OTC Conversations Turn to Market Structure, Away from Tech

On the topic of over-the-counter (OTC) derivatives trading, conversations have shifted in nature over the last few months. For much of 2013, those conversations centered on readying IT architecture for the new regime. Collateral management, risk upgrades, credit checks, building swap execution facilities (SEFs), connecting to SEFs, connecting to clearing entities and swap data repositories—these were the primary topics of discussion.

Everyone wanted to know how to properly build out and how much progress their colleagues had made. Regulators were a wild card. They established deadlines for certain work to be completed, but those deadlines have enjoyed varying levels of flexibility depending on industry pressure. The possibility of deadline relief was a disincentive for firms, especially on the buy side, to commit to technology projects until they knew for certain what would be expected of them and when.

Those questions have faded away lately, replaced in the fourth quarter of 2013 and the first quarter of 2014 by questions about market structure. Where will liquidity puddle among the SEFs? Is the made-available-to-trade (MAT) rule being implemented properly? Will swap volumes fall, possibly to be replaced by swap futures?

"People are calmer about where they stand technology-wise, but the focus on market structure is a function of having to trade," said James Wallin, senior vice president at Alliance Bernstein. "It's a natural function of moving from the preparatory phase to executing on SEFs."

General Transition
As a reporter for a magazine that covers financial technology, I've found the transition stark, if not unfortunate. While I have no desire for the investment managers we cover to be scrambling or unprepared, it makes my job more fun when technology is in the news. You might say the OTC discussion has migrated from the Waters wheelhouse to the Risk one—Risk being our sibling publication covering derivatives and regulation, whose US reporters sit a few desks down from the Waters crew.

As a reporter for a magazine that covers financial technology, I've found the transition stark, if not unfortunate. While I have no desire for the investment managers we cover to be scrambling or unprepared, it makes my job more fun when technology is in the news.

I asked a panel of OTC experts to comment on this phenomenon during last week's webinar on "Assessing the Evolving OTC landscape." Did they agree with my observation, and if so, what accounts for it?

Nick Solinger, head of product strategy and chief marketing officer at derivatives processing platform provider Traiana, called it indicative of a general transitional period. Although firms are equipping themselves, he cautioned against assuming that they've finished their work. There is quite a bit left to do.

"It depends on what part of the market you're looking at," said Barry Smith, Equinix's managing director of global strategy and marketing development for capital markets. "When we look at the buy side, we've seen some of the sponsored access pick up, the introducing broker models. But I don't think we have a lot of empirical data at this point."

An audience poll shed some light on the subject. Of the 150-plus respondents, 35 percent said their investment firms had completed between half and three-quarters of their planned infrastructure build-out for the new trading regime. That was the largest group. An additional 27 percent have done better, completing at least three-quarters of their work. Only a handful of respondents admitted to finishing less than one-quarter.

These results suggest that the conversation has shifted because companies have genuinely made progress and had their questions answered. The completed infrastructure is likely that which is necessary for trading on SEFs, while the remaining portion involves functionality that will improve said trading but isn't mandatory, such as collateral optimization.

"It's clearly well on the way," said Solinger. "In the US, mandatory clearing kicked in for most firms in June of last year. So on the clearing and trade reporting side, people have had more than a year to adjust to those new processes and most of them are in place and working well. The place where readiness is probably on the lower end of the spectrum is around the last-minute clarifications and interpretive guidance communicated in the October, November time frame last year. Big segments of market have had big changes in rules. As late as a few weeks ago we got some relief from the Commodity Futures Trading Commission (CFTC) on how multi-leg trades or packages would be treated. All of those things keep people from ever being able to say they're 100 percent ready. You could get another clarification next week on how something is meant to work, or changes on how the SEF is handling things, or a new entrant in the market. All of those things have kept people on their toes."