Despite Misconceptions, Credit Default Swap Market is Growing

Pre-dating Wall Street's current financial crisis, the credit default swaps market generated heated debate and discussion, moving from an initial focus on confirmation backlogs to a central counterparty clearing model and more recently to the possibility of requiring these products to trade on an exchange. Unfortunately, misconceptions regarding the utility and purpose of credit default swaps continue to spread and the financial industry's efforts to defend these instruments have been met with disdain by legislators seeking oversight of the CDS industry through misguided regulatory efforts.

But according to Kevin McPartland, senior analyst at Tabb Group and author of the new research report, "Credit Default Swaps: Industry Projections," although the outstanding notional value of the CDS market has declined dramatically largely due to trade compression, CDS market revenues from central clearing, electronic trading and existing trade migration will grow to $174 million, growing at 12% CAGR (compound annual growth rate) through 2011.

A new regulatory structure including central clearing and increased electronic trading, says McPartland, will streamline the market, lower barriers to entry for buy-side firms and ultimately increase volumes. "However, beyond the ubiquitous counterparty risk issue, concerns over operational efficiency issues continue to plague the CDS market at the same time that global regulators are pushing the industry to adopt central clearing for CDS trades and increase market transparency."

He explains how four proposed major initiatives from CME/Citadel, NYSE Euronext, Eurex and ICE (which includes Creditex and TCC), each vying to be the central counterparty of choice for the CDS market, will allow trades into their clearing houses from nearly any execution platform, including those operated by their competition. He does caution, however, that even when the first central clearing entity come online, a number of challenges will remain that require further thought and innovation.

Despite strong backing by regulators, he says that there are some in the industry who believe the problems with a central clearing solution for the CDS markets go deeper. "At least one alternative approach, NetDelta, a wholly-owned subsidiary of Knight Trading, currently exists, and others are likely in the works."

Casting an eye to the future, he also identifies three issues worth tracking: CDS market transparency; mandates; and electronic trading

Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=215800447

OTC Markets Handle Increased Demand in September

The over the counter (OTC) wholesale financial markets successfully handled increased demand during the month of September, according to ICAP, an interdealer broker. In the OTC spot FX market, average daily electronic broking volumes on ICAP's EBS platform in September reached a new high of US $274.2bn. This is an increase of 43 percent on September 2007. In the 12 months ending September 30, 2008, average daily electronic FX broking volumes on the EBS platform increased by 31 percent over the corresponding period in 2007 to $219.2bn.

Average daily volume in US Treasury products on the BrokerTec platform increased 18 percent year on year in September to $172.8bn. Total average daily electronic broking volumes at ICAP, including spot FX, US repo, EU repo and US Treasury products increased nine percent year on year in September to $903.2bn.

"The OTC financial markets are functioning very well and OTC market participants including banks, brokers, prime brokerage clients and post trade providers, have worked together to respond to the increased volatility. The EBS and BrokerTec platforms continue to deliver orderly, reliable and fair access to highly liquid and transparent markets. The high performance of our e-platforms during recent extreme conditions demonstrates ICAP's key role in the OTC markets and underscores our ability to provide value to our customers at all times," said David Rutter, deputy CEO for ICAP electronic broking, in a press release. Each month ICAP publishes average daily volume data in spot FX, U.S. Treasury and European and U.S. repo products.

Publish Date: October 03, 2008
Source URL: http://www.advancedtrading.com/showArticle.jhtml?articleID=210605541

Wall Street Meltdown Making Buy-Side Firms Really Rethink Sell-Side Relationships

In the aftermath of the elimination of four bulge-bracket firms (Lehman Brothers through its bankruptcy and sales of assets to Barclays and Nomura; Merrill through its sale to BofA; Goldman and Morgan Stanley through becoming bank holding companies) from the ranks of independent brokerage firms, new research from TowerGroup finds that the unprecedented restructuring underway on Wall Street will have major and lasting impact on the investment management business.

TowerGroup believes the apparent demise of the independent brokerage model will force investment management firms to carefully reassess their reliance on Wall Street brokerage firms for research, trade execution, market insight, and back-office services. "Brokerage firms play a vital role in the smooth functioning of the overall financial system by providing liquidity, being market makers, and assuming risks, which becomes critical during periods of market uncertainty," says Dushyant Shahrawat, a senior research director in the TowerGroup
Investment Management practice and author of the report, "How the Massive Upheaval on Wall Street Will Impact the Investment Management Business." "Although many Wall Street firms have found new homes in large commercial banks, it is highly unlikely their new parents will allow them to perform all these essential functions," Shahrawat wrote in the report.

Derivatives may lose their luster, the TowerGroup suggests. "Now that fewer brokerage firms facilitate over-the-counter derivatives trades and structured products, asset management firms may reduce their use of the products (at least temporarily) and instead make greater use of exchange-traded instruments," says Shahrawat. "Intense scrutiny in the use of derivatives and structured products will force asset management firms to reassess their use of these products, the way they are valued, the way firms manage risk related to them, and counterparty exposure related to them."

In all, TowerGroup predicts that the Wall Street upheaval will impact the buy side in eight key ways:
1. Less capital commitment from Wall Street.
2. Disruption in the provision of execution services.
3. Changes in securities lending services
4. Greater focus on risk management
5. Decreased buy-side appetite for structured products
6. Shift in order flow from dark pools to crossing networks
7. Buy-side opportunity to hire top Wall Street talent
8. Elevated positions of second-tier brokers, independent EMS providers, and OMS vendors

"This colossal upheaval raises scores of questions for asset managers, both in the short term and looking ahead to 2009," Shahrawat says. "Who will provide capital in times of need? Who will be confident enough in their risk models to assume risk for clients and counterparties? Who will fuel the underwriting of new companies and even new industries? Who will drive the growth of structured finance?"

TowerGroup believes recent changes in the brokerage industry will have both direct and indirect implications for the IT budgets at asset management firms. TowerGroup anticipates a decline of three to four percent in technology spending across the investment management industry in 2008 and 2009, as firms are forced to cutback expenditure amid declining assets under management and growing pressure on fees.

Publish Date: September 24, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=210603648

TABB Group Forecasts Monthly Novation of Credit Default Swap (CDS)

Eighteen years after the credit default swap (CDS) was created to help firms hedge against the risk of default of a given asset, TABB Group estimates that the average notional value at risk (the total value of a leveraged position's assets) of trades novated monthly will exceed $45.2 trillion by 2010, an 88% CAGR (compound average growth rate) from 2005.

Kevin McPartland, senior analyst and author of the new TABB Group research report "Credit Default Swaps: The Risk of Inefficient Markets," said in a press release that 90% of all CDS trades are confirmed electronically, but same-day matching of new trades and novations is rare and error rates are unacceptably high. "This is a lot of money to risk on a phone call," he added. TABB Group forecasts that nearly $170 million will be spent in 2010 by major sell-side broker-dealers to automate the affirmation process and mitigate the potential risk resulting from trade exceptions.

Despite current available technology, details of most CDS trades are still not affirmed between counterparties on trade date. The delay is not in legally confirming or settling trades, but simply in agreeing that each party recorded the same basic trade details such as the reference entity or notional amount. Where overnight batch jobs were once accepted solutions, with 2008 trading volumes and market volatility levels, explains McPartland in the release, "the risk created by not understanding your market and counterparty exposure until the next morning makes this standard practice rather unacceptable."

Publish Date: September 04, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=210300535

China Development Industrial Bank Outsources Trading Desk to Derivatives.com

Taipei-based China Development Industrial Bank (CDIB) has rolled out Imagine Software's Derivatives.com ASP-based solution to power the bank's new multi-strategy, global macro trading desk.

"The first and most immediate necessity for our new desk was an integrated multi-asset solution that could provide real-time front-office, middle-office, and risk management functions," stated Bertrand Hongre, head of macro trading at CDIB, one of Taiwan's largest and leading venture capital and investment banking institutions.

Among the factors that weighed on its vendor selection — including industry-leading functionality, fast deployment and implementation capabilities — were cost efficiencies and economies of scale. "We think an ASP-based solution is infinitely preferable to a traditional software implementation. Not only is Imagine's Derivatives.com inherently easy to deploy, but because it's a completely outsourced solution, the bank avoids incurring the customary internal IT and data management support requirements," said Hongre.

CDIB plans to spin the desk off into a standalone fund in years to come, so a portable ASP-based solution outsourced from CDIB's internal infrastructure is suited for that purpose, added Hongre. In addition, Hongre said that Imagine could become a future alternative to CDIB's existing systems for fixed income, credit and commodities businesses, and it looks forward to expanding its usage of the real-time portfolio and risk management product.

Publish Date: September 02, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=210300092

Eurex ventures into OTC derivatives clearing

Swiss German derivatives exchange Eurex is in talks with infrastructure providers about introducing a clearing platform for the over-the-counter (OTC) credit markets.

The news comes just days after CME Group said it would expand clearing services to OTC interest-rate swaps and Markit and the Depository Trust and Clearing Corporation (DTCC) said they would form a joint venture for processing and confirming OTC derivatives.

Eurex says its new initiative - which is expected to launch in early 2009 - aims to "complement current US initiatives with a European solution".

The European OTC CCP platform will utilise existing Eurex Clearing functionality, as well as new tools for trade and risk management. The system will initially focus on iTraxx index exposures that are mainly traded out of Europe. Eurex says an extension to other asset classes - such as equity, fixed income - can be "handled flexibly" according to market demand.

The exchange says it is in discussions with several infrastructure providers concerning their involvement in a new platform. Names have not been disclosed but one of the providers is rumoured to be the DTCC.

Eurex says the new service is "designed to address recent developments in the OTC market which suggest that concerns about systemic risk due to the backlog of transaction confirmation and potential counterparty defaults require improvements in the market's infrastructure".

Thomas Book, responsible for clearing on the Eurex executive board, says customers would profit from straight-through processing, enhanced collateral management and multilateral netting for OTC trades which currently account for 84% of all derivatives traded.

Earlier this month Nyse Euronext subsidiary Liffe previewed plans to launch a new set of contracts based on the iTraxx European indexes with integrated OTC clearing through its Bclear operation.

Meanwhile in May the US Clearing Corporation (CCorp) said it had agreed a deal with the DTCC that will result in the launch of a central clearing facility for over-the-counter (OTC) credit derivatives in the third quarter.

Source URL: http://www.finextra.com/fullstory.asp?id=18763
Publish Date: July 23, 2008

Study Reveals Massive Paper Backlog in OTC Derivatives Market

Paper-based processes of contract negotiations and confirmations in the $400 trillion over-the-counter (OTC) derivatives market have created a huge backlog of trade confirmations, according to a study by TABB Group.

Since 2002, the estimated outstanding value of all OTC interest rate, currency, credit, and equity derivatives has grown nearly 30 percent a year, TABB Group said.

But as the OTC derivatives market expanded, the automation of customer communication management processes such as contract negotiations and confirmations has not kept pace.

From June to August 2007, the total number of backlogged confirmations jumped 250 percent, TABB Group revealed.

"In this world where hundreds of millions of dollars are invested in nonstandard products, human error can lead to huge monetary losses and litigation," said Kevin McPartland, TABB Group Senior Analyst.

"Automation of the customer communications process is a must-have for any business competing in this market, as the potential for loss could be devastating," he said.

The backlog of trade confirmations has resulted in poor transparency and left the financial services sector exposed to unnecessary risk. In many cases, confirmations were not only unsigned, but uncreated, the study revealed.

Source URL: http://www.financetech.com/showArticle.jhtml?articleID=208800330
Publish Date: June 23, 2008

Back offices buckle under OTC volume surge

Despite concerted efforts since 2005 to improve operational efficiency in the credit derivatives markets, trading surges in the OTC markets since the credit crunch have resulted in corresponding spikes in unconfirmed trades clogging up back offices.

According to data released by UK-based Markit Group, average outstanding confirmations in the OTC derivatives markets jumped from around 6000 per dealer bank to about 13,000 between June and August 2007, at the same time as monthly trading volumes rose from an average of around 20,000 to more than 25,000 per dealer.

However the situation has improved over the past few months. Following a dip at the end of 2007, trading volumes rose again to near-peak levels of 25,000 trades per dealer for each of the first three months of 2008, but the average number of outstanding confirmations remained lower at around 7000 per dealer per month.

But despite the improving picture, regulators are still concerned about operational inefficiencies in the credit derivatives markets. Last month the Federal Reserve Bank of New York said the volume surges in mid-2007 showed that "processing challenges" still persist in the markets and warned that in order to support long-term growth "the processing infrastructure must be capable of processing transactions efficiently through periods of sustained high volume and market volatility".

A recent report from the Financial Stability Forum also cited the surge in unconfirmed credit derivatives trades during the credit crunch as an area of concern.

"Despite the significant progress that the industry has made in automating the infrastructure of the OTC derivatives markets during the last two years, the industry has not achieved a "steady state" in which spikes in trading volume do not lead to operational problems," says the FSF report.

Earlier this month reports surfaced that group of at least 10 major credit derivatives brokers are working to establish a central clearing house that would take direct exposure to counterparty risk.

According to a Reuters report Athanassios Diplas, chief risk officer for global credit trading at Deutsche Bank, told the annual meeting of the International Swaps and Derivatives Association (ISDA) that the clearing house would help "take a lot of risk out of the system" by enabling banks to trade without the fear that the default of a dealer could cause a shock to the market.

Some bank executives and analysts have voiced concerns that the default of a major derivatives broker could lead to a chain of counterparty failures and defaults, says the report.

It is thought the central clearing house would require counterparties in credit default swaps to put up collateral as well as initial margin to cover any decline in market value.

The brokers involved in the programme would contribute to a guarantee fund for the clearing house to cover potential losses from defaults, says the report.

Source URL: http://www.finextra.com/fullstory.asp?id=18377
Publish Date: April 23, 2008

Clearing the fog

Credit derivatives continue to boom, but the old order is under threat

BANKERS gathering in Vienna this week for the annual bash of the International Swaps and Derivatives Association (ISDA) had some big numbers to celebrate. The overall market for over-the-counter derivatives shot up to $455 trillion at the end of 2007. Some $62 trillion of that were credit-default swaps (CDSs), whose supercharged growth continues in spite of the crunch. But the emphasis this year was as much on playing down dangers as playing up volumes. ISDA was quick to point out that actual credit exposure was a mere 2% of the notional value of all contracts.

This coyness is hardly surprising. Regulators have been fretting since 2005 that the market's infrastructure was not keeping up with its growth. Then, in March, came the sudden implosion of Bear Stearns, a top-ten actor in CDSs, rescued partly because of the fear of chaos if such a large counterparty were to fold. The market's overseers may not agree with Christopher Whalen of Institutional Risk Analytics, a consultancy, when he describes off-exchange derivatives as an ?act of Satan?. But they want to see more robustness, especially in credit derivatives, and have hinted that they will impose their own solution if the market does not. ...

Source URL: http://www.economist.com/finance/displaystory.cfm?story_id=11060804
Publish Date: April 17, 2008

Hedge Funds Say Technology Is Critical to Business

As institutional investors increasingly turn to alternative investments, hedge funds' assets continue to mushroom. As a result, hedge fund executives increasingly see technology as a critical business enabler, particularly in the middle office, a recent Aite Group survey reveals.

According to the 20 hedge fund executives polled by the Boston-based advisory firm, technology investments aimed at improving operations are top priorities for 2008. Among the hedge funds' goals are improving automation around OTC derivatives, adding collateral management technology, exerting better control over prime brokerage charges and rates, improving access to data and reporting capabilities, and enhancing automation to boost efficiency and reduce errors.

Source URL:http://www.wallstreetandtech.com/showArticle.jhtml?articleID=207200116
Publish Date: April 11,2008

OTC derivatives trading remains a slow process, report finds

Industry group promises improvements, but no quick fix likely

While the processing of the over-the-counter derivative transactions has improved over the past few years, it is still a surprisingly slow process.

That state of affairs was underscored by a report released today by Aite Group. In it, Aite reports that the bulk of over-the-counter derivatives processing is done by hand. That, in turn, can lead to errors.

A single contract traded verbally and recorded on paper can involve between 80 and 100 variables in terms and conditions. In addition, many parties take part in the process, including not only a buyer (such as a hedge fund) and a seller (such as an insurance company), but also processing entities such as broker-dealers and prime brokers.

Part of the problem stems from the staggering growth in the market. The derivatives market stood at $516 trillion in outstanding notional value as of June 2007, according to the Bank for International Settlements, and it continues to grow. Interest-rate derivative contracts represent the largest chunk of the market, but credit derivatives are the fastest growing segment.

Trading systems have not kept pace, and industry players are clearly aware of the problem. In late March, a group of trade associations and major broker-dealers submitted a letter to the Federal Reserve Bank of New York and other regulators that confirmed their commitment to improving the processing of credit and equity derivatives.

The Aite report noted that a firm can upgrade to a fully automated system and still see little gain. Why? “OTC derivative trade processing is unique is that counterparties are tied to each other in a way that does not exist in the listed markets,” wrote Denise Valentine, senior analyst with Aite Group. “Ultimately, a firm is only as automated as its counterparty’s processing capability.”

To satisfy customer requests, many broker-dealers are paying for the development of electronic systems. “Yet, the large volumes and lack of automation in the non-listed derivative business still mean a manual maintenance routine for many firms,” the report noted.

By Marine Cole

Source URL: http://www.financialweek.com/apps/pbcs.dll/article?AID=/20080403/REG/998586512/1036
Publish Date: 03 April, 2008

InterContinental Exchange Acquires Yellow Jacket Software to Expand its Electronic Trading of OTC Derivatives

Exchanges are moving into OTC derivatives as these instruments become more standardized and can trade on exchange-like electronic platforms.

With an eye on expanding its market share in over-the-counter derivatives, Atlanta-based InterContinental Exchange will acquire YellowJacket Software, an electronic trade negotiation platform that traders use to consolidate quotes and structure complex trades in the weather and energy markets. In light of the huge volumes that occur in the OTC derivatives markets, few observers are surprised by the move.

"Exchanges want to get a piece of the OTC market back," observes TABB Group senior analyst Kevin McPartland, who covers the futures and options exchanges. "The OTC markets have exploded -- they see that they are losing some potential business to the collective OTC markets, and they want to make sure they keep that trading on their exchanges and on their technology." McPartland adds that technology has become an increasingly important competitive differentiator for all exchanges.

In fact, technology has been the basis of the ICE's rapid expansion and acquisition of other exchanges, including the International Petroleum Exchange (IPE), the New York Board of Trade and the Winnepeg Commodities Exchange. The ICE operates three futures exchanges in the U.S., Europe and Canada, and has expanded its trading and clearing activities into a full range of energy, soft commodities, foreign exchange and stock index futures.

Today, ICE provides a single high-speed, electronic platform for trading ICE futures and OTC-cleared products. It offers one architecture that supports futures and one that supports OTC markets, according to an ICE spokeswoman.

With the acquisition of Yellow Jacket, for which financial details were not disclosed, the ICE now has the potential to tap the liquidity from the OTC weather, natural gas, crude and power derivatives that are transacted on Yellow Jacket's network. While "ICE operates a widely distributed electronic trading platform for highly liquid products, Yellow Jacket serves the highly structured instruments and illiquid trades," says the ICE spokeswoman. "Certainly Yellow Jacket occupies a very interesting space in the technology side of the derivative market."

Founded in 2002, Yellow Jacket's core application is YJEnergy, a secure, peer-to-peer communications network used by OTC derivatives traders that rely on public instant messaging networks, such as Yahoo and AOL, to disseminate quotes to one another. "A trader at any given moment may have several instant messages coming in," explains the ICE spokeswoman. "This tool enables them to aggregate information and assemble where market prices are for the trade they want to do." The platform provides the added value of price transparency, the ICE spokeswoman notes.

Currently, 130 clients use the YJEnergy product, including big hedge funds, banks, utilities and power companies. The ICE, however, is looking at how it can leverage the technology beyond energy and weather derivatives. "We see this not just as an energy or commodities tool, but it could potentially apply to complex asset-class trades, such as fixed income instruments negotiated OTC," says the ICE spokeswoman, who adds that Yellow Jacket will be a wholly owned subsidiary of ICE.

One of the potential synergies between the ICE and Yellow Jacket is clearing. According to the ICE spokeswoman, Yellow Jacket currently submits OTC trades for clearing to several exchanges. "We're integrating that ... [into] ICE's cleared products," she says.

Liffe, SuperDerivatives Connect

But the ICE isn't the only exchange that is venturing into technology deals to penetrate the OTC derivatives space. On Feb. 26, Liffe, the London-based futures exchange owned by NYSE Euronext, partnered with SuperDerivatives to give users of the derivatives pricing and analysis platform direct access to the Liffe Connect electronic trading platform. "The partnership was driven by market demand from market makers and from buy-side investors who are looking for the right market to realize their investment goals," says Ed Crouch, global head of corporate and strategic development for SuperDerivatives.

Banks, brokers, asset managers and mutual funds use the SuperDerivatives products to price OTC derivatives. Now, market participants can access Liffe's direct execution capabilities and market data, while combining that with the analytical and productivity functionality that SuperDerivatives brings to the table with its platforms, says Crouch.

"There are certain structures that can be traded on the exchange, and that's the right venue, and there are other structures that can't because they are OTC structures," explains Crouch. "This gives [customers] a single platform so that people can choose what the best execution venue is for whatever it is they are trading at the moment." For example, if a trader were executing a back-to-back trade, for which he had an exchange-traded product on one side and an OTC product on the other side, he could execute both on the Liffe/SuperDerivatives platform, Crouch adds.

In addition to facilitating direct execution via Liffe Connect, the interaction of the two platforms "provides greater transparency and price discovery in that market participants can use the technology to have a greater sense of what appropriate prices are in these different venues," Crouch asserts, noting that while Liffe is the first exchange to which SuperDerivatives has linked, the vendor is in discussions to link to other exchanges. "The idea is that it helps increase volume on the exchanges," he says.

Still, Liffe can trade only listed derivatives, points out Mayiz Habbal, SVP of Celent's securities and investments group. "With this kind of linkage, Liffe is not going into the OTC buisness," he says, "SuperDerivatives is giving its users the option -- if they need to diversify their strategies, they can go into the listed derivatives. [The deal] is a connectivity provisioning more than anything else."

OTC, Exchange Convergence?

Habbal and other industry sources see the technology deals such as the ICE's acquisition of Yellow Jacket and SuperDerivatives' partnership with Liffe as leading to the convergence of the OTC derivatives and exchange markets. According to Habbal, the exchanges are trying to move into the OTC derivatives business dominated by interdealer brokers (IDBs). "[Exchanges] are preparing themselves to really venture into that market that the IDBs are operating electronically," he says.

The combination of electronic trading, more standardization of OTC derivatives contracts and the consolidation of the IDBs are fueling the convergence of OTC and exchange-traded environments, argues Habbal. An estimated 75 percent of the OTC derivatives market, he notes, is handled by three IDBs -- Tullett, ICAP and GFI. "And within the standardized instruments [i.e, credit default swaps and short-dated interest-rate swaps] they are the equivalent of running exchanges," Habbal maintains, citing the findings of a Celent research report, "Interdealer Brokers' Migration to an Exchange-like Platform," that was slated for publication in late February.

In the report, Celent divides OTC derivatives into three categories: First, they are introduced as exotic or illiquid instruments; then they evolve into liquid or flow instruments; and finally, they migrate into an exchange-type of environment, according to Celent. "Once the instruments become standardized and more liquid, they can be traded electronically," Habbal contends.

"For the exchanges, they see this as their next market," Habbal adds. "They're looking at how the interdealer brokers who specialize in this type of instrument have transformed their environment into an exchange."

As evidence of the trend, TABB's McPartland notes that the Chicago Board Options Exchange (CBOE) recently launched an electronic platform for trading Flex options, which basically are customized single-stock and index equity options that allow traders to create options with custom price strikes and expirations. While CBOE used to execute the Flex options through the floor, now brokers, liquidity providers and their customers can negotiate trades securely via CLFEX, an Internet-based, fully anonymous trading system developed for CBOE by Stockholm-based Cinnober Financial Technology. The system is based on Cinnober's TRADExpress Trading Engine and also utilizes the OTC platform Ctrade.

In yet another sign that OTC derivatives may be converging with exchange markets, on Feb. 28 Nasdaq OMX announced a $7.5 million stake in Agora-X, a new electronic communications network (ECN) for institutional commodities trading in energy and agricultural products. "The OTC trades are a complement to the exchange-traded products," says Chris Concannon, Nasdaq OMX's EVP of transaction services. But there are unique benefits to OTC products, he adds. For example, "You don't have the same position limits and restrictions that you find on exchange contracts," Concannon says.


Source URL: http://www.financetech.com/showArticle.jhtml?articleID=206905693
Publish Date: 25 March, 2008

Sell Side to Spend $70 Million on Derivatives Processing in ’08, Buy Side Far Less, Says TABB Group

The TABB Group forecasts that top-tier broker/dealers will ramp up spending on OTC derivatives processing automation software at a compound annual growth rate of 30% over the next two years.

In a research note published today, "OTC Derivatives Processing: Blazing a Trail to Automation," the TABB Group says that although top-tier, sell-side broker dealers have invested millions of dollars since the mid-1990s developing best-of-breed processing for their burgeoning OTC derivatives businesses, many other counterparties, including mid-tier banks, hedge funds and other trading firms, have yet to implement any kind of automated solution, a problem that has not gone unnoticed by the Federal Reserve.

According to Kevin McPartland, senior analyst at TABB Group and author of the note, "When the Fed first instructed major dealers in 2005 to catch up on unconfirmed trades, additional personnel provided most of the ammunition for shrinking the confirmations backlog. As recent credit market turmoil has shown, simply adding staff to solve a problem is insufficient." He goes on to explain that during a three-month period, June to August 2007, the total number of backlogged confirmations jumped 250%.

Although the technology exists for real-time monitoring, he points out, "many firms continue to rely on daily, even weekly, reports because it's often difficult and expensive to implement more frequent tracking." This forces the major dealers to weigh the cost of additional staffing and enhanced automation with the level of risk they are willing to carry. For years, the front office quants and traders always gained the attention of senior management, IT staffs and independent service providers for trading systems, high-speed data and algorithms that stole the spotlight and budget. "For OTC derivatives," McPartland says, "a new day has finally dawned. A process so critical and complicated, it is simply screaming out for automation."

McPartland also explains that credit default, interest rate and equity swaps transactions not handled by electronic confirmation platforms, averaging about 1,000 transactions per firm per month, continue to be handled through paper-based confirmations. In addition, almost all non-vanilla trades, averaging as many as 4,000 transactions per month for the largest firms, also use paper-based confirmations. Creating these confirmations is one of the most crucial steps in the trade lifecycle, "but without the right solution," he says, "it can be the most complicated. In fact, one major investment bank estimated that nearly 90% of its non-vanilla OTC derivative trades are still sent by fax."

TABB Group forecasts that the $70 million to be spent on OTC derivatives processing automation software in 2008 will experience a compound annual growth rate of 30% over the next two years, bringing the overall market size to nearly $120 million by 2010. In addition, with vendor installations to manage the post-trade capture process costing over two million dollars each in licensing fees, market size for the sell side alone, says McPartland, is approaching $30 million annually and as OTC derivative volumes increase, this will rise to over $45 million annually.

Unfortunately, while nearly 1,000 of the world's hedge funds use OTC derivatives, only a fraction of those have automated processing systems. Combining increased usage with existing users still in need of processing systems, TABB Group forecasts the market for software packages for hedge funds at nearly $40 million annually by 2010, rising from only $20 million in 2007.

By Penny Crosman

Source URL - http://www.financetech.com/showArticle.jhtml?articleID=206904327
Publish Date - 18 March, 2008

Spending on OTC derivatives automation to surge - Tabb

Banks will spend $70 million on automating over-the-counter (OTC) derivatives processing in 2008, rising to $120 million in 2010 - a compound annual growth rate (CAGR) of 30%, according to estimates from Tabb Group.

In a research note Tabb says that, whilst top-tier, sell-side broker dealers have invested heavily in developing processing for OTC derivatives, many other counterparties, including mid-tier banks, hedge funds and other trading firms have yet to implement any kind of automated system.

OTC derivatives processing has suffered in recent years as banks diverted budgets to trading systems, high-speed data and algorithms, says Tabb.

Tabb identifies hedge funds as particularly slow on the up-take with nearly 1000 trading OTC derivatives, but only a fraction of these using automated processing systems. Tabb forecasts the market for software packages for hedge funds will reach nearly $40 million by 2010 - double the figure for 2007.

Kevin McPartland, senior analyst, Tabb, says when the Federal Reserve first instructed dealers to clear settlement backlogs and tighten back office risk management procedures in 2005, most firms invested in extra staff to deal with backlogs.

But McPartland argues that the credit crunch shows employing extra personnel is not enough to solve the problem.

Despite technology existing for real-time monitoring "many firms continue to rely on daily, even weekly, reports because it's often difficult and expensive to implement more frequent tracking", says McPartland.

He says credit default, interest rate and equity swaps transactions not handled by electronic confirmation platforms - averaging about 1000 transactions per firm per month - continue to be handled through paper-based confirmations. In addition, almost all non-vanilla trades - averaging as many as 4000 transactions per month for the largest firms - also use paper-based confirmations.

"For OTC derivatives a new day has finally dawned. A process so critical and complicated, it is simply screaming out for automation," says McPartland.

Tabb's research comes a year after the Bank for International Settlements called on financial firms to introduce automated systems to cut confirmation backlogs in the over-the-counter derivatives markets.

The Committee on Payment and Settlement Systems, the public policy forum of the central bankers' collective, called for improvements across the complete post-trade environment in the booming OTC markets.

Source URL - http://www.finextra.com/fullstory.asp?id=18234
Publish date - 18 March, 2008

Aite Reveals Top 10 Investment Trends for 2008

Just in case your firm's IT managers aren't looking forward, Aite Group is doing it for them. The Boston-based research and advisory firm released its top 10 securities and investments trends for 2008. Among the hot topics this year will be OTC derivatives processing, international market fragmentation, data integration and aggregation, and corporate actions processing.

While industrywide enhancements have been made in processing OTC derivatives in recent years, there still is much room for improvement, according to Aite. But 2008 will see innovation in the trading, clearing and settlement of OTC derivatives across asset classes, notes the report.

Further, Aite believes the Markets in Financial Instruments Directive (MiFID) and the inevitable changes to European market structure in 2008 will receive increased attention in 2008. Specificaly, the viability of multilateral trading facilities and systematic internalizers will be under close scrutiny, the firm says.

According to Aite, the top technology priority in 2008 for Wall Street will be data integration and aggregation, with the industry spending more than $2.5 billion on enterprise data management and integration technologies, a category that is growing 20 percent a year. Aite notes, however, that many of these spending initiatives lack the flash necessary to sell to senior management and will end up pork-barrelled in other projects.

Additionally, the financial industry at large should be looking to get a handle on corporate actions processing, or what Aite calls "the last frontier in straight-through processing and risk-reduction efforts." Corporate actions departments are beginning to shed their cost center images and are being viewed as an opportunity to drive efficiency and create a competitive advantage by improving client service, the firm contends, adding that software vendors are likely to try to capitalize on this shift.

Top 10 Investment Trends For 2008

1. Subprime Goes Prime-Time
2. Continued Expansion of Electronic Trading
3. Socially Responsible Investing
4. Market Fragmentation in Europe and Asia
5. Data Integration
6. ETFs and Other Low-Cost Alternatives
7. Outsourcing: All Talk Becomes a Little Action
8. Self-Directed for Cost and Competition
9. RIA Space Sees Double-Digit AUM Growth
10. Corporate Actions a Legimitate Priority

Note: Trends are listed in no particular order

Source URL - http://www.financetech.com/showArticle.jhtml?articleID=206800367

Publish date:February 19. 2008