Craig Talbot, Global Head Trading & Connectivity at Hatstand
Recent years have seen unprecedented changes to the technical infrastructure of financial institutions. Many of these changes have been driven by regulatory mandates drawn up in response to the financial crisis of 2007/8. As the Global Systematically Important Banks (G-SIBs) battle to comply with the January 2016 deadline of the Basel III Directive BCBS239, it is interesting to reflect on how many of them have had the time or the appetite to review whether the early implementations and changes made to their systems are fit for business.
With falling revenues, fewer clients and changes in market behaviours, those banks who have regularly reviewed their business strategy with mindful consideration of their accumulated technology debt, will be ahead of the competition once the regulatory dust settles.
After the Global Financial Crisis of 2007/8 it became apparent that the risk exposure data that banks relied on to make decisions was compromised; the data was inaccurate. The banks did not have the technology in place to aggregate and report such data quickly. Each bank subsequently reviewed how data was collected, managed and reported. This was followed by a series of internal projects to aggregate the data, fill in the missing gaps and report the risk exposure.
There is no doubt that huge business and technical efforts have been made to strengthen the banks’ risk data aggregation capabilities and internal risk reporting practices. However, in January 2015 the Basel Committee on Banking Supervision published its progress report showing that nearly half of the 31 G-SIBs said they would not be fully compliant by the January 2016 deadline, being unable to comply with at least one of the 14 Principles of BCBS239.
Furthermore, the banks have reported their reliance in part on manual workarounds to achieve their existing level of compliance. In the early days of aggregating risk data, it is understandable why manual workarounds or bespoke conversions were implemented. The lack of a company-wide governance policy for trading systems in general has resulted in a diverse landscape of gateway connections for trading and market data, protocols, vendors and standards across different departments linked to trading activities or asset classes.
Given the diverse, disparate and decentralised starting point from which banks have been building their compliant risk systems, it is unsurprising that they have been accumulating considerable technology debt. Technology debt in this context is the accumulation of outdated systems still in use or where the original reasons for implementation have changed and the product is no longer fit for purpose. It could be software code itself or the inappropriate or outdated use of workarounds implemented around and including trading technology applications.
Repayment of this debt can be the overall cost of replacing outdated or inappropriately used systems, the price of which would increase the longer it is left. It can also be the direct financial losses incurred as a result of system mistakes, trading and reporting errors, as well as fines. Furthermore, debt can be paid in client perception and reputational loss as well as lost opportunities due to excessive rigidity.
Tactical mitigation and manual workarounds cannot always be avoided when core components are deeply embedded and cannot easily be changed. Technical managers are aware of the limitations of each workaround but there must be a clear way to quantify each and every one when communicating to the business sponsors. Part of the business development strategy must include future operational risk visibility incorporating the accumulation of technology and process debt. This debt could be very costly and damaging to the business in the future.
Revolution not Evolution
The post 2007/8 financial crisis regulatory changes have applied a form of evolutionary pressure on the banks. Their response has been to make small changes to the organism with adaptations of the existing technical infrastructure in order to survive in the new environment.
Like evolution, the regulatory changes are indiscriminate. This will result ultimately in some banks evolving into dominant species. Other banks may become extinct – at least in some areas of business. Some banks, perhaps the ones with smaller and simpler systems, may realise that building workarounds or bespoke patches for old legacy systems in small evolutionary steps would ultimately accumulate an unacceptably high level of technology debt.
A strategic vision is needed to take fewer and bolder revolutionary steps that accumulate less technology debt to leave systems robust, flexible and reliable. The systems are then better able to cope with any future regulatory, business and technical pressures.
Realising where in the complex trading infrastructure the revolutionary change points are is a challenge. Focusing on reducing the system complexity and increasing centralisation is key to uncovering them.
Much effort has been made to identify the many touch points within trading systems from where to collect the relevant pre-trade and post- trade risk data. This can come from multiple single market trading servers and their risk control modules. Data can also come in different formats and from decentralised and regional locations. The pre-trade risk modules that feed their data into aggregated databases sit side-by-side or in-line with the order-entry application server, meaning each one is blissfully unaware of the trading activities of the other markets. Some vendors or internally-built trading systems can support a truly globalised real-time order book. However, implementing such an infrastructure in the past would have been unnecessarily expensive, added unacceptable latency and would have lacked the governance practices to control it.
When reviewing risk architecture for compliance, the focus has been on data collection and reporting. A tactical rather than strategic approach was initially taken, doing what was required to tick the regulatory boxes. As compliance education within financial institutions matures, a need has arisen to review the technology that controls risk at the execution gateways. It is important to gauge how fit for purpose it is now and in the future and how much of this technology is good enough, and will not result in unacceptable levels of technology debt.
None of the 14 principles of BCBS239 cover automatically adjusting trading risk monitoring tools in real time. They do focus on risk reporting. As more time is spent looking at risk systems and exposure, the next logical step would be to automate risk sentinel parameters. These risk sentinels are the trading risk modules that have the power to stop trades if limit thresholds have been breached.
With more centralisation and a desire for simplification, banks will look to implement ‘smart’ risk sentinels, to replace the outdated, siloed and localised ‘dumb’ risk sentinels that only know their market in isolation and can only take modified limit instructions from human controlled administration screens. While some trading risk modules have open Application Protocol Interfaces (APIs) or can read global order book databases, there are historical reasons why the technology has not matured or been implemented. Reasons can include cost, practical re- architecting, governance and latency issues.
With the wealth of risk data now available and better governance across trading systems, the ability to automate trade risk modules in real-time across multiple exchanges and currencies is now possible. The alternative is to keep relying on high touch and slow human interventions.
There is no doubt that once the regulatory dust settles, the sheer volume of data available to analysts and sponsors will be unrecognisable in comparison with 5 years ago. Just how useful this data is in helping each business make informed decisions will depend on the chosen method adopted when building the data management systems. Those that adopted the revolutionary or centralised methodology will be much better placed then those burdened with the evolutionary decentralised approach.
Creating a robust and centralised data aggregation facility is essential to identify risk exposure. However, it can also be used to gather trade lifecycle data, client connection and trading behaviour data in addition to risk data. Together this can all help to develop a clear strategy.
Robust quality assurance processes in data collection and centralised governance on standardisation and data protocols will help to reveal previous risk patterns and allow early alerts to be flagged when fledgling patterns emerge. This will provide business decision makers with a new tool to review and assess the trading practices of each client and desk.
Changing market conditions have also brought to the surface the need to know at a granular level who is trading what and how often and, equally important, how much each type of instrument costs to service in respect of market fees together with database and infrastructure hosting. Banks will have already have done some divesting to drive down capital costs. To have a clear picture of what each client does, how they trade and how profitable each market, segment and instrument are could result in ‘trimming off the fat.’ Decisions on which clients to drop and indeed which instrument, markets or segments to also drop or invest in would rely in part on the business intelligence collected.
A strong, symbiotic relationship between business and technical strategies is key when embarking on a programme to identify revolutionary change points in what could already be a highly developed and evolved technical architecture. A strong understanding of the already accumulated technology debt is needed together with a clear appreciation of how this will cripple further progress and apply excessive rigidity to the systems. Principle 6 of BCBS239 states that risk systems should be adaptable. Manual workarounds built on decentralised systems cannot truly be described as flexible and adaptive.
Nobody knows when the tide of regulatory pressures will ease but it will be the banks with the clearest, most progressive strategies built on the solid foundations of simplified, centralised systems and governance with minimal technology debt that will be ahead of the competition.
Oil extends losses as Texas prepares to ramp up output
By Devika Krishna Kumar
NEW YORK (Reuters) – Oil prices fell for a second day on Friday, retreating further from recent highs as Texas energy companies began preparations to restart oil and gas fields shuttered by freezing weather.
Brent crude futures were down 33 cents, or 0.5%, at $63.60 a barrel by 11:06 a.m. (1606 GMT) U.S. West Texas Intermediate (WTI) crude futures fell 60 cents, or 1%, to $59.92.
This week, both benchmarks had climbed to the highest in more than a year.
“Price pullback thus far appears corrective and is slight within the context of this month’s major upside price acceleration,” said Jim Ritterbusch, president of Ritterbusch and Associates.
Unusually cold weather in Texas and the Plains states curtailed up to 4 million barrels per day (bpd) of crude production and 21 billion cubic feet of natural gas, analysts estimated.
Texas refiners halted about a fifth of the nation’s oil processing amid power outages and severe cold.
Companies were expected to prepare for production restarts on Friday as electric power and water services slowly resume, sources said.
“While much of the selling relates to a gradual resumption of power in the Gulf coast region ahead of a significant temperature warmup, the magnitude of this week’s loss of supply may require further discounting given much uncertainty regarding the extent and possible duration of lost output,” Ritterbusch said.
Oil fell despite a surprise drop in U.S. crude stockpiles in the week to Feb. 12, before the big freeze. Inventories fell by 7.3 million barrels to 461.8 million barrels, their lowest since March, the Energy Information Administration reported on Thursday. [EIA/S]
The United States on Thursday said it was ready to talk to Iran about returning to a 2015 agreement that aimed to prevent Tehran from acquiring nuclear weapons. Still, analysts did not expect near-term reversal of sanctions on Iran that were imposed by the previous U.S. administration.
“This breakthrough increases the probability that we may see Iran returning to the oil market soon, although there is much to be discussed and a new deal will not be a carbon-copy of the 2015 nuclear deal,” said StoneX analyst Kevin Solomon.
(Additional reporting by Ahmad Ghaddar in London and Roslan Khasawneh in Singapore and Sonali Paul in Melbourne; Editing by Jason Neely, David Goodman and David Gregorio)
Analysis: Carmakers wake up to new pecking order as chip crunch intensifies
By Douglas Busvine and Christoph Steitz
BERLIN (Reuters) – The semiconductor crunch that has battered the auto sector leaves carmakers with a stark choice: pay up, stock up or risk getting stuck on the sidelines as chipmakers focus on more lucrative business elsewhere.
Car manufacturers including Volkswagen, Ford and General Motors have cut output as the chip market was swept clean by makers of consumer electronics such as smartphones – the chip industry’s preferred customers because they buy more advanced, higher-margin chips.
The semiconductor shortage – over $800 worth of silicon is packed into a modern electric vehicle – has exposed the disconnect between an auto industry spoilt by decades of just-in-time deliveries and an electronics industry supply chain it can no longer bend to its will.
“The car sector has been used to the fact that the whole supply chain is centred around cars,” said McKinsey partner Ondrej Burkacky. “What has been overlooked is that semiconductor makers actually do have an alternative.”
Automakers are responding to the shortage by lobbying governments to subsidize the construction of more chip-making capacity.
In Germany, Volkswagen has pointed the finger at suppliers, saying it gave them timely warning last April – when much global car production was idled due to the coronavirus pandemic – that it expected demand to recover strongly in the second half of the year.
That complaint by the world’s No.2 volume carmaker cuts little ice with chipmakers, who say the auto industry is both quick to cancel orders in a slump and to demand investment in new production in a recovery.
“Last year we had to furlough staff and bear the cost of carrying idle capacity,” said a source at one European semiconductor maker, who spoke on condition of anonymity.
“If the carmakers are asking us to invest in new capacity, can they please tell us who will pay for that idle capacity in the next downturn?”
The auto industry spends around $40 billion a year on chips – about a tenth of the global market. By comparison, Apple spends more on chips just to make its iPhones, Mirabaud tech analyst Neil Campling reckons.
Moreover, the chips used in cars tend to be basic products such as micro controllers made under contract at older foundries – hardly the leading-edge production technology in which chipmakers would be willing to invest.
“The suppliers are saying: ‘If we continue to produce this stuff there is nowhere else for it to go. Sony isn’t going to use it for a Playstation 5 or Apple for its next iPhone’,” said Asif Anwar at Strategy Analytics.
Chipmakers were surprised by the panicked reaction of the German car industry, which persuaded Economy Minister Peter Altmaier to write a letter in January to his counterpart in Taiwan to ask its semiconductor makers to supply more chips.
No extra supplies were forthcoming, with one German industry source joking that the Americans stood a better chance of getting more chips from Taiwan because they could at least park an aircraft carrier off the coast – referring to the ability of the United States to project power in Asia.
Closer to home, a source at another European chipmaker expressed disbelief at the poor understanding at one carmaker of how it operates.
“We got a call from one auto maker that was desperate for supply. They said: Why don’t you run a night shift to increase production?” this person said.
“What they didn’t understand is that we have been running a night shift since the beginning.”
NO QUICK FIX
While Infineon, the leading supplier of chips to the global auto industry, and Robert Bosch, the top ‘Tier 1’ parts supplier, both plan to commission new chip plants this year, there is little chance of supply shortages easing soon.
Specialist chipmakers like Infineon outsource some production of automotive chips to contract manufacturers led by Taiwan Semiconductor Manufacturing Co Ltd (TSMC), but the Asian foundries are currently prioritising high-end electronics makers as they come up against capacity constraints.
Over the longer term, the relationship between chip makers and the car industry will become closer as electric vehicles are more widely adopted and features such as assisted and autonomous driving develop, requiring more advanced chips.
But, in the short term, there is no quick fix for the lack of chip supply: IHS Markit estimates that the time it takes to deliver a microcontroller has doubled to 26 weeks and shortages will only bottom out in March.
That puts the production of 1 million light vehicles at risk in the first quarter, says IHS Markit. European chip industry executives and analysts agree that supply will not catch up with demand until later in the year.
Chip shortages are having a “snowball effect” as auto makers idle some capacity to prioritize building profitable models, said Anwar at Strategy Analytics, who forecasts a drop in car production in Europe and North America of 5%-10% in 2021.
The head of Franco-Italian chipmaker STMicroelectronics, Jean-Marc Chery, forecasts capacity constraints will affect carmakers until mid-year.
“Up to the end of the second quarter, the industry will have to manage at the lean inventory level,” Chery told a recent Goldman Sachs conference.
(Douglas Busvine from Berlin and Christoph Steitz from Frankfurt; Additional reporting by Mathieu Rosemain and Gilles Gillaume in Paris; Editing by Susan Fenton)
Aussie and sterling hit multi-year highs on recovery bets
By Tommy Wilkes
LONDON (Reuters) – The Australian dollar rose to near a three-year high and the British pound scaled $1.40 for the first time since 2018 on optimism about economic rebounds in the two countries and after the U.S. dollar was knocked by disappointing jobs data.
The U.S. currency had been rising in recent days as a jump in Treasury yields on the back of the so-called reflation trade drew investors. But an unexpected increase in U.S. weekly jobless claims soured the economic outlook and sent the dollar lower overnight.
On Friday it traded down 0.3% against a basket of currencies, with the dollar index at 90.309.
The Aussie rose 0.8% to $0.784, its highest since March 2018. The currency, which is closely linked to commodity prices and the outlook for global growth, has been helped by a recent rally in commodity prices.
The New Zealand dollar also gained, and was not far off a more than two-year high, while the Canadian dollar rose too.
Sterling rose to $1.4009 on Friday, an almost three-year high amid Britain’s aggressive vaccination programme.
Given the size of Britain’s vital services sector, analysts say the faster it can reopen the economy, the better for the currency. Sterling was also helped by better-than-expected purchasing managers index flash survey data for February.
The U.S. dollar has been weighed down by a string of soft labour data, even as other indicators have shown resilience, and as President Joe Biden’s pandemic relief efforts take shape, including a proposed $1.9 trillion spending package.
Despite the recent rise in U.S. yields, many analysts think they won’t climb too much higher, limiting the benefit for the dollar.
“Our view remains that the Fed will hold the line and remain very cautious about tapering asset purchases. We think it will keep communicating that tightening is very far off, which should dampen pro-dollar sentiment,” said UBS Global Wealth Management strategist Gaétan Peroux and analyst Tilmann Kolb.
ING analysts said “the rise in rates will be self-regulating, meaning the dollar need not correct too much higher”.
They see the greenback index trading down to the 90.10 to 91.05 range.
The euro rose 0.4% to $1.2134. The single currency showed little reaction to purchasing manager index data, which showed a slowdown in business activity in February. However, factories had their busiest month in three years, buoying sentiment.
The dollar bought 105.39 yen, down 0.3% and a continued retreat from the five-month high of 106.225 reached Wednesday.
(Editing by Hugh Lawson and Pravin Char)
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