By Justin Llewellyn-Jones, Head of Capital Markets, North America, Broadridge
Like many other aspects of the financial markets, the arrival of the COVID-19 pandemic last year tested post-trade processes in the listed derivatives markets in unprecedented ways.
Amid the surge in trading volumes and volatility, and the pressures caused by a sudden and unplanned need to work from home, trades backed up, exceptions increased, and institutions found themselves signing off on increased overtime and weekend work while questioning the veracity of their positions and balances.
The industry did in fact do a great job of triaging problems in the moment while rigging together workarounds and short-term fixes, however, these were not intended to be long-term solutions. Now, at a moment of relative calm, when we can reflect on what comes next, the industry has an opportunity to get serious about committing to a new post-trade infrastructure and preparing for a future that promises to be busier than ever.
In recent years, the growth in trading volumes has been driven by a variety of macro events, such as large-scale monetary and fiscal policy decisions prompted by events such as recessions or the recent pandemic. Nevertheless, it is more than likely that volumes will continue to grow, exacerbated by industry-wide changes such as the move to T+1 settlements in the equity market, which will likely drive listed derivatives volumes higher still. As this happens, pressure will mount on those workarounds and short-term fixes and will drive the need to upgrade post-trade infrastructure.
The rationale that firms have used to delay back-office investments – that it’s purely a cost center, and that investments are better directed towards the front-office where firms are better able to differentiate – is not sustainable. The events of the last year have sufficiently demonstrated that the patches that have kept financial firms’ old systems going won’t survive the next set of problems.
A recent survey by Acuiti, a data and analytics firm that focuses on listed derivatives, showed that after last spring, 40% of tier 1 and 2 banks said they would be more likely to increase investment in post-trade systems as a result of their experiences. That’s on top of the 37% of surveyed firms who said they already had plans to invest more.
Once we have come to terms with the need to invest more, the question becomes: what kind of future do we commit ourselves to? After all, the systems we have now are decades old in some cases. The likelihood is that the post-trade world we build now is one we’ll be living with for quite some time, so it is important that we adopt modern design principles allowing for a component-based architecture that is more easily evolved as we move forward, but that is also capable of scaling and performing as volumes and activity continue to increase.
Two ideas whose time has come are standardization and mutualization. The way the listed derivatives markets have evolved over time, and the way in which the underpinning technology solutions have been updated to meet evolving industry needs, has resulted in a lack of consistency in approach. In the absence of clear standards, many FCMs have customized their own solutions, which, while they may meet their own business needs, add complexity and friction in their interactions with other participants.
The ability to agree on standards would not only open the door to solving for some of this complexity and therefore improving efficiency, but also enable the mutualization of the costs associated with some elements of the back-office. This would be tremendously beneficial, especially in areas where firms do not create positive differentiation from their peers. Moving clearance and settlement in listed derivatives towards more of a utility approach would give firms greater latitude to channel their energies into the kinds of functions that make them truly distinct.
The moment when firms across the industry are looking to upgrade their back-office solutions en masse is an auspicious time for this standardization discussion, and many in the industry have already started the conversation. If participants can reach an agreement here, their back-office investments will produce broader benefits and help remove operational risk and improve efficiency.
We’ve always known that there have been inefficiencies in the listed derivatives post-trade world. What’s changed is that the growth in both volumes and volatility have highlighted the shortcomings in existing infrastructure in a way that makes the need to change impossible to put off any longer. The time to address our problems is now.