Building an efficient and automated operations workflow focused on optimizing business processes.
In the last blog we discussed why firms trading OTC derivatives need to focus on post-trade data and how firms can position themselves for the challenging times ahead. In this article we will provide details of how firms can address those challenges, specifically the need for building an efficient and automated post-trade derivatives operations workflow.
The investment Management operations workflow can be understood at the highest level by breaking it down into three key parts i.e. Front Office, Middle office and the Back office operations. The next level break-down by the business processes can be as follows Pre-Trade, Trade Execution, Trade Affirmation/Clearing and the Post-Trade processes.
Within the Post-trade process we can have distinct sub-processes i.e. Trade Management, Position Management, Reference Data, Market Data, Cash, Collateral, Reconciliation, Reporting, Analytics (Performance & Risk), Accounting & Settlement.
A graphical illustration of this is more helpful in visualizing the view from the high-level operations to the detail business process view as in figure below.
|A key question one would ask at this point is – How did we arrive at this set of business processes?
One of the ways is by reviewing the life-cycle of instruments across various asset classes and the standards such as FpML (for derivatives) that was created by market participants and industry bodies such as ISDA.
Note that even though we are describing the post-trade view from a derivatives stand-point the above process details are still applicable for all financial instruments including mature products such as Equities and Bonds.
A key characteristic of the business processes defined as above is to not only allow for independent workflows for each of the processes but also to ensure that the processes themselves have minimal dependency on each other. This is important as it provides for changes to business processes more easily when necessary thus allowing firms to adapt to changing business needs including implementing the evolving regulations and/or adoption of newer technology. In addition, such granular break-down of the business processes will provide for easier fine tuning of workflows within each processes thus making the operations workflow at the highest level more efficient and automated.
Let us take a few example business processes to illustrate the above need –
a. Reference Data Management – In this process there is a growing need for the ability to access multiple data sources without getting tied to specific external data providers and their semantics/content elements. One way to make this process independent of data sources is to first create a common meta-data framework for reference data based on standards such as FpML for derivative instruments. Once this is complete it is easier to interface with external reference data sources i.e. by mapping required elements from the external source to the corresponding meta-data elements.
b. Margin/Collateral Management – Having a good grip on your post trade positions will open the door for more efficient posting of collateral in the future. Many traditional firms have no collateral systems, at least that are up-to-date with what will be required real-time. The Initial Margin(IM) module is an example in this process that is undergoing business changes specifically the regulatory changes around margin requirements for swaps. Although regulations are mandated for margins of cleared swaps for sometime now in the US (and now in Europe) the margin for uncleared swaps is still in flux and is getting finalized soon. Given this uncertainty one way to make progress towards meeting the needs is to start work on building a IM framework now that allows for integrating both cleared/uncleared swap calculations without a big redo when rules are more clear. This standardized IM framework should be defined to take in required inputs(i.e. Position/Reference/Market data) and outputs (say margin results by currency/counter party) for the IM calculations. Spending time now to finalize this interface will provide the ability in the future to plugin external/internal IM calculators that meet the regulatory needs when timelines are finalized.
The firms trading derivatives continue to face common challenges such as rising costs of regulatory compliance, growing trend towards passive investments, lower volumes of OTC trading and a very low interest rate environment. Also growing operational costs continue to add to firms woes – A recent BCG report mentions that the middle and back office costs at some firms constitute nearly 30% of total costs. These firms therefore need to act now and work on re-engineering their business processes in order to remain truly competitive and to stay in the business for the long term.
Adopting the above approach to define operations workflow and the business processes will make firms more effective when beginning the implementation process to ensure compliance with evolving global regulations without the need for radical changes to new cumbersome systems which will only increase the expenses. In addition, focused optimization of business processes one step at a time will not only keep the costs of adherence down but also allow for greater choices in the investment process itself as new products become less onerous to trade (for example- VaR will eventually come down on such products like swaptions – making hedging cheaper and safer to trade).
In the next part we will review how firms can go about ‘Enabling transparency and automation for life-cycle management and processing of OTC and Cleared derivatives’.