Riding the Tech Wave in a Volatile Derivatives Market

A surge in trading volumes has highlighted the need for brokerage firms to re-engineer their businesses for the future, writes John Omahen at FIS.

One of the side effects of Covid-19 has been a surge in trading volumes as investors around the world seek to mitigate the impact of the economic fallout on their portfolios. This has put unprecedented strain on brokers’ operations, which – unless addressed quickly – risks exacerbating an already highly volatile global economic system.

Nowhere has this been more noticeable than in the derivatives market, where many exchanges have seen volumes spike by as much as 40 percent. This has caused significant challenges for many brokers whose operations are not set up to cope with such demands. The current situation requires them to process extremely high transaction volumes quickly and efficiently, while still complying with local and global regulations.

While undoubtedly challenging, this presents an opportunity for firms to embrace new processes – not only to cope with short-term market conditions but also to re-engineer their businesses for the future.

Middle and back office

The middle and back offices often experience strain resulting from data management challenges, weak infrastructure, and process and execution bottlenecks. Though the middle and back offices hold the greatest risks, they also have the highest potential for improvement. Significant benefits such as process efficiencies and cost savings can be yielded if firms automate as many manual processes as they can.

Applying robotics and rules-based engines to automate tasks that are handled manually is essential to increasing efficiency throughout the middle and back office. Intelligent reconciliations, self-correcting data processing, integration with static data sources, modern APIs and new business analytics can all be deployed to achieve this.

Specifically, investments in automating order processing and trade allocation will significantly reduce risk while also freeing up valuable resources, so that staff can focus on solving more pressing and challenging issues.

The measure of success should be the ability to handle 10 or 20 times the “normal” trade volumes without having adjustments to make after the transaction date (i.e. on T+1). Yet this will require a concerted approach across the industry, with executing firms, the buy-side, and clearing brokers aligning their technology and processes.

Post-pandemic working

As various parts of the world slowly come out of lockdown, companies need to adapt to the new normal of work. Several technology giants have already stated that their staff will continue to work from home into 2021.

A recent survey by the Chartered Governance Institute shows that over 50 percent of employees are keen to continue working remotely. While brokerages have already put in place temporary systems, measures and processes to help staff to operate from home, this will not be sufficient to enable trading and back-office teams to continue their jobs remotely on a more permanent basis.

In order to enhance remote working operations, it will be essential for brokerages to further invest in cloud-based technologies that allow trading and back-office teams to connect to systems remotely and operate as if they were in the office. According to data from the 2020 FIS Pulse Survey, 62 percent of capital market executives are already looking to implement cloud-based systems to help deal with the current challenges.

Brokerages will also need to significantly increase internet bandwidths for employees, as the speeds at home are insufficient for traders to keep up with rapid changes in the market, and for back-office staff to process trades quickly on their behalf.

Additionally, to reduce the impact of black swan events on their operations, brokerages should rethink their location strategy and consider other business models such as full or partial Business Process as a Service (BPaaS). This is suitable for areas of processing that do not differentiate the brokerage from its competition or areas that have a high attrition risk. While large outsourcing vendors would have the scale and geographical breadth to adequately insulate operations, brokerages should still ask to see the vendor’s risk contingency plans on a regular basis.

Regulatory challenges

Alongside the need for brokerages to process trade volumes quickly, they must also ensure that they are complying with strict derivatives regulations and reporting requirements. These new regimes were introduced to improve market transparency and reduce counterparty risk following the turmoil in the derivatives market during the 2008 financial crisis.

For example, in Hong Kong, the SFC (Securities and Futures Commission) and the HKMA (Hong Kong Monetary Authority) established the Hong Kong Trade Repository, where all financial entities supervised by the two agencies are required to submit electronically all trade-level data to the repository daily.

Compared with their European and American counterparts who only need to comply with the EMIR (European Market Infrastructure Regulation) and the Dodd-Frank Act, Asia-based brokerages have to deal with multiple regulatory regimes, causing a significant headache for compliance and back-office teams.

To meet the increasingly complex regulatory demands, brokerage firms should look to adopt regulatory technology (RegTech) solutions. This entails bringing the powers of new technologies such as machine learning, artificial intelligence, no-code platforms and distributed ledgers to bear on regulatory and compliance challenges.

For instance, distributed ledger technology can help make trading data more accessible and transparent for regulators to review. Brokers should also leverage on RegTech to enhance cybersecurity defences and ensure robust data protection. This will help fend off cyber-attacks that are becoming increasingly sophisticated by the day.

Talent is key 

Although updating their systems and processes with the latest technologies is a core part of digital transformation, brokerages will also need to ensure their workforce is equipped with the right skills and knowledge to undertake the changes that are required. This entails attracting the right talent and upskilling current employees via bespoke training programmes.

With the geopolitical and economic environment likely to remain challenging for the foreseeable future, brokers will need to adapt – and fast. Failure to do so risks adding extra volatility to the system, at just the time smoothly functioning markets are needed.

By embracing and implementing new technologies, brokerages can help ensure that markets continue to function properly throughout this period of significant turmoil, and that they emerge stronger in the competitive, digital-first world following the COVID-19 pandemic.

John Omahen is Head of Product Strategy for FIS Post Trade Technology.

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