The push toward an exchange-traded derivatives (ETDs, also known as cleared derivative) market has exposed gaps in the post-trade process used by market participants to clear and settle these transactions, according to the new study from Greenwich Associates, a leading research based consulting firm, sponsored by Omgeo, the global standard for institutional post-trade efficiency.
Recognizing the need for greater efficiency in post-trade process, derivatives market participants are prepared to make investments to handle increased trade volumes.
In the report, Cleared Derivatives Processing: A Strategic Approach, Greenwich Associates spoke with over 50 buy-side operations professionals and found that trade confirmations in ETDs remain a largely manual process for institutional investors. Despite the growing use of electronic messaging to confirm trades, less than half of buy-side firms confirm and reconcile their trades in real time and nearly two-thirds of investors use manual methods including phone, email, fax and instant message, slowing the clearing and settlement process and increasing risk.
Many factors are driving increased trade flow volumes in the ETD market, and while regulations will continue to impact trading behavior in the next few years, participants stated that traditional market factors are set to have a more significant impact on cleared derivatives markets going forward. Roughly 80% of institutional investors say their changes in product usage are due to shifts in asset allocations and/or fund performance. Nearly one-third of buy-side participants report a shift from over-the-counter (OTC) products to futures, and market data tells us that this number is likely to grow. A potential leading indicator, CME saw an increase in volume of 11% in Q4 2013, with rate products seeing a 29% jump.
To address the issue, buy-side participants are increasingly spending on cleared derivatives processing. Greenwich Associates found an average spend of US$800,000 annually on cleared derivatives processing.
In North America, nearly 60% of this budget is spent on human resources, with the rest spent on technology. Over 80% of respondents say they have no plans to hire new resources, but instead plan to focus budget dollars on new systems to help streamline the process.
This is not the case in Europe. With EMiR implementation now getting under way and MiFID II not yet finalized, money managers in Europe are planning for a dramatic increase in spending - doubling in many cases - to ensure compliance and capacity in the next few years. Reporting complexities are high on the priority list in 2014, with increased volumes expected in 2015 and beyond as clearing mandates finally settle in.
"Regulations such as Dodd-Frank, EMiR and MiFID II are placing a greater emphasis on the post-trade processing of exchange traded derivatives. While regulations must be adhered to, investors are getting back to doing what they do best—investing—and operations teams must be ready to support them," stated Kevin McPartland, Head of Market Structure and Technology Research at Greenwich Associates. "The critical role operations teams perform to ensure the efficient clearing and settlement of derivatives transactions is more important than ever."
"In order to prosper in the exchange traded derivatives market, industry participants must ensure they have automated solutions in place that mitigate risk, process post-trade transactions consistently across all clearing methods and asset classes, and meet evolving regulatory demands and industry best practice," said Ted Leveroni, Executive Director of Derivatives Strategy & External Relations at Omgeo. "Automation is the only way to bridge the gap and drive consistency and operational excellence across a firm."
During the month of January 2014, Greenwich Associates conducted telephone interviews with over 50 operations professionals at both buy-side and sell-side firms to understand the current state of the Exchange Traded Derivatives (ETD) market. Study participants included 19 respondents from North America, 27 from Europe and 5 from Asia.