Spending on OTC derivatives automation to surge - Tabb

Spending on OTC derivatives automation to surge - Tabb

Banks will spend $70 million on automating over-the-counter (OTC) derivatives processing in 2008, rising to $120 million in 2010 - a compound annual growth rate (CAGR) of 30%, according to estimates from Tabb Group.

In a research note Tabb says that, whilst top-tier, sell-side broker dealers have invested heavily in developing processing for OTC derivatives, many other counterparties, including mid-tier banks, hedge funds and other trading firms have yet to implement any kind of automated system.

OTC derivatives processing has suffered in recent years as banks diverted budgets to trading systems, high-speed data and algorithms, says Tabb.

Tabb identifies hedge funds as particularly slow on the up-take with nearly 1000 trading OTC derivatives, but only a fraction of these using automated processing systems. Tabb forecasts the market for software packages for hedge funds will reach nearly $40 million by 2010 - double the figure for 2007.

Kevin McPartland, senior analyst, Tabb, says when the Federal Reserve first instructed dealers to clear settlement backlogs and tighten back office risk management procedures in 2005, most firms invested in extra staff to deal with backlogs.

But McPartland argues that the credit crunch shows employing extra personnel is not enough to solve the problem.

Despite technology existing for real-time monitoring "many firms continue to rely on daily, even weekly, reports because it's often difficult and expensive to implement more frequent tracking", says McPartland.

He says credit default, interest rate and equity swaps transactions not handled by electronic confirmation platforms - averaging about 1000 transactions per firm per month - continue to be handled through paper-based confirmations. In addition, almost all non-vanilla trades - averaging as many as 4000 transactions per month for the largest firms - also use paper-based confirmations.

"For OTC derivatives a new day has finally dawned. A process so critical and complicated, it is simply screaming out for automation," says McPartland.

Tabb's research comes a year after the Bank for International Settlements called on financial firms to introduce automated systems to cut confirmation backlogs in the over-the-counter derivatives markets.

The Committee on Payment and Settlement Systems, the public policy forum of the central bankers' collective, called for improvements across the complete post-trade environment in the booming OTC markets.

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