At the FIA International Derivatives Expo 2019 in London last week, there was much discussion on the challenges and opportunities facing exchanges and clearing houses, and the types of technology investments they might need to make over coming years. As a software house working with clients in this space, we at Sinara take a close interest in these developments, in which we expect to be contributing both in 2019 and beyond.
Always looking at opportunities to expand their business, clearing houses are experimenting with new types of access models (e.g. sponsored access) which will allow more firms to access clearing services, particularly from the buy side. Not all financial products necessarily need to be cleared, but it is of course in the interest of clearing houses to broaden the scope of their offerings, e.g. FX and fixed income. In some cases, there is still doubt on the part of buy side firms as to whether it is worth clearing at all, as opposed to simple bilateral settlement. Higher costs relative to the investments themselves are one issue. Furthermore, in the case of a default, the task of closing positions falls to the clearing house and is out of the hands of the investor; the closing out may not happen according to the preferred timing of the investor, potentially leaving them at a disadvantage.
This whole area of default management, i.e. what happens when a clearing member defaults, is an area of increased regulator interest, particularly after the recent incident at Nasdaq Clearing. Both national regulators and central banks are looking to have a stronger role in oversight of the clearing process. Clearing houses themselves are looking to improve their procedures and find ways to make the default management process more transparent and accountable. One big part of this is how positions from a defaulted member are transferred, or ‘ported’ to other members, e.g. via an auction process. The issue of “skin in the game” was brought up, i.e. the amount of capital a clearing house itself puts into the default fund versus the amount of risk that clearing members take on.
After many years of working to reduce latency and facilitate high frequency algo trading, exchanges are now looking at ways of slowing down some market access in order to provide a fairer playing field. Such a “speed bump” would probably be applied in a so-called asymmetric manner, i.e. market makers would not be slowed down whilst, for example, HFT traders might have a penalty applied. Currently, Eurex and ICE are conducting trials on a small number of instruments, and it remains to be seen how it might be implemented in the longer term and what regulators might require.
A large part of Sinara’s work is in commodities trading applications, and so we take a particular interest in developments in this area. Pre-trade transparency is another area where regulators are taking a keener interest, and looking for exchanges to offer solutions. It was pointed out that these solutions have to be suitable for each market, particularly for commodities, which often have many nuances.
Exchanges, clearers and financial firms in general have much more data to work with, mainly thanks to the increased demands of regulations such as MiFID II. AI and machine learning have certainly been buzzwords over the recent year or two, but there is genuine interest in finding ways of getting value out of these massive data sets (or ‘data lakes’). Financial firms are becoming increasingly comfortable with using cloud services such as AWS or Azure, which provide the infrastructure to store and manage these data sets as well as the compute power to more cheaply run complex algorithms. For example, if an investment house wants to build a new algo, an AI tool could potentially run different scenarios using historical data and iteratively build up a trading strategy.
With such algorithms and systems at all financial firms becoming ever more complex, the need for automated testing becomes ever more crucial. This is an area we have been investing in heavily at Sinara over recent years, improving both our internal toolset as well as developing automated testing tools which our clients can use to validate new deployments.
In looking to increase automation in general, it was observed that applying automation to what is already an inefficient operation often just magnifies the inefficiency! Rather than attempting to replicate an existing process, firms should take the opportunity to analyse their current business processes and see how digital transformation can offer the chance to do something better.
Investing in customer service
Firms across the trade lifecycle are also looking at ways they can improve their day-to-day service offerings to their clients. While technology can be a key differentiator, firms realise that investing in effective customer service provision can be hugely significant in maintaining business over the long term. This is certainly something we have known for a long time at Sinara, and we continue to invest in our in-house support team and resources. Exchanges and clearers are also looking to bring in technology that will assist their teams to service clients in an efficient way, e.g. with dashboards showing algo activity or robo advisors giving clients the choice of speeding up or slowing down trading in volatile market conditions.
It isn’t possible to write about one of these conferences without mention of blockchain. However, discussion of this was more muted this time, perhaps with recognition that the technology is yet to mature fully and it may be some time before significant benefits can be found. Whilst there is still some scepticism about blockchain/DLT, the broad consensus is that there is long term potential.
With exchanges and brokers also looking to invest in a new generation of trading platforms and improve their processes of trade capture and end-to-end data flows, Sinara look forward to bringing our development skills and frameworks to these exciting projects.