By Tom Healey, TH Technology Partners
For clearing firms, market trends over the past two years have provided a “good news/bad news” story. The good news is, as screen-based trading of listed derivatives increases, the role of the clearing firm will become even more important than the exchange where the contract is executed.
Traders are more concerned now about the efficiency, cost and other services associated with clearing their trades than they are about the execution process. Additionally, non-traditional users of listed derivatives – investment managers and insurance companies – are turning to the exchange contract as a way to increase returns and manage risk. Both trends are contributing to higher trading volumes, which help the clearing banks increase their revenues while at the same time, charging lower fees.
Unfortunately, the bad news is that the clearing banks are finding that their clients are being very selective when choosing a new clearing firm. Investment managers and insurers especially, are looking for more than simple core processing. They now expect the clearer to offer an array of reporting and risk management services. On top of the competition to provide better services, the clearing firms are exposed to considerably more operational risk than they have in past.
One reason is that many of the top firms that started doing business with some of the early generation derivative systems have never replaced or upgraded their systems to more advanced technology. The second challenge that clearing firms face is that as trading volumes increase, the industry is moving towards shorter settlement cycles, making it necessary to process and confirm trades in near real-time.
Despite the introduction of the euro and extensive Y2K testing, the clearing firms believe that upgrading their clearing technology is a top priority and are willing to undertake new projects to begin the necessary upgrades.
Three Vendors Lead the Pack
Some clearing firms, particularly in Europe, are responding to these demands by trading in their old systems for new ones that have more robust functionality and are processing high volumes on fault-tolerant three tier architectures.
The top three vendors that most of the upper tier banks turn to for new systems are SunGard Futures; Rolf & Nolan; and Paris-based ATSM. SunGard with its three separate futures and options systems, GMI, Octagon and Devon, is by far the biggest of the three, holding at least 65% of the market share among the top tier firms.
Although Devon 2.22 was the original system chosen by most German banks, SunGard has not been able to retain all of these original customers, due mostly to customer dissatisfaction with service and support, although customers now report that they are much more satisfied with SunGard than in previous years. SunGard even managed to avoid a major public relations disaster when they first informed Devon users that they were not going to make the system Y2K compliant. SunGard retracted under customer pressure and made Devon fully Y2K compliant, but it was enough to make many customers look for a replacement system.
Rolf & Nolan offers two separate systems – RISC is targeted primarily at the US market and RANsys, which incorporates an extensive amount of functionality that is well suited for the European markets. Rolf & Nolan pulled itself out from under a number of problems including the failed attempt to sell the firm to SunGard. Rolf & Nolan has accelerated its investments in new functionality and improved service to the delight of many concerned clients.
Although ATSM could be called the newcomer, it actually has more than 60 clients in Europe and has been very successful in capturing market share from both SunGard and Rolf & Nolan. ATSM has one system called Ubix for exchange traded derivatives that has been designed using object-oriented technologies and high performance SUN servers.
All three of these systems have advanced capabilities to manage margin accounts using the Standard Portfolio Analysis of Risk (SPAN) method and other risk-adjusted techniques that the exchange and clearing firms require. They also handle automatic downloads from the exchanges of new contracts, corporate actions and updates to the margin arrays.
Fast and error free settlement processing requires high performance applications and straight-through processing (STP) capabilities. Each of these vendors are aggressively pursuing STP capabilities by linking their trade processing interfaces to all the global exchanges and brokers.
While there are other systems that process exchange-traded derivatives, one major difference is the breadth of market coverage that a vendor provides. All of the three vendors mentioned have working interfaces to almost any exchange, anywhere in the world. This capability is critical when a firm considers the time and expense of building and testing new interfaces.
To minimise overhead and maintenance costs, many firms choose to out-source facilities management to the vendor. Both SunGard and Rolf & Nolan offer complete facilities management and service bureau options for customers. This type of service is exactly what the banks need to reduce the operational tasks that do not add value to their core business.
Improving Service & Reducing Risk
Beyond the core processing capabilities, portfolio managers and traders have prioritised their requirements for selecting a clearing bank to include: risk management services; stable and knowledgeable staff; online reporting; and an expectation that the bank will be a leader in technology and process innovation. For these reasons, many banks are giving new impetus to technology projects that enhance and upgrade their settlement systems.
With the increase in trading volumes, operations managers are extremely concerned with the potential for systematic disturbances. For many firms, the daily trading and processing cycle is so tight that the window to complete confirmation, calculate margin and make payments, can be easily disrupted if a system outage occurs. Such disturbances can result in penalties and late fees against the firm. Equally important is the cost to the firm’s reputation.
Regulators have also had a hand in driving change. The regulators are trying to catch up to the market by instituting new policies that will require intra-day margin valuations and additional risk controls. Most of the systems that the firms are using today will not adequately handle the more advanced risk management functions that regulators are seeking.
Institutions that do not require the extensive array of functionality offered by SunGard, Rolf & Nolan and ATSM, can choose a more affordable option, although these systems may not provide the same product range and functionality. Companies such as ATIS, Cortex, Data Exchange, FNX and MIS Banking Systems, offer a lower cost alternative.
Although the US market, like Europe, is somewhat saturated with listed derivative systems, the market for such systems is likely to continue growing at an annual rate of 15%-25%. With economic stability and growth beginning to return to Asia, countries such as Japan, Singapore and Hong Kong are likely to provide the next growth opportunities.
Tom Healey is president of TH Technology Partners, a New York-based consulting firm that specialises in technology and operational consulting for financial institutions. TH Technology has a Web site at: www.thpartners.com and Mr. Healey can be reached at: email@example.com.