By John Avery, director, client and industry engagement, the FIS Derivatives Utility
John Avery of FIS takes a closer look at the critical role that derivatives operations and technology play in the self-clearing process, the options available, and the one model likely to offer the least amount of effort, risk and cost to firms making the move to self-clearing.
It’s no secret that derivatives end users – from commodities firms to banks and asset managers – are all actively exploring self-clearing directly with central counterparties (CCPs). In most cases, because of continued capital and profitability pressure on clearing brokers, these end user firms have no choice other than to self-clear to gain better control of costs, capital and clearing risk.
But the decision to self-clear is not easy and should not be taken lightly nor analyzed or executed alone. Firms must look to vendors and partners to help them with a variety of services required for self-clearing, from compliance and legal services to project implementation. When it comes to operations and technology in particular, the resources and technology required for firms to comply with the operational responsibilities to clear their own trades must be carefully evaluated and understood.
Operations and technology play a critical role in self-clearing
A significant part of the decision to self-clear requires a close look at the operations and technology staff and infrastructure needed to support the additional commitments imposed by a direct relationship with the clearinghouses.
Key operational responsibilities include clearing and trade lifecycle management, margin and brokerage processing, and reference data management and reconciliation. Successful execution of these functions ensures that reporting to internal stakeholders and the clearinghouses is timely and accurate. A typical self-clearing processing environment requires:
- Integration with the trading platforms the firm uses for straight-through processing (STP) between front-office, exchange, and clearing systems.
- Connectivity to the clearinghouses for real-time, middle-office matching and clearing.
- Back-office processing of trades and positions, to capture all lifecycle events, maintain accurate books and records for accounting and deliver timely and accurate reports.
- End-to-end reconciliation activities, to ensure there is one version of the “truth” across the exchanges, clearinghouses, brokers and internal books and records and to ensure that margin calls and cash management transactions are accurately executed.
The technology required to support a self-clearing operation includes software applications and technology infrastructure that are configured, maintained and delivered securely, reliably and with sufficient capacity to support the operation. These technology requirements also evolve over time and firms must continually invest in projects to comply with market and regulatory changes and technology upgrades.
Firms investigating the self-clearing model have four options for operations and technology support:
- In-house operations staff and technology – Requires significant capital investment and onboarding effort of staff, applications, and infrastructure, plus the ongoing cost of maintaining these to comply with new market and regulatory requirements.
- In-house operations staff and vendor managed technology – Requires significant effort in onboarding staff and maintaining expertise, but leverages a vendor to support the technology applications and infrastructure.
- Vendor managed operations and technology – An option where the vendor is responsible for nearly all self-clearing operations and technology requirements, limiting the risk, effort and cost of building out a team, maintaining the clearing expertise and complying with ongoing market and regulatory changes.
For firms exploring self-clearing, the vendor managed operations and technology option is optimal since it provides immediate access to the capabilities a firm must have for self-clearing, but in a flexible, scalable and lower-cost mode delivered by a vendor.
Benefits of the mutualized utility model for operations and technology
Operations and technology utilities are creating a paradigm shift to drive significant scale efficiencies in the derivatives clearing industry by mutualizing common, non-differentiating derivatives processing functions across firms – the same processing required for self-clearing. As a result, utilities can deliver a unified solution to self-clearing firms so these firms can focus on risk management and capital optimization instead of maintaining an operations and technology team and infrastructure.
By providing immediate access to existing clearing capabilities and resources used to support other similar clearing firms, the utility model offers reduced risk, effort and cost for self-clearing firms – eliminating the need for large onboarding and maintenance projects that can increase risk and distract firms from focusing on their core business. Self-clearing firms also benefit from the global focus of utility services to provides faster access to new markets that may be required to support future business growth and expansion of self-clearing relationships with additional clearinghouses.
The best utilities use industry-standard market-leading clearing technology platforms and have operations built on top of this technology. These market leading utilities deliver their service using transparent and proven interaction model for self-clearing clients, and are managed through a formal governance structure that ensures self-clearing firms can continue to focus on their core business activities.
For any business assessing the opportunities and challenges of the move to self-clearing, operations and technology is a crucial part of the business model and the migration. For the first time ever, these businesses can access the technology and operations support they need through a turnkey solution from a single vendor – making it easier than ever before to rely on a vendor to manage people, processes, controls, technology, and ongoing compliance with market and regulatory changes.