London’s fintech sector targets the derivatives industry
Four examples of how technology vendors are bringing innovative solutions for financial services firms wrestling with cost pressures, legacy systems and new regulatory requirements.
FACING A RAFT of new regulatory requirements and pressures on their profitability, banks and brokers are looking for more cost-effective ways to meet their operational needs. That is creating new opportunities for outside service providers to offer solutions for a range of front-office and back-office services.
Clearing firms have long relied on outside vendors for certain functions, but in recent years a wave of new firms has emerged with innovative solutions. Many of these start-ups are tapping into a surge of venture capital investment in financial technology. According to an Accenture report released in March, global investment in financial technology ventures tripled to $12.21 billion in 2014.
London is a major center for this activity. According to Accenture, $623 million was invested in fintech ventures in the U.K. and Ireland in 2014, twice as much as anywhere else in Europe. While most fintech ventures are aimed on the consumer side of finance, offering services in areas such as mobile banking and peer-to-peer lending, several U.K. start-ups are looking to leverage London’s importance as a global hub for capital markets.
This trend is beginning to impact banks and brokers in the derivatives clearing business. Global clearing firms are confronting burdensome new capital requirements and are coming under “extreme cost pressure,” commented John Avery, head of managed services solutions in the Americas for SunGard. “They want a way to reduce operational and technology costs in order to claw back discretionary funds so that they can invest in innovation.”
Matching and Reconciliation
One of the biggest challenges faced by clearing firms in electronic exchange-traded markets is the need to match a huge number of trades in real-time to make sure the details are accurate. London-based Duco addresses this need through a platform built on the latest web technologies. The company was founded in 2010 by Christian Nentwich, who graduated from University College London in 2004 with a Ph.D. in Computer Science. Duco, his second technology venture, retains strong connections to the university and also has attracted venture capital investment from ICAP.
Duco provides the ‘Duco Cube’, an online reconciliation platform designed to use statistical analysis in order to match hundreds of thousands of trades within seconds. In the futures industry where a lot of manual work still exists in the back office, a self-service model of reconciliation with no requirement to install software offers relief from additional workload at a time when the strain is showing.
The platform is data agnostic, so users can load data for any asset class, from futures and options to cash trades. Having launched in April 2013 it went live with its first customer in January 2014 and since then has acquired another 20 with five more expected on board shortly.
“We have five to six hedge fund clients who use us to reconcile with their prime brokers,” said Nentwich. “We have several service providers to the buy and sell side. We have eight futures brokers including R.J. O’Brien, INTL FCStone and China Merchant Securities. For those firms we enable them to operate more efficiently without doing any manual work. Then we have got a few banks where the reconciliation challenge is much more global and much more widespread throughout different parts of the organisation.”
Other fintech innovators are reaching out to buy-side and sell-side firms struggling with the management and optimization of collateral that is needed to underpin derivatives trades.
Collateral Management
Other fintech innovators are reaching out to buy-side and sell-side firms struggling with the management and optimisation of collateral that is needed to underpin derivatives trades. Several dynamics, including the increasing illiquidity of bond markets, unsteady sovereign credit ratings and interest rate movements, will affect the eligibility of certain fixed income instruments under the different rules offered by different CCPs at any given point in time. Consequently firms have to come to grips with which instruments they have available to post as margin. That requires a single view of data within different business lines identifying what is tradable, what has been pledged and what can be posted.
When Xavier Bellouard, Georges Bory, Kathy Perrotte and Allen Whipple—all four veterans of U.S. cross-asset trading platform provider Summit Systems—realised the potential that in-memory processing held for capital market firms facing a wall of data, they teamed up with Jean Safar, then a director at grid computing pioneer Datasynapse, and formed Quartet FS in 2005. The London-based firm tackles the big data challenge primarily for sell-side and very large buy-side firms. It offers an in-memory real-time analytical platform called ActivePivot that can sit on top of existing data sources in a firm and offer multi-dimensional views of the information they contain. Consequently businesses with pools of inventory that are distributed across the enterprise can use the system to get a single view of assets, tagged to identify those instruments that already pledged and those that are usable as margin.
CloudMargin offers an alternative take on the same issue, by offering buy-side firms the ability to manage their collateral in a cloud-based system. The London-based firm was founded by Andy Davies and Stuart McHardy, both former investment bankers with experience across risk, collateral and securities lending.
It took just six month from the first line of code being written in Christmas 2013 to have a live platform up and running in June 2014. CloudMargin directly connects with investors’ buy-side intermediaries and sell-side partners.
“We aggregate everything to one page, so rather than asking our clients for a feed to their half-a-dozen fund managers or a consolidated-inventory feed, we get in touch with their intermediaries,” said Davies. “While we started off building out proprietary links to our clients’ counterparties and service providers, we are in the process of joining SWIFT, the interbank transaction network, and we expect to become a member in the next few months.”
Employing SWIFT as the network for messaging will allow CloudMargin to use the standardised messages it employs, making the process of requesting and aggregating data far simpler.
“As soon as we've got that then we can use a MT535 standard statement of holdings custodians. So if information for a single client comes from a exercise for us to put it together,” Davies said.
Post-Trade Utility
SunGard represents another side of this trend–a well-established software vendor that is taking a new approach to outsourcing. SunGard is setting up what it calls a utility model for post-trade processing of futures and cleared swaps. The idea is to use one infrastructure to service several clearing firms, reducing the burden on middle and back office personnel and reducing costs via economies of scale. SunGard’s Avery said the solution covers “somewhere between 60-75% of the operations and technology services” that clearing firms manage currently, allowing the clearing firms to concentrate dozen custodians it is a the areas where they can differentiate themselves.
In March 2015, Barclays signed up to be the first user of this utility, saying it expects significant savings from the deal. SunGard expects Barclays to go live in June and has another four prospects in the wings.
The model makes sense to buy-side clients as long as any added complexity is managed, said Supurna Vedbrat, co-head of electronic trading and market structure at BlackRock. “Outsourcing any type of pre-trade or post-trade trade flow that is repeatable, standardized and requires connectivity by the entire market—and I would put trade processing into that category—is following a standard trend, as we already see with firms like Markit or Traiana,” she said.
