OTC derivatives market reforms are supported by all G20 countries, and, in time, perhaps the goals of increased transparency and liquidity along with reductions in counterparty and systemic risk can be achieved. However, fund managers must now make decisions about how to comply with these regulatory challenges that will have immediate and strategic impacts on their businesses. Regulatory change presents opportunities to optimize derivatives operations. So how can fund managers leverage their investment in compliance to increase their business value via better operational controls and efficiencies? Geoff Harries, global head of Asset Servicing at DST Global Solutions, explains.
Turning Business Challenges Into Opportunities
The evolving timelines of initiatives such as Dodd-Frank and regional variants mean firms must strategically prioritize imminent market developments and rulemaking against the longer-term, global regulatory change process and related jurisdictional challenges. The different requirements coming from various national entities, as well as their timing and the content required, are creating a lack of harmonization. However, firms must press on with compliance projects, creating a prime opportunity to optimize derivatives operations.
We all know the business drivers for reengineering OTC derivatives operations, including the new extensive requirements for central counterparty clearing (CCP) connectivity and changes to regulated fund mandates such as UCITS III, but this exercise doesn’t have to be just a cost center, driven by requirements to comply with regulatory demand. Why not take this opportunity to boost efficiencies in OTC and broader derivatives operations, reduce administration and the reporting burden and free up more time to generate alpha?
Rethinking the Operational and Technology Landscapes
Swaps are becoming increasingly popular as an investment strategy and need to be considered in future operations requirements. It is an opportune time whilst implementing CCP workflows and other OTC market reform changes to improve the entire process – after all, derivatives operations are only as good as the weakest link in the system. By proactively responding to the new business environment and effectively structuring OTC derivatives business, institutions can take advantage of opportunities, protect franchise value and avoid the potential downside of these changes.
A well-thought-out operational strategy mitigates risks including requirements to interact with new market infrastructure and internal fragmented processing between front, middle and back office. Manual interventions giving rise to cumbersome reconciliations can also be overcome. Above all, it offers the opportunity to implement a more streamlined infrastructure. Effective automation is key – using existing systems in order to achieve rapid response to new investment strategies and trading new instruments, with derivatives-based investment strategies requiring integrated cross-asset class processing from front to back offices.
Firms can optimize derivatives operations by improving operational capabilities for growing volume, removing operational bottlenecks and reducing risk with scalable, audited processing and reconciliations. Real-time status management is an important provision as is building capabilities to enable and support new investment strategies. Operational capacity and efficiency can be increased through process consistency and automation.
Improving Operational Control and Efficiency: Defining and Achieving Best Practice
Best practice can be seen as a composite of fund manager practices that have unintentionally been distilled as the most effective ways of conducting business under conditions of budgetary constraint. A firm’s own individual systemic view of operations should reflect what is being achieved in the marketplace as a whole. Best practices include:
• Accurate portfolio accounting and event processing
• Flexible instrument setup
• Efficient post-trade processing between counterparties
• Composite view of all derivatives positions and activities
• Effective asset, credit, counterparty and operational risk monitoring
Realizing Business Value
OTC regulatory compliance is not a box-checking exercise. It requires a change in operational workflows and systems integration. By engaging early in the planning and conduct of your compliance program, better synergies can be achieved with respect to system changes to deal with new market infrastructure.
A broad review of derivatives operations is essential. Ensuring that specialist swaps accounting capabilities are deployed to provide a robust post-trade operational environment is a beneficial baseline requirement. Firms must break down operational silos that prevent the timely and efficient exchange of information ensuring accurate valuations, including cash management, intraday margin management and collateral management. All data requirements, both new and old, must be captured at each transaction stage and stored intelligently for future uses such as counterparty risk management and dispute resolution.
Regulatory changes will make ever-increasing demands on financial institutions to accommodate new market infrastructure, forcing revisions to working practices. Whilst evaluating the regulatory response it makes sense to consider the end-to-end process flow to ensure efficient and scalable processing. There is an opportunity to use the need for regulatory compliance to improve current operating procedures and realize real business value.