Despite rising transaction volumes in the OTC derivatives markets, trade costs have remained stubbornly high, according to new survey data published by consultants Z/Yen Limited.
“Although average trade volumes for OTC derivatives have risen significantly, there has been little resulting reduction in the cost per trade,” says the report of the survey. “Much of the growth has come from manually intensive exotic or end-user trades and thus the banks’ own costs have risen significantly.
Z/Yen says 2005 saw significant volume growth in the interest rate, equity and credit derivatives markets. Overall trade volumes were up 46% for credit derivatives and 62% for equity derivatives, while costs per trade were up 1% in the former and down just 11% in the latter. Although trade volumes in the more-commoditised interest rate derivatives market only grew by 16%, in so-called exotic trades the average increase was 83% , yet costs actually increased by 7%.
These volume increases, together with the take up of cross-market industry utilities, should have led to significant reductions in the market average operations cost per trade, says Z/Yen. Yet:
* The Cost per Trade for a Credit Derivative increased from $218 to $221
* The Cost per Trade for an OTC Equity Option decreased from $152 to $135
* The Cost per Trade for an Interest Rate Derivative increased from $204 to $218
A number of factors have combined to negate expected cost reductions, says Z/Yen. These include the growth of “exotic” or structured trades, which require more manual intervention and are not readily supported by the banks’ main processing engines; the continued growth in end-user or “client” trades rather than “interbank”; increases increase in staffing costs as demand overwhelms supply for experienced operations staff; and the cost of compliance with regulatory programmes such as the Federal Reserve Board’s “Steady State” initiative.
“It is clear that the industry needs to look further at the automation of OTC Derivatives,” says Jeremy Smith, Z/Yen’s Director of Financial Services. “Although utilities such as DTCC, SwapClear and SwapsWire are gaining market share, there is still a disjointed approach and for many banks, increased volumes can only be taken on with large numbers of additional staff.”
The survey compared processing costs and volumes for 9 major banks for 10 product types and 15 operations & IT activities.