Derivatives

deputy head of strategy, SunGard’s capital markets business

A DERIVATIVES DELAY? WHAT TO DO FOR THE NEXT 15 MONTHS

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Originally posted on FTF’s The Bull Run here.

Author: Tony Scianna, deputy head of strategy, SunGard

Last week we read that U.S. House Republicans voted to delay new derivatives rules by 15 months. Before we go into what this means for the derivatives industry, let’s take a look at how long 15 months really is:

  • 5 seasons will pass
  • We’ll all be 1.25 years older
  • U.S. citizens will be preparing to vote in the 2012 presidential election

    A lot can happen in 15 months. For an industry that has been facing an uncertain regulatory environment since the approval of Dodd-Frank last July, the proposed delay would only extend that uncertainty. I am concerned that with such a long period of waiting for regulatory guidance, the urgency of Dodd-Frank could diminish and leave firms feeling forced to sit back on their heels. Firms will have to reevaluate their strategies and budgets, and they may choose to focus their energy and investments in different areas rather than regulatory compliance. How long can lawmakers say “hurry up and wait” before firms “hurry up” and focus on something else? Firms need guidance to be proactive.

    While both sides of the political aisle have agreed that more time is needed to finalize the rules, there are big disagreements about what this proposed delay means.  On one hand, one side is arguing that they are “not repealing any rules… just setting a more deliberative rule-making process.” On the other hand, others are saying that “it’s not a bill to give the regulators more time—it is a bill to prevent the regulators from acting.”

    And then there’s the perspective of the regulators. CFTC Chairman Gary Gensler, who recently stated that the CFTC would not meet the original July 2011 rule-writing deadline, warned that a delay would put the U.S. “at great risk,” and that “reform will only be effective once rules are completed.”

    So what is a firm to do? Continue planning. Ensure that your approaches are flexible. Partner with your vendors to be sure your technology strategies are ready to tackle new challenges and reveal new opportunities. Talk to as many industry experts as possible. Participate in industry groups that are working to shape the end-state of the regulations.

    What is your take on the proposed Dodd-Frank delay? If we do wind up with a 15-month wait, what will your firm do with your budget for regulatory compliance in 2011? And will you be allocating the same, a bigger, or a smaller budget to regulatory compliance in 2012? I would encourage you to comment here, and to tell me your thoughts in person at SunGard’s New York City Day discussions on Pre- to Post-trade Implementation of Dodd-Frank and Regulatory Reform on June 20.

    While you’re here…

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    FUTURES ARE SAFE

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    “Futures are safe”, that’s not an expression you hear very often.

    Let’s face it, in a world where most people’s exposure to futures markets is limited to watching “Trading Places” and hearing nightly news reports about surging commodity prices, the perception is that futures markets are fraught with danger and are just one step above the blackjack table in Vegas. But there was Donald Wilson, founder of DRW Trading and one of the leading minds in the exchange traded derivative spaces reminding an audience at last week’s Aite Group “Trading 2011: Trading In The Fast Lane” conference that in spite of all the sensationalism, futures markets provide an efficient system for price discovery and risk management.

    Wilson’s thesis revolved around five points:

    • Transparency. The current market price for any contract is always displayed to all participants. Trades are reported the moment a match is made, and historical trade activity is readily shown and easily accessed. There’s no secondary marketplaces, no off-tape transactions that get published after the fact.
    • Trade certainty. Futures exchange matching algorithms are pretty simple—whether they’re pro-rata or first in first out. In either case, if you’re in the market and your price is traded through, you know your order is matched. There’s no chance of a smaller market participant getting “lost in the shuffle” when a trade takes place between two large dealers.
    • Heterogeneous liquidity. Contracts are flexible in duration, delivery and expiration terms, but standardized in terms of how they are priced and settled. Every contract traded is listed along with its specifications on an exchange website for all to see. From these standardized contracts, hundreds of thousands of different exotic combinations can be created but still centrally listed and subject to a standard set of rules.
    • Independent Settlement. Price settlement is determined by the exchange based on the price at the end of the trading session, not by a consortium of dealers trying to lobby in favor of their positions.
    • No accumulation of losses. Every futures position is held at a clearinghouse and marked to market at the end of every session. Central clearing eliminates the possibility of off-books trickery.

    When catastrophes have crippled the markets, futures have always been there to provide a venue for risk management. When the stock market crashed in 1989 and trading on the NYSE came to a halt, all eyes focused on the Major Market Index pit at the Chicago Board of Trade as it remained open. As the swaps market blew up in the wake of AIG’s collapse, the CME Group’s Eurodollar contract boomed.

    With advantages such as this, it’s no wonder that so much of the proposed financialreforms revolve around a futures-type business model for execution and clearing. Reviewing the five points above, the futures marketplace sounds pretty safe to me.

    Do you think futures markets have been unfairly demonized over the years?

    head of Valdi Options US, SunGard's capital markets business

    MEGA-EXCHANGES AND THE BLUR FACTOR

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    Russ Chrusciel, product manager – derivatives trading, SunGard Valdi

    In the past few months, it’s clear that the trend of mega-exchange formation is already underway. Combinations include the London Stock Exchange and Toronto Stock Exchange, Singapore SGX’s bid for Australia’s ASX, BATS Global Markets’ merger with Chi-X Europe, and last but certainly most controversial – the Deutsche Borse and NYSE Euronext.

    As the financial landscape continues to evolve, most existing exchanges will not stand pat, but will seek logical partners to both expand their product offerings and to remain relevant to the trading community on a global scale. But as we settle in to watch this trend unfold, it’s important to see through the flurry of high-level media coverage.

    Don’t get me wrong, the rise of the mega-exchange could be a boon to securities firms that use any kind of exchange services! The consolidated exchanges to come will certainly streamline their business processes and IT infrastructures – which will likely result in these mega-exchanges being able to offer lower fees to their customers (largely taking advantage of economies of scale, almost what I’d term the Wal-Mart effect).

    Yet the most recent coverage of the Deutsche Börse’s takeover of NYSE Euronext missed a subtle point that I think deserves more attention. For lack of a better term, I’ll call it the “blur factor.”

    Assuming the Deutsche Borse – NYSE merger comes to fruition (unless Nasdaq finally enters the fray with a bid real soon), the consolidation of these two major entities will herald a new age of mega-exchanges – one that will progressively redefine what it means to be a “listed exchange” in our modern financial world. This new breed of exchange is a far cry from the origins of the NYSE back in 1792 – when stock brokers signed an agreement under a buttonwood tree on Wall Street to transact simple business with each other. Contrast that event to the present in 2011, where these burgeoning mega-exchanges have uniquely evolved into large technology organizations that not only bring together a variety of market participants, but also have expanded their reach into software, hardware and other services.

    So what drives and differentiates exchanges today? I’d argue that more and more, the differentiator has largely become – in some shape or form – technology. Most exchanges would acknowledge the fact that business relationships are certainly important to conducting business in the financial industry (or any industry for that matter!). However, over the past few years, one could also argue that technological advances have become even MORE valuable to exchanges or selected groups in the trading environment. Not too long ago, common financial market buzzwords were terms like “trading pit”, “stamping tickets” or “payment for order flow” – terms that reinforced more of the human side of trading and exchange activity. But what descriptive words do we now use more and more when talking about exchanges and trading? Terms like “latency”, “co-location”, “microseconds” and “matching engines”.

    Going forward, the relevance and profitability of global exchanges will not be determined solely by bringing buyers and sellers together in one common location to trade. Rather, each exchange will ultimately succeed or fail based on its ability to offer a compelling mix of varied trading products combined with a valuable set of complementary technology offerings. Quite simply, exchanges will need to provide its customers a full suite of products across many asset classes (like equities, options, futures) while simultaneously offering even greater access to exchange infrastructure, hosting facilities, server farms, market data and the like.

    So will these mega-exchanges be able to perform well in their dual roles of marketplace and service provider? And what will this shift mean for other participants in the financial industry? Rest assured, even though mega-exchanges will seek to expand their large “footprint” into new markets and related services, there will also be nimble competitors of miscellaneous sizes who will ultimately seek to gain leverage by simply focusing on smaller niches within the larger financial industry.

    I can guarantee that it won’t be dull. However, only time will clear up this “blur factor”.

    deputy head of strategy, SunGard’s capital markets business

    “A DAUNTING TASK” – REGULATORY READINESS: THE DATA MANAGEMENT CHALLENGE WEBINAR RECAP

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    Author: Tony Scianna, executive vice president, SunGard

    I recently participated in a webinar with DerivSource that tackled the topic “Regulatory Readiness: The Data Management Challenge.” You can now hear the playback on the DerivSource website, and I thought I would provide a brief recap to highlight some of the key points I discussed with Anshuman Jaswal, senior analyst in the Securities and Investments Group at Celent, and Norman Brower, executive director at Morgan Stanley.

    If you were listening live, you’ll know that we covered a lot during this webinar, which was moderated by DerivSource’s Julia Schieffer. From my perspective, here are some of the top takeaways:

    • We are just at the tip of the iceberg here. We still don’t know exactly what the regulatory requirements are going to look like, and there are plenty of questions that can’t be answered yet.
    • Regulatory risk is a critical concern for firms, even more than operational risk or counterparty risk today. Every firm knows it has a lot of work to do.
    • I boiled down the data management challenge to this: Firms must be able to capture their data in as close to real time as possible, standardize, normalize, and cross-reference that data then have the ability to access it. Financial services firms have grown up with multiple silos, and breaking them down is a complicated, “daunting” process.
    • Find ways to influence and shape the regulations. We had some questions about how to get involved, and the panel mentioned industry groups like the EDM Council, working groups such as the SIFMA Technology Work Group, and conferences like those put on by the Financial Information Management Association. Also a great resource: requests from regulators and responses from the industry groups, such as SIFMA and the FIA, which you can find on sites such as the SEC and CFTC.

    Did you attend this webinar? Do you have any questions about the data management challenge that you haven’t been able to ask? Continue asking your questions and offering your perspective in the comments below.

    deputy head of strategy, SunGard’s capital markets business

    OTC DERIVATIVES AND THE QUESTION OF WHEN

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    Author: Tony Scianna, executive vice president, SunGard

    It had been a while since I participated in a Twitterview – a real-time interview via Twitter – so I was glad to have the opportunity to join TABB Group’s senior analyst Kevin McPartland in yesterday’s “DerivChat” conversation. SunGard’s own director of analyst relations, Alyssa Gilmore, moderated the discussion, which focused on OTC derivatives.

    During the Twitterview, Kevin and I discussed the topic of OTC derivatives in the context of his recent article on TabbFORUM titled, “OTC Derivatives: Not What, But When.” We talked about business and technology challenges, as well as our thoughts on timing and preparedness. There is no doubt this is a topic that we’ll continue watching and discussing throughout the year and beyond, as regulatory requirements become clearer and new regulations are announced.

    If you didn’t see it happening in real time, you can read the interview here or in Twitter Search under #derivchat. And if you have your own answer to one of the questions or want to ask something new, leave a comment for us below.

    Alyssa4AR: Welcome to #derivchat! Today we’ll be talking with @kmcpartland of @TabbFORUM and @tonyscianna of @SGBrokerage at SunGard.

    Alyssa4AR: Follow the #derivchat conversation by using the hashtag. Thanks for joining, @kmcpartland & @tonyscianna. Ready to get started?

    Kmcpartland: Glad to be part of #derivchat, @Alyssa4AR. Looking forward to discussing OTC #derivatives today with you and @tonyscianna

    Tonyscianna: Likewise, @kmcpartland @Alyssa4AR. Let’s get started #derivchat

    Alyssa4AR: Let’s jump right in. @kmcpartland, you recently wrote: OTC Derivatives: Not What, But When. What makes “when?” such a big Q? #derivchat

    Kmcpartland: They will finish most of the rules on time, but the implementation times are up in the air. Q1 2012 we will start to see change. #derivchat

    Tonyscianna: I agree. In my opinion, the regulators will move forward faster then we expect and require some form of compliance by 2012. #derivchat

    Alyssa4AR: And there is a lot to accomplish btwn now & 2012. What are some of the key business challenges re: central clearing of OTC? #derivchat

    Tonyscianna: Firms need to be able to capture data, normalize it and access it in real-time or near real-time … #derivchat

    Tonyscianna: …to meet reqs such as intraday reporting. But a lot of info is locked in legacy systems & silos and batch processes #derivchat

    Kmcpartland: Then there is connectivity to CCPs, SEFs and the new data sources @tonyscianna mentioned.  #derivchat

    Alyssa4AR: With the “when” now on the horizon, what needs to be done in terms of technology? #derivchat

    Tonyscianna: Firms need to align tech w/new reg reqs, & be able to not only get info in real-time but cross-reference data from mult sources #derivchat

    Kmcpartland: Most of this falls on the brokers. PB platforms, execution platforms, the clearing infrastructure. All need major revamps… #derivchat

    Kmcpartland: …Buy side clients are depending on their brokers in this regard. #derivchat

    Alyssa4AR: From @CFTC O’Malia: So Many Regulations, So Little Time http://on.wsj.com/haMvcX. What does this mean for firms asking “when?” #derivchat

    Kmcpartland: O’Malia recognizes importance of these rules & doesn’t want to rush. Politics say they’ll hit deadlines for most things though. #derivchat

    Tonyscianna: Also means you need to build your enterprise data management solution NOW to be prepared. #derivchat

    Tonyscianna: Soon, no matter where you are or what regs apply to you, you’ll need to report every transaction & it can’t be a week later #derivchat

    Kmcpartland: And this is global. Europe isn’t as far behind as some think. The MiFID Review will require major changes as well #derivchat

    Alyssa4AR: Keeping with the theme of “when,” let’s fast forward to next year. What will we be talking about in 2012? #derivchat

    Tonyscianna: Don’t know what new challenges will come up, but believe we’ll be talking about same issues but w/ more clarity from regulators #derivchat

    Kmcpartland: Hopefully we’ll be talking about how liquid the vanilla swaps market has become, and which SEF has the liquidity! #derivchat

    Alyssa4AR: That closes #derivchat! Thanks to @kmcpartland and @tonyscianna and everyone who followed.

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    SOME IMPLICATIONS OF EXCHANGES CONSOLIDATION

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    The world’s major stock exchanges are involved in another wave of mergers: Deutsche Boerse intends to pair up with NYSE Euronext, and the London Stock Exchange has announced that it is to combine with Canada’s TMX group. Meanwhile the takeover of ASX by Singapore’s SGX faces political opposition in Australia, but the two exchanges are pushing hard to make it happen.

    In the face of increased competition from electronic venues (which are not immune from the consolidation trend, witness the BATS purchase of Chi-X Europe) revenues of the exchanges have been under pressure. The mergers seek to offset margin compression with reduced costs and increased volumes.

    Cost reduction will come from the basic synergies of the mergers with reducing clearing and operational costs. The rationalization of trading and clearing platforms should mean savings for exchanges, brokers and investors from less complexity in connectivity. However, only in the Deutsche Boerse/NYSE and SGX/ASX tie-ups will such benefits be meaningful; separate platforms and business models are likely to be maintained in the LSE/TMX and BATS/Chi-X pairings. In general though the exchanges’ increased scale should mean that further resources can be put into platform development given the greater implementation footprint. Hopefully developments in new services and contracts will also result from the greater scope of the consolidated exchanges.

    The exchange groups are increasingly focused on growing their lucrative derivatives and commodities businesses, and also on the promotion of multiple listings; high-frequency order flows also continue to grow and expand into new markets and asset classes, but further growth in this field may be limited by increased regulatory pressures.

    With regulators worldwide driving derivative trading onto exchanges the growth prospects are very positive. That’s not to say that the merging exchanges have not already achieved some derivatives dominion – the Deutsche Boerse/NYSE combination, with its Eurex and Liffe derivatives exchanges, has a virtual monopoly in exchange-traded European derivatives, a situation about which AFME has expressed some concerns but such concerns might be addressed by greater competition by BATS/Chi-X.

    Deepened liquidity is another result of increased scale and will attract more listings. In fact one could ask whether the consolidations are somehow driven by opportunities in dual and multiple listings.

    While it has generally become easier for investors to trade in foreign markets over the last decade some impediment to this comes from exchange controls – particularly in the major emerging markets currencies. To counter this a trend towards dual and multiple listings is developing – making it easier for companies to attract foreign capital and also giving them a greater impression of global presence. But listings on local exchanges will always have a role, especially if, as currently is often the case, local regulators adopt protective competitive positions towards them and that trading costs in them tend to be lower for local investors.

    Two final thoughts, one positive implication for the exchanges, one perhaps negative implication for their users: The value of market data in a post-MiFID II environment should not be overlooked – those institutions with the broadest deepest data and the technology to distribute it the fastest may be sitting on a goldmine.

    Lastly, the general theme of consolidation will inevitably lead to some decrease in competition from the levels seen in the past few years. While this is a desired outcome for the exchanges it possibly should be less welcomed by brokers and investors: what are the implications for exchange and clearing fees down the line?

    deputy head of strategy, SunGard’s capital markets business

    WEBINAR: REGULATORY READINESS: THE DATA MANAGEMENT CHALLENGE

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    Author: Tony Scianna, executive vice president, SunGard

    When it comes to the Dodd-Frank Wall Street Reform and Consumer Protection Act, there continues to be a lot of discussion about new requirements and challenges, with an emphasis on data and risk management.  But even before Dodd-Frank was a household word, we had been discussing the need for a real-time, enterprise-wide data management infrastructure. Today the story is just more urgent.

    As everyone tries to understand the new data and reporting requirements under Dodd-Frank, I will be joining Anshuman Jaswal, senior analyst in the Securities and Investments Group at Celent, and Norman Brower, executive director at Morgan Stanley, in an interactive webinar with DerivSource titled Regulatory Readiness: The Data Management Challenge.

    During this webinar, we will discuss the requirements of the Dodd-Frank rules, including new data and reporting requirements, how operations and technology can help improve compliance with the new regulations, and how to prepare for regulations that will soon be introduced by other jurisdictions, including in Europe and Asia.

    It’s a big topic and undoubtedly one that will continue to be a top priority for financial firms throughout the year. Some of the specific questions we are going to cover include:

    • What are the implications of the new real-time reporting requirements?
    • What are the OCR and the OFR?
    • How can firms build a ‘future proof’ data management infrastructure that is capable of meeting current and future regulatory requirements across the globe?

    REGISTER HERE
    WEBINAR: Regulatory Readiness: The Data Management Challenge
    DATE: Wednesday, March 2, 2011
    TIME: 10:00 a.m. EST / 3:00 p.m. GMT

    I hope you will join Anshuman, Norman and me for this timely webinar. As part of registering for the webinar, you will also receive a copy of our latest whitepaper, Managing Risk and Exposure in the New Regulatory Environment. Please bring your questions and ideas to the webinar on Wednesday – I look forward to this important discussion.

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    DEFINING “THE BIGGEST CHALLENGE” – A VIDEO INTERVIEW WITH FIA

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    Author: Rich Hulit, former executive vice president, SunGard

    Last month, I attended the FIA Futures & Options Expo in Chicago. Not only did I sit on the Expo’s Tech Solutions for OTC Clearing panel (which you can now listen to on the FIA site), but I participated in a video interview series with the Futures Industry Association.

    Dodd-Frank with its many nascent requirements was, of course, the subject of many conversations at FIA Expo. One question that many people discussed was, “What is the biggest challenge?” From my perspective, the most pressing issue today is that the industry needs to be ready to comply with new regulations that are not fully developed yet. Right now it is about preparing to respond. As I say in the video, the “biggest challenge is understanding the challenges themselves.”

    When it comes to OTC derivatives in particular, we also talked about the push to increase transparency. As I say in the interview, regulators will require transparency into what’s being traded, how it’s being traded, how it’s being priced, how it’s being processed, exposures, and positions… Are you ready for this?

    Watch the video above and tell me your thoughts here in the comments section. How would you have answered the questions? What do you think is “the biggest challenge” as we head into 2011?

    Video recorded at FIA Futures & Options Expo 2010. Visit www.futuresindustry.org/expo for more information.

    deputy head of strategy, SunGard’s capital markets business

    OTC DERIVATIVES, HOLISTIC DATA AND STANDARD REPORTING: A VIDEO INTERVIEW WITH FINEXTRA

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    Author: Tony Scianna, executive vice president, SunGard’s brokerage & clearance business

    During a recent trip to snowy London, I was fortunate to finally meet Finextra’s Liz Lumley in person. As the multimedia and special projects editor, Liz conducted a brief video interview with me that is now live on the Finextra site.

    In the video, you will see us discuss several topics that I believe are only going to become a bigger conversation as we move into 2011. This includes the move toward central counterparty clearing of OTC derivatives; the imperative for centralized, holistic, real-time data aggregation; and on-demand, standardized reporting. I may sound like a broken record, but when it comes to the new financial regulatory landscape, we are still just beginning to learn what the regulators have in mind for the industry in the coming months and years.

    Click the video below to watch (it will take you to Finextra’s website) and then join the conversation that Liz and I have started. Here on this blog, I’d encourage you to comment on a few relevant questions: What are your thoughts regarding the move to central clearing of OTC derivatives? Do you agree with Liz that the notion of a centralized, holistic, real-time view of your data and risk may be “mythical?” This time next year, how will this conversation sound different?

    executive vice president, post-trade derivatives, SunGard's capital markets business

    THE NEW OTC REGULATIONS AND YOU

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    Author: Laurent Jacquemin, global head of post-trade services, SunGard

    Over the next two to three years meat is going to be put on the bones of both the US ‘Dodd/Frank’ legislation and the proposals of the European Commission. The precise shape of the regulation is still unclear but I thought it would be useful to think about the most likely ways in which financial markets will be impacted.

    Systemic risk is believed to have been a main reason for the crisis and certainly needs to be addressed.  In 2008 less than 50% of OTC transactions were confirmed electronically and there is no OTC derivative asset class that has aggregate post-trade workflow automation greater than 57% whereas in exchange-traded derivatives straight-through-processing rates can be close to 100%.

    So it is inevitable that the clearing of most OTC transactions will soon be required.  The use of central counterparties can reduce systemic risk by increasing transparency, increasing operational efficiency and decreasing counterparty risk.

    Further, it is clear that as many transactions as possible will be required to be traded and confirmed electronically and that all trades will have to be reported to a trade repository.

    However, under both the European and US legislation, it is still unclear precisely which contracts will be deemed as ‘eligible’ to be cleared and a central counterparty used.

    What contracts will be clear-able?

    A study by Morgan Stanley tried to estimate the ‘clearability’ of the OTC asset classes. Credit derivatives appeared the most clearable (probably because they are already quite regulated and standardised) whereas FX products seemed to be much more difficult to clear or to standardise.

    The same is found when it comes to the question as to which current OTC derivative contracts will become exchange-traded: studies report it is thought to be quite likely with credit derivatives but less so with FX and equity-linked derivatives because of the bespoke nature of the products.

    Additionally, with the greater complexity of OTC products there is the problem of the implementation of valuation and risk calculation methods by clearing houses; there will be considerable time and investment required to develop the correct margining methods and of course, even when they are in place, clearing houses will have to ensure that they also have the processing capacity to cope with the huge volumes that will flow through them.

    Impacts for market participants

    But, in my opinion, it is in reporting to regulators that participants will be most impacted: risk exposure will need to be reported to regulators intraday or on-demand. This means that existing reporting systems will need to be seriously enhanced or new reporting systems put in place. In order to address the risk management and reporting issues market participants will need to rely on a new generation of tools to get a holistic view of risk exposure across assets and systems. Technology is going to be vital.

    For more information, read the related SunGard City Day London article.