Source: State Street
Buy-side firms are unprepared for new trading mechanisms, costs and increased complexity and should partner with established providers to adapt to an evolved OTC derivatives marketplace, according to research commissioned by State Street Corporation (NYSE: STT).
The new research paper, "From Readiness to Revolution: The Implementation and Impact of Derivatives Clearing Regulatory Reform," provides insight into preparations for swap execution facilities (SEFs), central clearing, collateral management and reporting.
State Street, which operates as a futures clearing merchant (FCM) and a SEF, commissioned the research with Aite group which surveyed buy-side firms that collectively represent more than $6 trillion in assets under management. The research highlights developments across the entire trade life-cycle and includes a roadmap to readiness for Category III firms - those firms that have yet to complete the Commodity Futures Trading Commission's (CFTC) phased implementation of derivatives clearing.
"The days of the excel spreadsheet are gone, collateral management has moved to the front office and phones have been traded in for exchanges," said Jeff Conway, executive vice president and head of State Street Global Exchange. Global Exchange brings together existing components from State Street's research and advisory, analytics, Currenex®, Global Link® and derivatives clearing capabilities to address clients' data information and trading challenges. "As the trend towards electronification continues, regulatory reform demands strong technology. We are well positioned to provide the buy-side with solutions to these challenges across the entire trade cycle, from execution to clearing to collateral."
Key highlights from the research include:
Clearing and Collateral
Category I firms (companies that have completed the transition to mandated clearing) report that first movers had the advantage to negotiate more advantageous FCM agreements that allowed for preferential terms and conditions relating to fees and margin requirements, while Category II firms (firms that have also met clearing mandate requirements) later found FCMs less flexible in their willingness to lower fees. Category III firms who have not put agreementsreements in place early will need to partner with well-established FCMs that can quickly respond to their customers. Other findings include:
Firms tend to select FCMs based on financial stability and pre-existing relationships; for firms that had a pre-existing relationship, the FCM's ability to bundle services to reduce cost became a consideration
Many firms have only on-boarded with a single FCM and clearing house, allowing only for short term compliancy rather than long term success with multiple FCMs to diversify risk exposure
Posting initial and variation margin continues to be an operational and technological headache; nine out of eleven firms indicate that they either already outsource the collateral management function or intend to do so
More than 60% of respondents indicate that staffing and timing are critically important, with frequency of collateral movements and impact on performance ranking "highly important" for more than 70% of those interviewed
On June 4, 2013, final SEF rules were published in the Federal Register that provided clarity to SEFs wanting to enter this new marketplace, and established an effective date of August 5, 2013. With the effective date looming, "From Readiness to Revolution" not only addresses the anxiety the buy-side still has over new trading mechanisms, immediately increased costs and electronification itself, but also highlights the long term benefits that standardized work flows and increased competition offer.
"The creation of SEFs will transform OTC derivatives markets, resulting in economies of scale, reduced transaction risk, cost savings, and growth in trading volumes and liquidity," explained Conway. "State Street's decision to launch and apply early as a SEF before the effective date reflects our determination to meet our clients' needs and be one of the first providers to help lead the way in a revolutionized marketplace."
State Street filed registration documents with the CFTC today for SwapExSM to become a multi-asset SEF. This submission establishes State Street as one of the initial entrants into this market, and has ensured that it is among the first wave of applications to be reviewed for approval.
By leveraging the core technology and best practices of State Street's Currenex, FX Connect and GovEx execution platforms, SwapEx gives clients trade flexibility by providing multiple execution styles across numerous asset classes. The platform will provide portfolio compression capabilities to help relieve the regulatory burden of higher margin requirements. SwapEx adds electronic execution to State Street's existing end-to-end derivatives solution, DerivOneSM, which includes clearing, servicing, collateral management, valuation, and risk and analytics.