Derivatives: how to make contactless and front-to-back workflows a reality


By Francesco Margini, Head of Product Management for Cleared Derivatives, ION Markets

If anything has reinforced its importance throughout the pandemic, it is technology. Everything we did before the outbreak of the Covid-19 crisis has now received a technological boost. But when we talk about how technology automates processes in the capital markets industry, we are most likely referring to e-commerce and the transformation of the front office function. Unfortunately, the post-trade processes that are essential to support all market activity have historically received less attention.

Recognizing this loophole, the Bank of England convened the panel of post-trade technology market practitioners to explore how market participants could harness technology to create a robust post-trade ecosystem. In the report which was subsequently released, the panel of experts concluded that post-trade processing in the industry is too dependent on manual and outdated technological processes – a thorn in the side of many banks and brokers.

Post-trade trades always involve more manual processing than any other phase in the trade lifecycle. On the other hand, the execution of the front office is largely fully automated. What is it that still causes this discrepancy?

Root cause

Post-trade processes, both within and between companies, have evolved organically over time, with layers of infrastructure and workflows. While the goal was to support significant market expansion, it instead multiplied the complexities. Over the years, derivatives trading has focused on fixing old, obsolete systems rather than investing in new technology. However, the patchwork of fixes and short-term workarounds (adding layer after layer) is starting to unravel as it fails to deliver new levels of automation. In short, it is complex, expensive and inefficient, which has a direct impact on operational effectiveness, resilience and profitability.

Decades of underinvestment in the aftermarket have made large-scale platform redesigns rare, unlike the front office. And that needs to change – post-trade needs to follow the front office, and here’s why.

Front-to-back contactless workflow

The digitization of order flow has accelerated and the sell side is under closer scrutiny from the buy side and regulators. Transactions should be processed directly from front to back office with minimal or no contact, and clients expect brokers to provide a real-time view of their activities, including trades, positions, liquidity and risk .

Due to the fragmentation of post-trade systems and processes and the significant limitations of legacy applications, brokers are often unable to handle their clients ‘affairs in an accurate and timely manner and lack a holistic view of their clients’ affairs at through enforcement and compensation. As a result, brokers typically face significant remediation work on T + 1, where adjustments can be very complex; not to mention the various related consequences, which can prevent merchants and clients from accurately valuing their portfolios, not complying with reporting obligations or even incurring financial losses.

Inefficiencies in the back office are not just due to the lack of technological investment on the seller’s side. Other factors such as the disconnect between exchanges and CCP systems, lack of standardization in the industry in several areas (commodity symbol, brokerage) and buy-side FIX execution flows have all contributed to the enormous complexities that the sales side needs to take charge within its systems. In order to do business and serve their clients, clearing brokers must capture, map, enrich, reconcile data to bridge the gap between fulfillment and clearing flows. In addition to incurring exorbitant costs to manage their clearing activities, brokers face significant challenges in complying with increasingly stringent regulatory requirements.

Pain points for organizations

Bad static data is one of the most important issues affecting organizations. Front office, middle office and back office merchants suffer, resulting in significant operational inefficiency and business impact.

With the growing need to map and standardize static data between systems back and forth, brokers are looking to automate the management of static data of the products of exchanges, clearing houses, different internal systems and their clients. However, due to the duplication of data on several different systems, this is a daunting task that requires a significant technological overhaul to simplify the architecture and create central static data repositories. To this day, a very large portion of business disruptions is still due to incorrect static data.

Another pain point in the industry is the management of commissions. Existing systems are unable to accurately capture all of the trading information needed to accurately calculate and accumulate execution, commission and foreign exchange fees, resulting in significant remedial work typically done manually. Also, it results in lost revenue as companies are unable to collect the correct commissions from clients and third party fulfillment and clearing brokers who are involved in the billing process.

Additionally, the industry as a whole has not been able to implement processes to standardize and centralize fulfillment brokerage reconciliation and payment among market participants. This results in a huge backlog of unpaid invoices due to large discrepancies between the calculations made by the parties involved in the execution and clearing of customer affairs.

Capturing all the data required from front-office and clearing systems and keeping it on the stack through to end customers is critical to eradicating the issues that have plagued the cleared derivatives industry for decades. Meeting this challenge successfully, however, requires a deep understanding of the business processes involved and a significant technological investment to develop new automated solutions to replace obsolete systems.

Post-market reengineering

The market has undoubtedly evolved, but it has been done at a different pace for each asset class, and of course in different ways. When it comes to automating post-trade processes, equities have taken a head start, and while cleared derivatives have followed suit, increased regulation (EMIR, MiFID) has accentuated various weak points. .

In several banks, cleared derivatives are part of the equities business, quite simply because the first does not have sufficient profitability to be sufficient on its own. The low profitability of the cleared derivatives industry will persist unless the sell side rethinks its operating model and invests in modern technology that eliminates system fragmentation, streamlines key business processes, supports automation end-to-end and real-time processing.

The inefficiencies of post-negotiation processes present a compelling case for change. Banks have the easy choice between adopting a new technology and thriving or continuing with a patchwork of legacy systems and ending up falling behind existing competitors and new market entrants. By automating post-trade processes and implementing real-time solutions, banks will not only be able to reduce overheads, increase profits and grow at scale, but also improve service. client and gather important operational and business information through data and analytics.


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