw ~150 people come out to Telx’s new data center in Clifton, NJ to see what I felt was a pretty interesting panel. We also learned Telx is in the process of filing for an IPO.
There is constant talk of whether cloud computing will make its way onto Wall Street. I’m not talking about the use of web based CRM, but realshared storage and compute power cloud computing. The hybrid idea is an interesting one as it could allow firms to scale quickly without keeping the huge amounts of excess capacity they currently need in the event of unforeseen market events. Some excerpts of my commentary:
Hybrid cloud is still probably a couple of years away for even the more experimental financial services firms, while they focus on virtualizing and cloud-enabling their applications in-house. But eventually the hybrid-cloud model could be the solution to financial services firms’ cloud security worries and bridge the confidence gap. As time goes by, we will likely see applications being developed for deployment on hybrid clouds, although probably not this year, says McPartland.
Latency is another problem: Firms are reticent about deploying cloud in the equities space and other latency-sensitive areas. In a recent survey of equities technology executives in sell-side firms, the Tabb Group found that only 4 percent of firms questioned actually had cloud deployments and most of those were internal, according to McPartland, the report’s author. “Bulge-bracket firms are experimenting with cloud for things like back testing and other non mission-critical activities,” McPartland says. Seventy percent of firms questioned do not have a cloud strategy at this time, although a quarter of firms said they were looking into it. Seventy-two percent of those questioned said that security was a concern.
No one is using cloud for real-time equities trading applications, McPartland says, because it does not yet meet the low-latency demands of algorithmic trading.
The guys from Exegy who run the Market Data Peaks website say market data rates will only continue to increase. I agree – although I’m not sure doubling in 2010 is necessarily in the cards. Either way everyone needs to be ready. An excerpt:
Data rates will certainly continue to grow with trading firms keeping considerable excess capacity on hand to handle unexpected market events,” noted Kevin McPartland, a TABB Group senior analyst specializing in OTC derivatives as well as technology issues. “We must also look to OTC markets such as FX and US Treasuries that are seeing huge growth in automated trading – where automated trading goes, increased data rates follow.
I got a demo and this is pretty cool stuff. I’m sure we’ll continue to see initiatives like this from financial services focused software firms:
“CEP and open source have both seen major adoption in financial services over the past few years,” said Kevin McPartland, senior analyst at TABB Group. “CEP has helped the industry to deal with ever-increasing data volumes and complexity while open source has helped many firms to find software development efficiencies. Bringing these two ideas together into open-edge model could help drive collaborative innovation in the event processing space.”