New Report Projects Technology Spending for OTC Derivatives
by Judy Inosanto
Investment in technology solutions to support the global over-the-counter (OTC) derivatives market is expected to grow 5.5% annually, reaching $232.5 million by 2011, according to Celent, a leading financial industry research and advisory firm.
In its recent report, "OTC Derivatives: The Post-Trade Landscape for Hedge Funds and Asset Managers," Celent anticipates that market participants will increase technology spending as they look to improve operational practices and better manage risk in a market where growth is outpacing capacity.
The 32-page report also assesses the current environment of the OTC derivatives market, the trends shaping its growth and the evolution in the technology being offered to market participants. In addition, it provides a description of the overall derivatives trade process.
Who's spending?
Nearly 64% of the spending on third-party technology solutions comes from the dealer community, observes Celent. While the larger and most active asset managers and hedge funds are also making significant investments in automation, spending by buy-side firms has lagged.
Given the nascent stage of technology in the marketplace, the report notes it is likely that the buy-side is waiting for further advancements in automated service offerings. In addition, because the buy-side is generally more resource-constrained when it comes to technology investment, these firms are more apt to purchase services that enable them to manage a wide range of derivatives products on a single platform.
Toward 'a win for all'
"The challenge for money managers and broker-dealers is to automate processing," writes Celent. "Potentially, the next five years will be a new era of collaboration, technological creation and an amazing race where the finish line is a win for all."
The report estimates that less than 50% of OTC derivatives processing is automated and that up to 80% of trade confirmations contain errors. As the market becomes more mainstream, with a significant portion involving cross-border trading, the costs of these errors and the need to rebook or amend trade details remain concerns for the industry and global regulators.
Progress is well underway, notes Celent, particularly in the market for credit derivatives, where more than 80% of trades are now confirmed electronically and the total number of confirmations outstanding has been reduced by 70%. According to the International Swaps & Derivatives Association, by yearend-2006, 70% of credit derivatives confirmations were being sent out by T+1, up from 50% the year prior.
Global Technology Spend OTC Derivatives Processing,
Setting aggressive goals
Post-trade/Pre-settlement
Celent sees the industry setting tough goals, extending automation to a more comprehensive list of instruments, with OTC equity derivatives garnering the greatest attention. The focus on equities is particularly evident following the global derivatives dealers' March 2007 letter to the Federal Reserve Bank of New York outlining their strategy and affirming their commitment to increase adoption of electronic processing in the equity space.
In addition, the industry aims to issue confirmations by T+1 and to complete confirmations by T+5 for "vanilla" products processed electronically, according to the report. For more complex products, the industry aims to issue confirmations by T+1 and have them completed by T+30.
'On the heels of success'
Moving forward, Celent sees the OTC derivatives community continuing to cope with its growth boom and the need for standards among the growing list of participants in the marketplace. "The key drivers to change are the broker/dealer community, organizations like ISDA, DTCC Deriv/SERV and the regulatory agencies, as well as very large traditional asset managers and hedge funds. It's a collaborative effort that will take time but is launched on the heels of success in credit derivatives."
Celent also anticipates that the technology options in the marketplace will continue to grow rapidly. "The sector is a long way off from commoditization; regulators are collaborating globally; and the brokerage community is determined to make the pain go away." @
[For more information on Celent's report, visit www.celent.com.]
Celent on the Warehouse
Here's what the Celent report says about DTCC's Trade Information Warehouse, an extension of Deriv/SERV that provides a centralized and secure global infrastructure for processing over-the-counter derivatives over their lifecycle.
"An important global initiative launched in November 2006 by Deriv/SERV is the central Trade Information Warehouse, currently underway for credit derivatives. Deriv/SERV estimates it is receiving 80-85% of the credit derivative confirms. The project launched with credit derivatives because of the success Deriv/SERV experienced in broad dealer use for confirmations. DTCC hopes the central repository will ultimately become the 'golden copy' for all derivatives trades.
"Currently, broker-dealers have entered the second phase of the project, which entails back loading trades by broker-dealers and buyside firms. This phase will likely take the balance of 2007. When completed, it will further support the ongoing bilateral administration and automation.
"Deriv/SERV clients include 800 buyside firms, of which DTCC estimates there are 550-600 hedge funds. There is no cost to the buyside."