The search for greater capital and operational efficiency is one of the top areas of focus for the derivatives industry, according to a recent survey of industry professionals conducted by FIA and Coalition Greenwich.
That theme was echoed across all segments of the industry, including asset managers, hedge funds, and other users of derivatives as well as clearing firms, exchanges and technology vendors. When asked what the top issues facing the industry were, all segments flagged capital requirements, and many highlighted improvements in margin calculations and collateral management as key to further growth in the industry.
Following the financial crisis of 2008, banking supervisors worldwide increased the amount of capital that banks must hold for their trading businesses. This has impacted their ability to act as liquidity providers in derivatives markets as well as their ability to offer clearing services to their clients. US banking supervisors are now considering another round of increases in capital requirements, leading to increased concerns among clearing firms and end-users.
The focus on operational efficiency comes from a different source. When asked which parts of the trading and clearing workflow have the greatest need for modernization, respondents pointed mainly to back office and middle office functions. Although trade processing is already highly automated, the respondents pointed to certain areas where improvements would lead to greater efficiency. Clearing firms, executing brokers, and other intermediaries put allocations and give-ups near the top of their list, while end-users flagged collateral management and sourcing liquidity as areas in high need for modernization.
Looking out on the horizon, the survey asked what new operational or technological advances have the greatest potential to be a "game changer" for the trading and clearing workflow. Although a considerable number pointed to the adoption of GenAI, the next wave of artificial intelligence, the majority pointed to two other directions – the use of tokenization in collateral management and the development and adoption of global operational standards.
Tokenization, which refers to the conversion of cash or securities into digital tokens, has only just begun to be deployed in the financial services industry, but many believe that one of the best use cases will be in collateral management. Since the spike in market volatility in 2020, margin requirements on cleared derivatives have increased dramatically, and if some portion of the collateral can be transformed into tokens and moved more efficiently, the potential savings could be enormous. Among the survey respondents, it was the end-users who said they see tokenization as having the greatest potential to be a game changer.
The development and adoption of global operational standards point again to the importance of efficient processing of trades for this industry. In fact, when end-users were asked what is the strongest incentive to use central clearing, efficiency came out as the number one incentive, ahead of risk management, reduced margins, and transparency.
The processing of trades involves a complex ecosystem of exchanges, intermediaries and technology vendors, and the process can bog down when firms are using different product codes, operational processes, and messaging protocols. Moving towards greater standardization would speed up the process and give the industry more capacity to handle spikes in trading volume. Among the survey respondents, clearing firms and other intermediaries chose operational standardization as having the most potential to be a game changer for their workflow, and many flagged it as a top priority in their relationships with clearinghouses.
Regulatory change and geopolitical conflict are also among the top issues facing the industry, according to the survey. The respondents flagged the regulatory agenda in the US and Europe as the second most important issue facing the industry, and the potential for geopolitical conflict to cause market volatility as the third. Cyber risk also ranked among the top issues, especially among intermediaries and market infrastructure providers that were affected by recent ransomware attacks such as the ones involving the derivatives processing business of ION Group and the US bond trading arm of the Industrial and Commercial Bank of China.
Survey Methodology
The survey was conducted by Coalition Greenwich during the month of December. The survey was conducted on a confidential basis, and the names and company affiliations of the respondents were not disclosed. More than 200 people responded, with roughly half in the US and one quarter each in Europe and APAC. Eighty-seven respondents work at clearing firms, executing brokers and other intermediaries. Fifty respondents work at asset managers, hedge funds, pension funds, insurance companies, and other firms that use derivatives for risk management or investment purposes. Seventy-three respondents work in other segments of the industry, primarily infrastructure providers such as exchanges and clearinghouses and service providers such as tech vendors.
