Dodd-Frank confusion reigns among buy-side asset managers, while sell-side investment banks spend over a billion dollars in anticipation

London, New York, Toronto - 12 March 2012

Rule Financial, an independent provider of business consultancy, IT consultancy and IT services to the global investment banking community, today launches the results of a study into the impact of the Dodd-Frank Act on the buy and sell-sides.

The research finds that sell-side firms are making large changes to their operations and IT, investing heavily in client execution and clearing propositions that will become operational in 2012. The buy-side is taking a different approach, placing a heavy reliance on the sell-side to provide a solution to the problems created by the new regulation. Whilst 70% of the sell-side claim to have finalised their ‘to-be’ business process design, only 20% of buy-side firms have conducted this analysis.

On average, spending by sell-side banks with aggressive OTC strategies has been in the order of (US) $10-50 million annually, since 2010. At the other end of the spectrum, those banks planning to adopt a ‘franchise protecting’ minimum day-1 offering have spent less than $5 million annually over the same period. As expected, buy-side spend has been negligible in comparison, and is estimated to be in the order of $1 million to $2 million for each participant this year.

The regulatory onslaught impacting the full OTC lifecycle has forced the sell-side to appraise their operating models. The research finds that banks are converging OTC, exchange, prime and collateral businesses into a single organisational entity. Due to its significance on P&L, the collateral management department is gaining in importance and receiving heightened attention and investment. Basel III is driving closer integration of the securities lending and repo units.

The survey highlighted that sell-side banks are taking a pragmatic approach to execution support, choosing to support their clients at any venue required. However the research indicates that the buy-side is overwhelmingly in favour of Bloomberg, with the majority of respondents identifying it as the execution venue of choice, trailed by Tradeweb and ICE, both with just over half the support that Bloomberg received. There appears to be little appetite to use the inter-dealer brokers that are currently readying their swap execution facility (SEF) platforms.

The buy-side displayed much confusion over the mandated OTC clearing timelines, with respondents citing a range of deadlines from 1st September 2012, through to 1st September 2015. This lack of awareness reinforces the assumption that the buy-side views the consequences of Dodd-Frank as a regulatory burden, rather than as a positive driver to instigate a change in their business model.

David Holcombe, specialist in Markets and Trading, Rule Financial commented: “The sheer scale of change to the global OTC derivatives markets agreed by the G20 has overwhelmed many of the regulatory bodies. Despite the G20 target being the end of 2012, there is still no finalised regulatory landscape, no specific compliance dates, and no completion of the rules mandating clearing in any jurisdiction. It is not, therefore, surprising therefore that confusion reigns.

“This uncertainty has not stopped the sell-side in making a significant investment in new systems and processes, which become operational in 2012. These institutions have ambitions to thrive in the new landscape, so they are not waiting for completed rules from the regulators to launch their client clearing propositions. The ‘golden circle’ of large banks seeking high market share have, on average, spent over $100m each in building their propositions, to date.

“The cost to the buy-side of trading OTC derivatives will certainly increase, with the expectation being that charges for collateral will have a significant impact on their returns. Consequently, buy-side firms are looking to clearing brokers and futures commission merchants to minimise the increase in cost of the central counterparty (CCP) model, via collateral optimisation and pricing.

“The OTC derivatives market has changed and will continue to evolve in-line with the G20 requirements, despite the lack of regulatory certainty.”

Key findings of the research:

Competitive differentiation:

  • Advanced client service (e.g. financing and collateral) is considered to be the differentiating factor in each sell-side bank’s proposition, with 78% of respondents planning to compete with their peers on this point. This is unsurprising, given that OTC business models are moving towards charging for these services.
  • Sell-side and buy-side opinions differ greatly on the perceived importance of cost efficiencies, with the sell-side placing lower importance on cost efficiency than the buy-side, who ranked it as the highest competition factor. 33% of sell-side firms surveyed state cost efficiency is a high differentiator in their offering, whereas 65% of buy-side firms plan to use this as a key measure in their dealer selection.

Impact of collateral charging on returns:

  • 67% of buy-side respondents believe collateral charging will have an impact on their returns, with 43% of the respondents classing the impact as ‘significant’.

Decision making process:

  • 55% of the sell-side have already completed their ‘build or buy’ decisions, and by the end of Q2 2012, 89% will have done so, whereas only 17% of the buy-side have already made these decisions, with 50% planning to reach a decision in Q1/Q2 2012.

Timelines for offering client services:

  • 70% of sell-side banks already offer client clearing of OTC derivatives, with 20% planning to offer this by the end of 2012; 10% have no plans to offer this service.
  • 60% of sell-side banks claim to already offer cross-asset margin calls, with 20% planning to offer this service within 12 months; 10% plan to offer this service beyond 12 months, and 10% have no plans to offer this service.
  • 60% of sell-side banks already offer indicative margins (predicted margin by CCP), and 30% plan to offer this service within 12 months; 10% have no plans to offer this service.
  • 35% of sell-side banks already offer collateral upgrades / transformation, and 55% plan to offer this service within 12 months; 10% have no plans to offer this service.

Organisational structure changes:

  • 65% of sell-side banks have made organisational changes to address OTC clearing, with 35% creating new roles specifically for the OTC clearing. 70% of sell-side banks have made key appointments to improve trade processing, affirmation and confirmation processes.

Definition of target application infrastructure’s logical architecture:

  • 70% of sell-side banks have already defined their target application infrastructure’s logical architecture, with the remaining 30% planning to complete this before H2 2012. Only 20% of buy-side firms have conducted this definition process already; 45% are intending to carry out this work before H2 2012, 25% are planning to undertake this in Q3/Q4 2012, and the remaining 10% are unsure when this work will be done.

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