OTC Derivatives Face Rocky Road

Terry Flanagan

OTC derivatives had a bumpy ride in 2013, and users can expect more of the same this year as regulations enacted under the Dodd-Frank and Emir legislations kick in.

“Regulatory readiness took center stage in the derivative markets,” said Sean Owens, director of fixed income and derivatives at Woodbine Associates. “Most of the key Title VII rules were finalized, requiring implementation throughout the year. Trade reporting and mandatory central clearing began early in the year for dealers and was phased in for other participants. Many firms found themselves unprepared for the operational challenges and shortfalls they suddenly faced thanks to their existing technology and infrastructure.”

Woodbine’s research has focused on navigating these changes, establishing regulatory readiness and positioning for success in the new derivatives market structure.

In its OTC Derivatives Readiness Guide, Woodbine examined the business and regulatory requirements for asset managers, hedge funds and other end users. It detailed the key business, operational and technology requirements firms face and provided a road map to establish relationships and prepare operational infrastructure to function optimally within the new framework.

Late in 2013 the SEF rules were finalized. “This is the last major piece of Title VII regulation affecting execution and will significantly impact the swap and futures markets when the trading mandate begins in 2014,” Owens said. “As former traders, we understand the practical steps firms must take to meet the new challenges the SEF rules will bring to the derivative execution space. We provided an early view in our opinion piece Interest Rate Swap Futures: Finally the Right Time and will continue our focus on execution and risk transfer landscape issues in 2014.”

Woodbine has also focused on post-trade processing and the new challenges introduced with central clearing for firms managing collateral. Its report Collateral Management: Business Requirements and Vendor Systems addressed how organizations can respond to the challenges of central clearing and higher margin requirements.

Research firm Celent has highlighted the growing importance of portfolio reconciliation and how firms are trying to make the best of what has been an operationally challenging few years.

Automating reconciliation is crucial for firms of all sizes because it allows them to obtain a better overview of the trading function, Celent said in a report.

Regulation has been a driver, as has legacy platform rationalization, with firms relying on automation and streamlining of their reconciliation platforms. Having a number of legacy platforms across the trading function makes it difficult for firms to run their compliance optimally. Finally, in a tough economic environment, cost minimization is becoming a mantra across the board.

“Trading volumes in derivatives have been relatively high, and the gross credit exposure for OTC derivatives has shown growth in 2013,” said Anshuman Jaswal, senior analyst with Celent’s securities and investments group and author of the report. “Hence it was important to improve portfolio reconciliation in a way that benefits operational capabilities in the derivatives markets, and this seems to have been the case.”

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