The problems facing global clearing firms are well known. Regulations are forcing firms to put aside more capital and segregate it in new and more complex ways. Interest rates and volumes remain stubbornly low. With little money available to upgrade post-trade processing, many firms are dealing with antiquated systems that are cobbled together from a variety of technologies.
Meanwhile, exchanges and clearinghouses are offering an ever-increasing number of products, trading venues, risk management practices and incentive programs. Clearing firms and system vendors are overwhelmed by these innovations, especially as regulatory inconsistency and fragmentation of trading and clearing venues have squeezed revenue.
We queried numerous clearing members and industry titans to get a handle on the problem and find potential solutions.
Our research revealed that what is needed is for systems to be revamped to eliminate redundant and inefficient processes and to standardize data. Rather than continue to “nibble around the edges” with annual headcount reductions, many leaders believe industry-wide collaboration is required to achieve the necessary transformative change.
A comparison of futures clearing firms in 2008 vs. 2015 shows a 30% drop in their number because increasing capital charges have made the business model unsustainable. Industry leaders expressed a desire for more large-scale common initiatives such as industry utilities to define data and process standards and to encourage exchanges, clearinghouses and regulators to adopt a consistent and open approach in their data requirements and interfaces. The research also revealed a willingness by the industry to collaborate and embrace utilities as the driver of transformative change in post-trade processing.
“Firms can differentiate on client interfaces, regulatory reporting, execution and clearing and settlement reporting,” notes a clearinghouse executive. “Everything else—taking the trade from the clearinghouse, calculating margin, client margin [calls], paying exchange fees, maintaining product definitions and data fields—is done the same by everyone.”
While there is a desire to collaborate to adopt more standardized processes, the lack of a “single voice” to date has hindered progress. This mission has become increasingly challenging as regulators and clearninghouses differ in how they wish to address risk.
And there is little standardization elsewhere in the industry. One clearing member says that the problems regarding capital and segregating client funds are that, “every clearinghouse has come up with its own approach to address Basel III and to create new clearing member categories. So, practically speaking, it has not simplified things for the clearing firm.”
The research showed that the vast majority of respondents identified data standardization as the greatest opportunity for the improvement. An industry utility also was mentioned as an opportunity to create improvement (see “Action plan,” below).
Clearing members want to define data requirements and work with exchanges, clearinghouses and regulators to standardize data across the globe. Yet, many of the post-trade processes that remain manual currently do not lend themselves to to automation without standardization. Collection rates for brokerage are often in the 18-month to two-year range. This was cited as the biggest pain point by virtually every clearing firm. By adding a simple indicator to transaction data on how a trade was executed, full automation of both reconciliations and payments could be achieved. This change also could reduce post-trade processing costs significantly.
“The exchange systems were designed for processing floor brokerage,” notes one operations manager. “No one ever got around to upgrading them to accommodate such things as Tag 50 (electronic trading operator IDs) or broker algorithms. We need to come together as an industry and agree on a standard way to process this” (see “Operational challenges,” below).
Some attempts to collaborate are already occurring. FIA Technology Services (FIA Tech), a subsidiary of the FIA and a provider of web-based software systems, is planning to address this shortcoming by designing a data schema for getting trades executed and applying it to its
current give-up billing system.
“We are currently validating the data schema and getting feedback from industry participants on the optimal way to apply it to eGains (FIA Tech’s brokerage payment system),” notes James Woods, chief technology officer of FIA Tech. “We hope to begin testing by the end of 2016.”
The Need to Standardize Data
Another challenge created by non-standardized data involves the application of exchange incentive programs to client profit/loss and balances. Industry leaders consistently cited the difficulty in applying exchange fee programs to client trading activity, particularly when the client is not a member of the exchange. Fee reconciliations was another pain point respondents believed could be solved through greater collaboration (see “Wish list,” below).
Software providers are addressing the issue by attempting to obtain and standardize fee data and apply it to reconciliation. However, they too struggle to apply this data across multiple systems. And, because collecting exchange fees brings no additional revenue to clearing firms, the clearers are hesitating to make significant investments. However, the need for a standard solution is apparent as regulators are paying attention to how fees and commissions are reconciled; a clearing firm was fined by the CFTC in 2014 for failure to supervise fee reconciliation.
The FIA also is spearheading an effort to understand how exchange incentive program data can be made more accessible.
In addition, different regulatory reporting requirements by various regulators present a new problem. Clearing firms have a strong desire for a centralized reporting facility that could source trade data from exchanges and clearinghouses, enrich it with client data and deliver it back in a specified format to a variety of data repositories.
One clearing firm suggested designing a way to “keep the client data centrally so that it can be aggregated across clearing firms and identified in whatever format the regulators want.” However, this creates concerns over forcing clients to disclose confidential data and whether this data can be safeguarded properly.
“Some of the large clients would be very concerned about commingling their data between clearing firms within a utility,” notes a European clearing member.
technology to the rescue?
Leaders are hopeful that new technologies such as cloud services or blockchain could provide distributed, secure data repositories with secure information. But, technology alone cannot solve the lack of data standardization.
Many clearing firms rely on technology inherited through mergers, and systems cobbled together by a myriad of customized interfaces and databases. This has resulted in delays in reconciling trades and performing basic analyses such as profit and loss, margin requirements and balance sheet utilization. Trading is global, but technological processing delays result in firms missing key information.
Clearing firm leaders emphasized the need to see client balances in real time to ensure that capital and profitability are maximized and that clients’ data is properly managed.
In addition, existing technologies make it very difficult to add new product types or exchanges with different trade load and margin protocols to the current technology configuration. Coding takes too long and testing processes take much longer than is required by newer, more flexible technologies. The study cited processing delays as one of the greatest challenges to be addressed collaboratively (see “Getting on the same page,” below).
Technology investment has been a growing expense since trading went electronic, and tying together new and old technology together has been a problem.
All study participants expressed interest in adopting innovative new technology; however, a big concern was the lack of open interfaces between vendors, third-party utilities and processing technologies already in place. Particularly with the advent of more complex cross-product margining, individual client segregation requirements and the demand for analysis of balance sheet impact, clearing firms expressed frustration with their inability to access data and perform calculations in their core processing engines.
The lack of open interfaces to core processing engines stifles the introduction of new, more modular systems designed to address allocations, cross-product margining, customer data maintenance and trade and cash reconciliation. Adoption of innovative new technologies has been slow due to the tremendous cost of integration.
“All the players should be encouraged to facilitate information exchange to make it easier to split up information and disseminate it to customers,” argued the CIO of one mid-sized clearing firm. “More APIs should be created to make it easier to exchange data between customers, exchanges and other clearing firms.”
However, even some of the recent innovations have been slow to achieve market adoption because of the tremendous cost of integration. What is apparent from this study is the industry will migrate to newer technologies only once a standardized core processing utility with open interfaces becomes widely available.
The industry recognizes that jointly defining data requirements and redesigning core processes is the only affordable way to deliver the efficiencies that will enable clearing firms to survive. Today’s challenges will not be solved by technology alone. In the constrained profit environment, no one player can afford to lead the charge. Only a radical transformation of the way the industry works together can deliver the required efficiencies.
Derivatives industry leaders are looking for mechanisms to drive collaboration in ways that were not necessary when profit margins were high. Clearing firms believe that if they can speak with one voice, then clearinghouses and regulators will adopt a more consistent, global approach to data reporting and the handling of margins, segregation and clearing requirements.
Clearing firm leaders have begun to collaborate with the FIA and the International Swaps and Derivatives Association. Indeed, FIA Tech has implemented several collaborative technologies to address inter-clearing firm issues. But transforming data standards and core processes will require wider industry cooperation and mutual investment.
Industry-wide utilities, whose success is dependent on providing data standardization, core process collaboration and open interfaces to specialized systems could enable clearing firms to adopt a big-bang conversion to more efficient technologies. A clearing firm manager notes: “I like the idea of sharing some baseline cost with the industry so that members can focus on where they differ from each other.”
The idea of a utility is gaining steam. “A third party is better placed to solve industry problems for everybody,” adds one clearing firm chief. And, industry utilities can enable the addition of new products and new markets in a more timely fashion.
Utilities are emerging as a new catalyst for moving the industry beyond its current state. They can significantly ease the conversion to new and innovative technologies as well as help transform clearing economics to a long-term sustainable level. Our study reveals that clearing members need a game changer that can reduce costs in a more substantial way than recent consolidation and one-off efforts to create efficiencies have delivered. A broad front-to-back office utility may provide the standardization of data, systems and processes needed to bring profitability back to the industry.
This article is based on a White Paper written by industry Consultant Leslie Sutphen commissioned by FIS.