Patrick Lastennet, Interxion’s Director of Marketing and Business Development, Financial Services, looks at the evolving derivatives market, and asks how firms can best manage the onset of digitised trading
The notional outstanding value of the over-the-counter (OTC) derivatives market now stands at $700tn as firms are showing a renewed appetite for dealing in structured products. However these products have been targeted with swathes of regulations, redefining the market by enforcing that these transactions take place electronically. So how will these regulatory changes affect trading firms, and how can they utilise data centres within their IT reforms?
The aim of creating a digital market is to remove opacity from the market, cited as a major contributor to high levels of systemic risk. Mandated by both the European Markets Infrastructure Regulation and Dodd-Frank, central clearing adds new market participants and increases collateral demands on trading firms. These collateral demands not only increase costs, but requires firms draw on more collateral to cover initial margin calls.
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The introduction of new Swap Execution Facilities (SEFs), clearing houses and market data providers now need to be connected into a trading firm’s network. With a variety of options for firms to connect to, securing the right partners is essential, so factors such as global distribution and capabilities for both OTC and Exchange traded products must be considered.
With so many simultaneous changes taking place, firms across the buy and sell-side are reviewing their technical capabilities if they wish to continue trading derivatives. Given the added complexity to processing derivatives in the new landscape, IT infrastructures are required to function in a cost-effective manner and provide access to a wide range of venues for optimal trading.
For savvy firms, implementing smart collateral management across the array of venues they connect to, could save them money and improve firm-wide risk management assessments.
IT overhauls are renowned for their cost and complexity. However, firms must be compliant in time for all upcoming deadlines. For some firms that have acknowledged the size and cost of the challenge they have taken steps to either outsource their trading technology demands. For example, UBS recently outsourced its fixed-income trading platform. The alternative for many has been to reduce operations with a possible long term view to pulling out of trading certain products.
Connect, cover, commune
For those who see value remaining in the derivatives market, they should take their lead from equities and spot FX markets. These more mature markets have harnessed the power of data centres making them the epicentre of trading activity. The use of a colocation data centre allows firms access to an infrastructure that provides the essential connectivity, coverage and community needed for quality trading.
All trading firms understand the importance of connectivity. Utilising a data centre that houses access points to key trading venues brings with it significant reductions in the cost and complexity of connecting to them. If a colocation centre also provides access to both OTC and Exchange traded derivatives as well as the host of new market participants, then traders can receive comprehensive market coverage all in one place.
London is the established industry community in Europe, earning its standing from providing access to a host of different derivatives market. Firms trading derivatives in London have direct access to the Liffe trading engine, London Metal Exchange, Singapore Exchange and NASDAQ OMX.
With this community in one place, firms gain the benefits of fast and low-cost interconnectivity. The move to electronic trading is a major reform for derivatives traders and with all of this expertise in one location, it provides a pool of knowledge which will support a business making the transition to a wholly electronic trading environment. One area that this is most prevalent is the outsourcing of crucial trading and risk management processes to be hosted in the cloud.
Look to the future
The manner in which regulators have targeted the OTC derivatives market has caused trading firms to undertake major short term IT reforms, with a view to providing long term benefits. Unable to rely on legacy systems that cannot perform the needed market functions or abide by new regulatory demands, firms must now look towards choosing appropriate connections and partners and lay the foundations for success in the new trading landscape.