By Francesco Margini, Head of Product Management for Cleared Derivatives, ION Markets
If anything has reinforced its importance throughout the pandemic, it is technology. Everything we did prior to the outbreak of the Covid-19 crisis has now received a technology boost. But when we talk about how technology is automating processes in the capital markets industry, we’re most likely referring to electronic trading and the transformation of the front office function. Unfortunately, post-trade processes which are key to support all market activity have historically received less attention.
Recognising this gap, the Bank of England convened the Post-Trade Technology Market Practitioner Panel to explore how market participants could harness technology to deliver a robust post-trade ecosystem. In the subsequent report that was released, the Panel concluded that post-trade processing across the industry was too reliant on manual and outdated technological processes – a thorn in the side of many banks and brokers.
Post-trade operations still involve more manual processing than any other phase of the trade lifecycle. On the other hand, front-office execution is largely fully automated. What then, is still causing this gap?
Root cause
Post-trade processes, both within and across firms, have evolved organically over time, with layers of infrastructures, and workflows. While the purpose was to support significant market expansion, it has instead multiplied complexities. Over the years, derivatives trading has focused on fixing the old, outdated legacy systems rather than investing in new technology. However, the patchwork of short-term fixes and workarounds (adding layer upon layer) is starting to unravel as it’s failing to deliver new levels of automation. In a nutshell, it is complex, costly and inefficient, which directly impacts operational efficiency, resilience and profitability.
Decades of under-investment in post-trade has meant that the large-scale platform overhauls have been few and far between, unlike in the front office. And this needs to change – post-trade needs to keep up with the front office, and here’s why.
No-touch front-to-back workflows
Digitalisation of the order flow has accelerated, and the sell-side is under tighter scrutiny from the buy-side and regulators.Trades are expected to be processed straight through from front office to back office with minimum to no-touch, and clients expect brokers to provide a real-time view of their business, including trades, positions, liquidity, and risk.
Because of the fragmentation of post-trade systems and processes and the significant limitations of legacy applications, brokers are often unable to process their clients’ business in an accurate and timely manner and lack a holistic view of their clients’ business across execution and clearing. As a result of this, brokers typically need to deal with extensive remediation work on T+1, where adjustments can be very complex; not forgetting the varying related consequences, which can cause traders and clients being unable to accurately value their portfolios, fail to comply with reporting obligations, or even suffer financial losses.
Inefficiencies in post-trade is not only due to the lack of technology investment by the sell-side. Other factors such as the disconnect between exchanges and CCP systems, the lack of standardisation in the industry across several areas (product symbology, brokerage) and buy-side FIX execution flows have all contributed to the huge complexities the sell-side has to support within its systems. In order to process the business and service their clients, clearing brokers must capture, map, enrich, reconcile data to bridge the gap between execution and clearing flows. In addition to bearing exorbitant costs to run their clearing business, brokers face significant challenges to comply with ever increasing regulatory requirements.
Pain points for organisations
One of the most significant pain points that is affecting organisations is erroneous static data. This is suffered by traders across the front, middle and back offices, causing substantial operational inefficiency and business impact.
With the increasing need to map and normalise static data across systems front to back, brokers are seeking to automate the management of product static data from exchanges, clearing houses, the various internal systems and their clients. However, due to the duplication of data across several different systems, this is a daunting task that requires a significant technology overhaul to simplify the architecture and create central golden static data repositories. To the present day, a very large portion of trade breaks is still due to incorrect static data.
Another nagging pain point in the industry is commission management. Legacy systems are unable to accurately capture all the trade information required to precisely calculate and accrue execution, commission and exchange fees, which results in extensive remediation work typically performed manually. Also, this results in loss of revenue because firms are unable to collect correct commissions from clients and third-party execution and clearing brokers who are involved in the billing process.
In addition, the industry as a whole has not been able to implement processes to standardise and centralise reconciliation and payment of execution brokerage among market participants. The result of this is an enormous backlog of unpaid invoices due to significant discrepancies between the calculations performed by the parties involved in execution and clearing of clients’ business.
Capturing all required data from front-office and clearing systems and persist it through the stack to end-clients is key to eradicate the issues that have affected the cleared derivatives industry for decades. Successfully tackling this challenge, however, requires a deep understanding of the business processes involved and significant technology investment to develop new automated solutions replacing antiquated systems.
Reengineering post-trade
No doubt the market has evolved, but this has happened at a different pace for each asset class, and of course in different ways. When it comes to automating post-trade processes, equities has been ahead of the game, and while cleared derivates followed suit, increased regulation (EMIR, MiFID) has accentuated the various pain points.
Within several banks, cleared derivatives is part of the equities business, simply because the former doesn’t have enough profitability to stand on its own. The low profitability of the cleared derivatives industry will persist unless the sell-side rethinks its operating model and invests in modern technology removing fragmentation of systems, streamlining key business processes, supporting end-to-end automation and real-time processing.
The inefficiencies in post-trade processes present a compelling case for change. Banks are left with an easy choice between adopting new technology and flourishing or continuing with a patchwork of legacy systems and eventually falling behind existing competitors and new market entrants. By automating post-trade processes and implementing real-time solutions, banks will not only be able to reduce overheads, increase profits and grow at scale, but also improve customer service and gather significant operational and business insights via data and analytics.
