At a recent summit on synthetic finance, Laura Craft, co-chair of the FIX Trading Community Global Post-Trade Working Group and director of product strategy at Traiana, moderated a panel discussion which focussed on the role of post-trade in equity swaps. The panel was comprised of HSBC’s Dominic Amura, JP Morgan’s Stuart Neale and TT International’s Ian Lloyd, who all outlined the progress that has already been made in the post-trade processing arena under the impact of changing post-trade regulatory and business requirements, while still pointing out the remaining challenges.
The international financial markets have played host to unprecedented uncertainty of late, some of it emanating from the regulatory changes outlined in my FIX colleague Daniella Huggins’ earlier bobsguide blogger (aka contributing editor) submission. As financial market participants seek to reduce costs and risk in this new environment, while increasing regulatory compliance, post-trade processes in the back-office have come under increased examination.
This blog will outline the major challenges and opportunities that exist in relation to the automation of allocation, confirmation, clearing and reconciliation activities undertaken by market participants following the execution of a trade.
While front-office activities have borne the brunt of the shift in public opinion towards the financial industry, it is to the middle- and back-office that regulators are increasingly turning their attention to in order to de-risk and re-regulate the trading environment. In the quest for greater transparency into transactions, regulators are demanding more and more information pertaining to post-trade processes. Increased electronic activity allows regulators to store trade-related information easily, irrespective of volumes, even as they are sent to central counterparty (CCP) clearing houses for examination and reconciliation. The move towards CCP clearing for over-the-counter (OTC) trades is one of the key regulatory shift underway, alongside the need for a central repository, common legal entity identifier (LEI) framework and the attendant impact on things like swap execution facilities (SEFs) and so forth. SEFs are the new category of US execution venues brought in under the Dodd-Frank Act and, although the mutual recognition ‘Path Forward’ pact signed by the US CFTC and EC over the summer to recognise the other’s rules as equivalent enabling ‘passporting’ seems to have failed in recent days, the new post-crash OTC derivatives trading rules are coming into effect nationally anyway and causing big changes. Other global initiatives also remain on track.
Traditional, manually managed post-trade processing stands in the way of the kind of information-gathering that regulators now want to see. Whether a single global regulatory understanding to implement the wishes of the Pittsburgh G20 meeting from 2009 consistently around the world is reached or not, with some regional SEF differences perhaps remaining until a new ‘Path Forward’ pact is reached, the approach towards increased automation and reporting should be clear.
It should be of little surprise that regulatory bodies around the world are now encouraging increased automation of the post-trade process to increase transparency. By encouraging trading institutions on both the buy and sell sides of the markets to embrace electronic trading, regulators hope to reach a point where they can achieve maximum visibility into firms’ trading activities.
However, it would be wrong to suggest that the drive towards automation in post-trade is due solely to regulatory scrutiny. Success within the financial markets frequently depends upon a firm’s ability to view market information as close to real-time as possible. There are business and market drivers towards automation too. Speed to market is the difference between profit and loss, and financial institutions have an established record in driving technological development to improve their prowess in this regard.
Standardised Messaging Aids Post-trade Automation
Financial market participants are increasingly turning to protocols like FIX to communicate trade information. Traditionally used by the front-office for execution instructions, FIX standardised messaging is now being used by large asset managers for post-trade allocation and confirmation messaging. Adopting FIX into this space provides a variety of benefits: many see it as a natural evolution from front-office trading, others as a more efficient and low cost option for confirming trade details.
My firm, Traiana, has been integral in working with the industry via the FIX Trading Community Global Post-trade Working Group to ensure that standard post-trade guidelines and workflows are available to market participants.
Alongside the prior focus on front-office activities, elements of complacency have crept in to the collective wisdom concerning the middle- and back-offices; this is what needs to change. Up until recently, it had become an accepted truism that post-trade processing would always lag behind executions on T+1, T+2 and T+3. With trade confirmations coming on T+1 or T+3 the possibility arose for complications and confusion in the reconciliation process.
Streamlining and automating the post-trade processes allows trades to be confirmed on T0, de-cluttering the settlement process from T+1 onwards. A clear emphasis has been made in the last 12 months on closing this gap between execution and reconciliation. This is an area where a lot of technological innovation is being brought to bear. Use of the FIX Protocol can be instrumental in achieving same-day affirmation, which makes the move to T+2 settlement a relatively simple step, rather than a wholesale change in market practice.
In the last five years, cash equities have been the focus of much of the drive to improve automation and achieve T0 matching. However, that attention has recently turned towards the contracts for difference (CFD)/equity swaps market. In the last 12 months some institutions have seen an increase in automation to the point where as much as 90% of CFD swaps are being matched electronically, of which 70% are being confirmed on T0. This results in improved peace of mind for counterparties, executing brokers, and clearing houses. In an ideal world, front- and back-office staff can go home once the business day is over, safe in the knowledge that trades are confirmed.
Full reconciliation of trades is unlikely to reach T0 at the moment due to the global footprint of markets and foreign exchange (FX) markets still adhere to T+2 settlement. Regardless of the sophistication of the post-trade technology, there is no work-around to speed up settlement on trades happening between distant geographies, time zones and across currencies. As such, there will always be a delay between the trade execution and the reconciliation. However, it is possible to automate confirmations of trades from brokers. If this process reaches T0 then the playing field is cleared for reconciliation to proceed on a T+1 basis.
Moving to T0 confirmations and T+1 settlement is an expensive prospect, should it prove to be possible to do so. Established financial institutions are already using custom-evolved, complicated systems which have been built out over the last 30 years and changing will not be easy. Moving to T0 will require significant IT investment, with the potential cost standing in the billions of dollars range across the industry. It is therefore is highly unlikely in today’s cost-constrained environment that you’ll see a move towards T0.
Given this situation, firms are increasingly emphasising the efficiency of the settlement process, complying with the ever changing regulatory landscape, and adhering to best market practice in both risk and operations management.
Furthermore, the technology created in response to the post-trade demands of the market has developed its own new set of challenges, aside from cost. The financial services industry remains as competitive as ever, and the difficulties presented by post-trade automation have inspired many different solutions. Market participants across the buy side and sell side now face the task of isolating themselves from having to connect to multiple different platforms in multiple different ways. As such, there is a desire on both sides of the market to develop a set of standardised post-trade protocols.
This may or may not emulate the approach taken in cash equities markets, where use of a single market-standard protocol has become non-negotiable. The FIX Trading Community Global Post-trade Working Group is turning its attention from cash equities towards the CFD, Fixed Income and FX markets to ensure the same guidelines are in place across multiple asset classes.
Best-practice risk-management requires that everyone is speaking the same language. It is to be hoped that this kind of standardisation of communication protocols would be reached naturally due to a combination of market forces, peer pressure between firms and the desire to comply with regulations.
• For further stimulating technology discussions, viewpoints and blogs please visit our new bobsguide blogger (aka contributing editor) landing page, where you can view a selection of blogs about mobile financial services (MFS), information security and capital markets from the Mobey Forum, ISACA and the FIX Trading Community respectively. Other BG Bloggers on transactional banking and a range of other topics can be viewed here.