Market infrastructures have been criticised for failing to innovate, but speakers at this year’s Sibos conference said they believe the sector has seen a quiet revolution.

An audience poll revealed 53.4% felt that market infrastructures are less innovative than other parts of the financial sector, but panelists disagreed with this outlook.

Michael Bodson, CEO of the Depository Trust and Clearing Corporation (DTCC), said simply dealing with the heavy regulatory burden currently facing market infrastructure firms was seeing the industry innovate.

“We keep up with all these regulatory demands while still running a viable business, so I would ask, who is ahead of us in developing so much new technology to cope with this unprecedented pace of change?”

Euroclear CEO Tim Howell agreed, and added that the kind of innovation seen in market infrastructure is often not the same as innovation in other sectors.

“We’ve been innovating more in the sense of continuously improving ourselves, rather than the sort of disruptive innovation that people typically think of,” he explained.

He added that the nature of market infrastructure and the high barrier to entry meant it is unlikely to ever see seriously disruptive innovators, but that does not mean the sector is standing still.

GV Nageswara Rao, managing director and CEO of the National Securities Depository of India, added that market infrastructures were actually often the key to fostering innovation in front office organisations.

“The whole market can only innovate when market infrastructure gets involved,” he said, “When market infrastructure innovates it pushes everyone to develop new products and services that they can now offer based on the improved infrastructure.”

The panelists said it’s unlikely there will be any great disruptive developments in market infrastructure, but by constantly developing new technologies and ways of interacting with market participants, infrastructures are having a major influence on how the rest of the market can innovate for the benefit of investors.

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Asset managers must embrace new technology, such as mobile applications and digitised, real-time investor reporting if they are to retain their competitive edge, according to Linedata.

Fund managers have been criticised for failing to embrace technological advances unlike retail banks. A study in May 2014 by MyPrivateBanking Research, an independent research firm, found just 10% of asset managers provided an information app designed to be used by existing investors or prospective investors.

“The asset management industry has yet to fully recognise the benefits of digitisation. Utilising new technology, which can offer investors real-time reporting instead of monthly fact-sheets outlining performance, has enormous benefits. Investors appreciate such technology as information on their funds can be accessed online in real-time, while it can also help bring about cost savings for managers,” said Patricia Regnault-Fouqueray, director of client management at Linedata, speaking at the Linedata Exchange conference in London.

Undertaking investor reporting manually can be time consuming and costly, and there is a strong risk of error creep. Regnault-Fouqueray highlighted that digitized reporting would be particularly welcome by retail investors, although institutional allocators will probably retain their own systems for receiving reports from managers.

A report by PricewaterhouseCoopers (PwC) in 2014 – “Asset Management 2020: A Brave New World” – predicted most asset managers will employ a chief digital officer by 2020 focused exclusively on technology issues within the firm. The report highlighted that just 40% of asset managers used social media, and that this needed to change. The PwC paper emphasised social media, mobile phones and other devices would be crucial for managers to attain big data on their customers, which would enable them to tailor products accordingly.

A failure to evolve will undoubtedly cause enormous challenges for asset managers and puts them at risk from technology savvy market disrupters. A study by State Street in July 2015 found 79% of asset managers feared being usurped by a market entrant which was non-traditional such as a major technology behemoth, for example.

Yu,E Bao, the money market division of Alibaba, the Chinese ecommerce business, has raised nearly $90 billion in less than two years. Meanwhile, there is widespread speculation that Google might enter the fray in what could be a major threat to traditional asset managers. 

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The many risk elements intrinsic to a fixed income transaction interact in almost infinite combinations across the various markets in which the asset class is traded.

Indeed, many finance professionals have devoted their energies and careers to the proper identification and management of these risk variables and elements. Over the last decade, we have seen a number of significant market events concentrate the industry’s focus on the cause and effect of those variables for significant periods, particularly those in the credit and market risk categories.

However, in my humble opinion not enough energy and focus has been applied to the holistic view of operational risk, a risk profile that has arguably changed more than any other in the last decade.

Multiple changes in the very fluid operational risk profile of fixed income instruments have stemmed from global regulatory reforms, trends in investing globally, shortened settlement cycles, and the use of varied instrument types in the quest for alpha and outperforming benchmark indices.

These ongoing and significant changes mean that firms looking to trade effectively across multiple fixed income markets need to have a full understanding of the operational and related risk elements they encounter across the lifecycle of the transaction, from idea generation and trade execution in the front office, to settlement, accounting and reporting in the back office.

Operational risk management is often considered a back-office responsibility that, like a computer system, must always be up and ever vigilant. But in reality the pre- and post- execution operations cycle is made up of many moving parts. In fact, DTCC research highlights roughly 10% of all global fixed income transactions are not matched, confirmed and locked in for settlement on trade date, quite a large aggregate global exposure for this market and industry at large.

These operational shortcomings not only cause back-office headaches but can also severely constrain the ability of asset managers to implement investment strategies. The time is right to introduce a new concept – transactional risk analysis (TRA) – based on a thorough understanding of risk categories including credit, market, interest rate, liquidity and operational risk. In this chapter, we will investigate TRA in more detail and explain how it can improve the overall efficiency of the fixed income investment and trading process.

Constructing the transaction operational risk profile

In our journey to manage operational risk, we must first properly define each broader functional category and underlying risk variable across the fixed income trade life cycle, noting that execution of these tasks are most likely assigned organizationally to an operations or compliance team, not the fixed income trading desk itself. Furthermore, these risk profiles and characteristics can and often do vary across different fixed income instruments and markets (e.g., corporate, muni, mortgage, financing or repo transaction).

How best to group different categories of risk? What should be the key operational focus areas? Below we propose some high level groupings and associated key activities:

Pre-trade

Before any securities market participant enters into a transaction, a number of pre-execution checkpoints and processes must be completed, some mandated by regulation that varies by jurisdiction.

Having the account or owner properly documented and open for trading activity can ensure both regulatory and counterparty certainty in the trade processing life cycle and in some instances avoid costly penalties that can wipe out business returns on the transaction.

Trade or execution date

Fixed income transactions are often conducted in very high denominations – exceeding US$1 billion in the financing or institutional repo markets – and represent a great risk to each firm. As such, it is imperative to use a standardized and automated process with highly well-defined confirmation and internal controls on settlement.

Immediately after execution, a critical task in the fixed income market is the ‘block checkout’, a process whereby each counterpart agrees the key details of the transaction, such as counterpart, security and settlement information and its economic components. Subsequently, the block or aggregate transaction can be broken down or allocated to individual accounts, which may be owned by different legal entities, each potentially specifying different locations or central depositories.

The operational teams are required to facilitate the transaction’s progress along the trade life cycle in order to provide as much certainty in settlement as possible.

The DTCC European Fixed Income community recently provided feedback that trading desk behaviour is the largest contributing factor to the failure of fixed income market participants to match and confirm trades on trade date. It is critical to both the individual firm and the market at large to ensure rigour and discipline is deeply embedded at each step of the investment process.

Trade netting and central counterparty (CCP)

In trade netting, many similar transactions are combined to net down individual security exposures to an aggregate level which reduces the number of physical settlements. This allows firms to manage the credit exposure by security more efficiently while reducing settlement risk and costs.

Similarly, in central clearing, the central counterparty steps in and acts as the buyer to every seller and seller to every buyer, while imposing a market risk management process that is more efficient than a bilateral ‘trade-for-trade’ exercise undertaken with each counterpart, thereby reducing counterparty risk for individual trading counterparts and the overall market.

In today’s fixed income market, netting and central clearing are used primarily in dealer-to-dealer clearing and settlement channels. But the buy-side is becoming more aware of the benefits of these processes and how they can be applied to the institutional transaction chain to also reduce risk and costs.

Collateralisation

The process of Collateralisation is a post settlement life cycle activity that ensures sound fiduciary responsibility while also fulfilling required regulatory compliance for various fixed income products such as ‘TBA’ mortgages, repos, bond and rate futures as well as OTC derivatives. An efficient process must be established for storing critical counterparty documents like master securities forward transaction agreement, credit support annexes and others. Once the legal narrative is fully captured and stored, daily operational execution can occur.

It is critical to have an automated process that can determine the appropriate market values, negotiate and deliver on collateral movements to secure the appropriate interest. These activities can be fairly highly standardized for each product type and across the global marketplace and could potentially leverage a shared and common infrastructure.

Often the cash bond trade has a companion hedge or contract and both are marked to market daily for accounting and Collateralisation of the hedge, often an OTC derivative contract. Sound operational processes can be a significant part of the transactional risk management of the firm. 

Trends impacting operational risk in the middle and back office

The multi-faced and diverse fixed income universe is constantly changing, throwing up new challenges on a weekly if not daily basis, in terms of operational risk.

DTCC has developed a community user base by broadly engaging with clients to create awareness of automation opportunities as well as collaborating to solve common challenges. We are working with our fixed income communities in US, Canada, Europe and Asia to address common issues through community solutions, thereby steering product and market developments.

Topics we have recently identified for further discussion and development include: trade date exceptions in areas including new issue corporate bonds; trading desk behaviours including timely trade capture, risk and operational implications of cross currency bonds; as well as pre-trading account openings.

We have seen record volumes in the new issue corporate bond syndication in recent years, in response to the prevailing low interest rate environment. In many respects, this has been a positive development for many segments including brokers, asset managers and corporations themselves. Corporate participation in the fixed income markets has definitely been on the upswing, in terms of refinancing balance sheets. At the same time, asset managers have been highly keen to participate or buy allocation in these new corporate bond placements as

a means to provide their accounts greater returns and also surpass the indices that often don’t embed these offerings for 90 days.

However, new corporate bond issues can bring operational challenges as the process of securing an allocation in an new instrument is not as proven as seasoned, secondary market transactions, particularly with respect to the all critical security identifier, i.e., ISIN or CUSIP.

Often, the new security’s identity is not widely disseminated on execution date, which cam leave back-office teams scrambling to set up and establish the security on settlement paths as well as books and records. 

Recent global market liquidity challenges

Market liquidity challenges can often require market participants to identify the location of the security in a compressed timeframe in order to deliver and avoid a fail, which can carry a hefty financial penalty in some markets.

Operations teams on both sides of the transaction, i.e., delivering or receiving, must be alert and persistent within their respective organizations to ensure the bonds are on a path to good delivery. This risk is exacerbated by the recent compression of securities settlement cycles to T+2, impacting the corporate bond market the most as largely currently in a T+3 environment.

Furthermore, liquidity challenges in the major bond markets have led asset managers to use the bond futures market more extensively to buy or take-on the same risk as the cash bond trade. More risk is introduced, at least initially, with any new trading process or instrument and raises some questions: is your middle and back office ready and able to support these transactions? Can any of your trading system or back-office partners fully support these trades? What are the operational risks and are they properly captured and supported with the right operations risk internal controls? 

Geographic risk

One of the trends in the fixed income markets the last decade has been the acceleration of global bond investing. We have seen growth in this area for a number of reasons including the broader search for alpha in the low-interest rate environment, the displacement caused by the European sovereign bond crisis and the advent of many new emerging market funds.

The growth in this area has caused operational teams to identify and manage global investing risks each day in settling and maintaining these transactions on the books. Some of the challenges introduced by global investing include, but are not limited to, disparate time zones, longer settlement agent chains, interaction with local depositories, local rules and – last but certainly not least – the risk management processes of the FX market (yet another product type with unique operational risks and challenges). If it is not properly managing, the currency risk can sometimes negate returns on the underlying asset.

How industry utilities can help

While many front office and revenue generating centres can often dominate a firm’s capital budget, the pace and scale of recent developments in the fixed income markets confirm the crucial importance of investing in proper tools and processes for transactional risk management across the trade life cycle. The failure to do so can catch up when you least expect.

As history has repeatedly taught us, we are only as strong as our weakest link in the transaction risk management chain. This weakest link can arrive at our doorstep very quickly and comes in the many forms, from the counterpart themselves or a weak internal control checkpoint in the operational life cycle, which can ripple into a broader market disruption. For this reason, DTCC will continue to work with industry partners to develop integrated solutions that drive down processing costs, reduce systemic risk and minimize duplicative infrastructure investments.

Adaptive change in response to industry needs is top of mind at DTCC. We are looking at risk management holistically in the each of the risk categories discussed in this chapter.  Certainly transactional risk analysis discussed in the is paper could be further developed by the industry in a similar vain to transactional cost analysis as a means to properly identify risk holistically across organizational silos. We stand at the forefront of innovation to mitigate risk, create market efficiencies and reduce costs. Furthermore, we believe that utilities have a uniquely important role in building and maintaining the processes and services on which the financial markets can grow on a stable and consistent basis.

This article was written by Kevin Arthur, director of fixed income and derivatives DTCC for The TRADE’s 2015 Fixed Income Handbook.

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UK financial groups are failing to adequately invest in archiving technology to keep track of corporate social media activity, a new report has claimed.

The research, conducted among its client base of 20,000 financial firms in the UK and US, found that UK firms are significantly behind those at US-based financial groups, when it comes to keeping records from a variety of sources including social media, instant messaging and mobile communications.

Ken Anderson, vice president of marketing at Smarsh, says that in the US, both the Financial Industry Regulatory Authority and the Securities and Exchange Commission are making increasing numbers of requests to regulated firms to produce evidence of e-communications and requests are growing more sophisticated.

He added: "It is little wonder really that US firms are most concerned with increased scrutiny from regulators.

"UK firms on the other hand, have not seen as much regulatory attention given to e-communications compliance nor the examples of firms being punished or sanctioned for non-compliance."

The report from Smarsh suggests there is no means of record keeping or record monitoring for social media output at 58% amongst UK financial firms compared with an average of 34% for US based firms. 

Researchers at Smarsh also concluded that the gap in mobile text messaging and instant messaging channels at UK firms could cause problems in the future.

It stated that UK firms allow use of these types of messages more often than US firms for business purposes and yet UK firms have a low number of archiving/supervision systems in place for instant messaging.

Figures show a lack of recording, archiving and monitoring for instant messaging at 39% of firms in the UK, compared to 22% in the US and for mobile text messaging there is a gap of 58% compared to 64% in the US. Furthermore, only 39% of UK firms are concerned about cyber security threats.

The company did not disclose the exact sample size for the poll at the time of writing.

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Interdealer broker ICAP has made a strategic investment in a regulatory reporting specialist, Abide Financial.

The firm hopes to capitalise on the growing need for regulatory reporting tools as a result of new regulations across many regions globally.

Abide Financial was founded in 2011 and has developed technology and solutions for firms to meet their reporting obligations. It has a reporting hub for EMIR, MiFID and REMIT in Europe, as well as specialist reporting services for entites in Canada, Australia and Singapore.

The investment was made via ICAP’s early-stage funding programme, Euclid Opportunities, which aims to support financial technology firms in areas such as post-trade risk management, data and financial markets.

Steve Gibson, managing director of Euclid Opportunities, said: “As an increasing number of financial services companies are looking for effective ways to optimise their post trade reporting capabilities, we believe the opportunity for Abide Financial is significant.
“Clients have spoken to us about the high regard they have for Abide Financial’s expertise, product quality and service levels, which they are now able to expand globally. We look forward to supporting Abide Financial through the next stage of their development.”

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SIX Securities Services’ operating income rose 10.7% in the first half of the year to CHF 177.6 million. EBIT rose 4.5% higher year-on-year, at CHF 30.9 million.

The securities services business of the SIX exchange group achieved the strongest growth of all of business areas. Following the discontinuation of the exchange rate floor, settlement transactions grew sharply (+18.4%) and the volume of securities under custody rose by 9.2%.

SIX performed well in the first half of 2015. Results improved slightly compared with the previous year. EBIT rose by 4.4% to CHF 157.7 million, despite the difficult environment caused by the strong Swiss franc. The tougher environment was reflected in the net financial result, which declined by CHF 14.4 million compared with the previous year. Due to lower net interest income and higher taxes, Group net profit decreased by 2.4% to CHF 127.5 million.

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Financial data provider Markit has agreed to acquire foreign exchange trade processing specialist DealHub.

Markit said the deal will enable it to offer customers a full solution for FX, covering venue connectivity, trading service, trade confirmation and regulatory reporting.

It will also benefit from a significant expansion of its customer base among banks, brokers and asset managers active in the FX markets.

Brad Levy, managing director and head of Markit’s Processing division, said: “DealHub is a great company and highly complementary to Markit’s growing FX processing business.  This acquisition adds depth to our FX offering while bringing an exciting set of trading solutions to Markit.  Connecting DealHub’s technology to our network will accelerate centralisation of FX trade processes, making it easier for customers to transact.”

DealHub’s main office is located in London but it also has offices in New York and Singapore and employs 55 people.

The deal, which is funded through a combination of cash and Markit’s revolving credit facility, is expected to complete in Q3 2015. Financial details were not disclosed.

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When it comes to best execution, wealth management platforms face a radically different set of challenges to those faced by institutional fund managers.

In the Financial Conduct Authority’s Thematic Review, published one year ago, the regulator stipulated that firms must take “all reasonable steps to obtain the best possible result” for their clients.

However, platforms operating in this market have often been criticised for failing to execute in real-time because of legacy systems or the cost involved. The worst perpetrators bundle trades together and execute them at the end of the day.

Unlike some operators in the wealth platform market, Ascentric was originally built as an equity trading platform and is consequently a member of the London Stock Exchange.

Royal London – the UK’s largest mutual life and pensions group with funds of £79 billion under management – acquired the business in November 2007 from Investment Funds Direct.

Many of Ascentric’s rivals started out as fund platforms, which has restricted their evolution somewhat and certainly influenced their execution policies. For Ascentric, its history turned out to a huge benefit in today’s regulatory climate.

At the time of writing, the platform had around £9.6 billion in assets under administration and the management there hope to break the £10 billion barrier by the time it reaches its ten-year anniversary in 2017.

As you might expect from an operation of this size, it has a relatively large trading team with 13 staff concentrating on in-house dealing and trade support, some of which have institutional trading backgrounds.

Heading up the operation is head of dealing Daniel Hughes, the former European director of equity trading at Knight Equity Markets.

Hughes joined Ascentric in January after three years at his old firm where he was focussed on managing larger orders in less liquid securities.

These days, his focus is on transaction cost analysis, transaction reporting and, of course, timeliness of execution. The beginning of April has been a busy period for the Ascentric team.

For the wealth market, the new tax year is traditionally when investment advisers rebalance client portfolios, which mean dealing desks can be a busier place than usual.

This presents a tricky task for Hughes and his team as they don’t currently use algorithms to execute their trades and can’t deal in parts because it would upset any client portfolio rebalancing.

Another marked difference to the institutional world is that Ascentric’s dealers have to be extremely careful with the information they give out to advisers. As an execution-only platform, they are forbidden from giving out any information, which could be considered ‘advice’. That said, they often face questions from advisers on liquidity statistics.

Mike Morrow, sales and marketing director at Ascentric, said its clients are taking a much keener interest in the trading function of late.

He explains: “For the first time the market is starting to ask questions about how we place our non-fund dealing.”

Like their institutional cousins, retail intermediaries are becoming more interested in the quality of their traders and the costs associated with trading itself.

It is perhaps no surprise that Ascentric decided to build its marketing campaign around trading charges at the start of the year.

Ascentric’s Morrow says retail intermediaries paying closer attention to trading quality and cost has meant dealing with more requests about the dealing team as a whole.

He said: “They want to meet the people at the front desk who are answering the calls, they want to meet the dealing team and have a decent level of visibility in the business.”

In January, the company began to offer a standardised fee structure to financial advisers alongside its standard charging model.

The new policy allowed intermediaries to opt for a flat 30 bps fee up to £1 million and 10 bps for additional assets over £1 million for all fund trades and assets in model portfolios including exchange traded instruments.

In recognition of how competitive dealing charges have become across this market, the company also revised its standard charging structure with dealing charges on funds and ETIs cut too.

Royal London as a group has been keen to promote its decision to move away from its old, fragmented model in favour of one, distinct group brand. All of the previous subsidiary brands are being phased out, except for Ascentric.

Despite that head of dealing, Daniel Hughes, says the business has benefitted from the closer working.

He explains: “Andrew Carter, the chief executive of Royal London Asset Management is also CEO of wealth, which we fall under as a group. I have taken junior dealers up to spend a morning with RLAM to give them an overview as to what they do.

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Murex, a collateral and processing solutions provider, has entered into a strategic partnership with Omgeo, a wholly owned subsidiary of The Depository Trust & Clearing Corporation (DTCC), to enhance post-trade operations.

With real-time certified connectivity to Omgeo’s central trade manager software, the Murex MX.3 platform will be able to provide increased automation and straight through processing (STP).

Buy- and sell-side clients will benefit from a single platform to support their investment process, post-trade operations and settlement, including exceptions management with brokers directly from a centralised end-user dashboard.

"In today's risk adverse global markets, the minimization of operational risk and the associated time and cost savings are critical factors for instilling confidence in operational processes and capabilities,” says Simon Powell, regional manager of global partners at Omgeo.

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London-based trading venue operator Aquis Exchange has signed its first software licencing transaction with a South African group.

A2X, a South African exchange, will be supplied with Aquis’ trading platform, clearing and surveillance systems and support services.

A2X has been launched to provide competition to the incumbent Johannesburg Stock Exchange.

Alasdair Haynes, CEO of Aquis, said: “This is a major development for us. Aquis has developed market leading exchange technology systems which has enabled us to enter the software licensing market and we are delighted that A2X has chosen to partner with Aquis. A2X has recruited a first class team of experienced market professionals and with strong financial backing and with the support of Aquis technology A2X will provide the market in South Africa with a realistic alternative to the JSE for the first time.”

Aquis was set up by Haynes, former CEO of Chi-X Europe, and launched in 2013 to provide an alternative pricing model for pan-European equities trading. It offers subscription-based pricing modeled on the telecoms industry.

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