MARCH 2016 THE STATE OF THE INDUSTRY

Size: px
Start display at page:

Download "MARCH 2016 THE STATE OF THE INDUSTRY"

Transcription

1 The changing clearing landscape Innovation and commercial performance Where are we heading? MARCH 2016 THE STATE OF THE INDUSTRY THE OUTLOOK FOR ETD BUSINESSES

2 Futures and options trading and risk management - from the workflow specialists Follow the sun order management Global market coverage Specialised derivatives algos Order analytics Care and DMA order flow Integrated middle office fidessa.com

3 WELCOME TO FIA INFONET As well as marking a new year, this January s InfoNet also marked the completion of a new FIA the result of the merger between FIA, FIA Europe and FIA Asia into a single organisation. The new FIA serves both the global and the regional needs of the futures, options and cleared swaps industries. While strengthening our ability to address international issues and reflecting the global nature of the industry, staff in the Americas, Europe and Asia are continuing their specialised work on regional concerns, providing feedback to regulators and supporting our membership. The merger also gives us access to more resources and greater efficiency as we work to promote the health and stability of the derivatives clearing infrastructure. It is no secret that this infrastructure is facing considerable pressure at the moment from new regulations including MiFID II; the roll out of mandatory clearing rules set out in EMIR; and, of course, capital rules, among other issues. Cumulatively, these are impacting liquidity and access to clearing at a crucial time when the obligation to clear OTC derivatives is fast approaching in Europe. It is no surprise, therefore, that the number of firms providing clearing is shrinking. Yet, it is not all bad news. Three positives emerged in the first couple of months of the year the delay to MiFID II implementation; the long-awaited agreement on EU/US equivalence for CCPs, which smooths the way for the start of mandatory clearing in Europe in June; and, at last, an acknowledgement, in the form of the European Commission s Call for Evidence, that regulators are listening and waking up to the challenges that their new rules and regulations place before the market and its participants. Equally refreshing is the recognition of innovation as an important part of the industry. Despite the focus being on dealing with and implementing new rules, the industry is also able to look at innovative ways of operating. The fact that some of that innovation is driven by those very same rules is no coincidence. So, while recognising that this is not the easiest of times in which to be in this industry, there is enough to be positive about and FIA will play an even more crucial role as the guardians of the health and stability of derivatives trading and clearing infrastructures. Emma Davey, Senior Vice President, Global Communications, FIA edavey@fia.org January s InfoNet was sponsored by: Platinum Sponsor Gold Sponsors Silver Sponsors 3

4 CONTENTS CONTENTS 05 Setting the scene 07 Session one State of the industry 12 Session two The changing clearing landscape 19 Getting the balance right By Drew Shields, CTO, Trading Technologies 22 Session three Innovation and performance 32 Defining real innovation By Michael Marconi, Co-founder and CTO, Duco 34 Interview Emma Davey, Senior Vice President, Global Communications, FIA, interviews Drew Shields, CTO, Trading Technologies 36 The emergence of a new normal By Steve Grob, Director, Fidessa 38 FIA news 27 How derivatives clearing technology innovation tackles the cost challenge By John Omahen, Vice President - Post Trade Derivatives Solutions, FIS 39 FIA events calendar (Cover image istock) 30 Evolution of market models as a result of MiFID II requirements By Stuart Deel-Smith, Head of Market Structure and Product Development, Nasdaq NLX THE INFONET TEAM Emma Davey Senior Vice President, Global Communications, FIA edavey@fia.org +44 (0) Bernadette Connolly Corporate Events Manager, FIA bconnolly@fia.org +44 (0) David Setters Contango david@contango.co.uk +44 (0)

5 SETTING THE SCENE Simon Puleston Jones, Head of Europe, FIA The start of a new year is the customary time to review past milestones and consider what lies ahead. FIA s January InfoNet The State of the Industry was no exception to that rule. Market participants, exchanges, vendors and users came together to consider the challenges and opportunities faced by the listed and cleared derivatives industry in a climate of continued regulatory change, growing costs and volatile market conditions. Across three broad subject areas, panels and individual speakers shared their thoughts with an audience of FIA members in an interactive format. In his opening remarks, Bank of England Director of Market Infrastructure David Bailey shared his observations on the progress made to date in implementing the regulatory change agenda set out by the G20, while looking ahead at what was still to come. While the market had been anticipating a one-year delay in the implementation of MiFID II/MiFIR, no such announcement had yet been made, so the overriding message from Bailey, and FIA s Head of Europe, Simon Puleston Jones, was to maintain business as usual. Puleston Jones said that even if a delay was, as widely expected, announced, it would not be wise to be complacent My message to you is a simple one: please press on with your MiFID implementation. Do not delay your MiFID II implementation. Hopefully we will get a delay, but we must press on as much as possible. In his introductory remarks, Puleston Jones also complimented regulators in Europe on their more collaborative approach to markets regulation. It s often said that regulators never listen. But that is unfair on the regulatory community. And a great example of this is the European Commission s Call for Evidence where they have listened to the industry call to look at the cumulative effects of regulatory change. For the regulators, Bailey described the progress made to date and the current relationship between industry and regulators as a hugely collaborative effort. He complimented FIA and its members on their dialogue in implementing regulatory change. The importance of upfront engagement with regulators in an open manner on policy implementation was the key message. The clearing firms and exchanges who spoke on the opening panel were broadly in agreement that while the industry faces many challenges, there are, nevertheless, many opportunities in meeting the changes that lie ahead these ranged from product innovation in new markets to providing OTC clearing services for those having to meet Europe s new mandatory clearing obligations this summer. Other panels drilled down in more detail on specific issues, including the clearing landscape and innovation in technology. The former recognised that the market was still adjusting to new clearing models and account structures. The latter contemplated the need to strike a balance between innovation for the sake of innovation and providing solutions that meet commercial needs. In an increasingly mature market environment, innovation is an area of growing interest, not just for the fintech start-ups that are more agile and able to deliver change in a faster timeframe, but also for the established parts of the industry who recognise the need to look at new ways of achieving more efficient processes and results. Certainly 2015 s volume figures gave the industry something to be positive about. Global volume increased year-on-year by 13% to reach 24.7 billion contracts. While not quite a record 2011 saw 24.9 billion lots traded it nevertheless gave some encouragement to market participants. In summary, while nobody is pretending that the listed and cleared derivatives industry is in a bullish phase of its development, January s InfoNet implied a more optimistic and pragmatic view of the opportunities that can be found, even during adversity. As one panellist reminded the audience: Necessity is the mother of invention. 5

6 In 2014, Spain exported the equivalent of 3.04 billion bottles of wine. More than any other country. Eurex Exchange turns figures into opportunities. And now we offer the most effective and convenient way to hedge exposure to Spanish sovereign debt with futures on 10-year Bonos y Obligaciones del Estado (BONOs). As the home of the euro yield curve, we offer Europe s broadest range of interest rate derivatives and eight other asset classes including the most liquid euro fixed income products. And because each trade is centrally cleared, you maximize capital and cost efficiencies. It s how Eurex Exchange helps investors get more from the market. Eurex Exchange the home to the euro yield curve. The information published in this publication is for general information purposes only. It is not intended to constitute investment advice nor is it intended for solicitation purposes. Eurex is not responsible for any errors or omissions contained in this publication. Before trading, persons should consider the risks involved and the legal requirements of the relevant jurisdiction.

7 A REPORT ON THE 26TH FIA INFONET SESSION ONE: STATE OF THE INDUSTRY PANELLISTS Robbert Booij ABN AMRO Clearing Victoria Kent Nasdaq Alex Lenhart Credit Suisse Andy Ross Morgan Stanley Cees Vermaas CME Europe From left to right: Robbert Booij, Victoria Kent, Alex Lenhart, Andy Ross, Cees Vermaas The January InfoNet was a chance to reflect on the state of the industry looking back on recent developments, recognising the challenges that lie ahead as well as the opportunities. The panel set out the core issues facing the industry, including the leverage ratio, regulatory change and the impact on liquidity, and the introduction of mandatory clearing in Europe this year. While widely anticipated, the one-year delay to the implementation of MiFID II and MiFIR had not yet been announced; neither had the agreement between US and EU authorities on the recognition of CCP equivalence in both jurisdictions. And while there were numerous examples of areas of difficulty for the industry, the participants remained generally optimistic about the future. For ABN AMRO s Robbert Booij the leverage ratio was the most significant issue that needs to be resolved this year. With the majority of our customers being proprietary traders, market makers and corporate hedgers, it s very important that we see movement on the current exposure methods of calculation for the leverage ratio, being changed to the SACCR [standardised approach for measuring counterparty credit risk exposures] definition. It is very important for our customers, who provide liquidity to many markets. Under the current definitions, he said, customers offsetting positions are not sufficiently recognised, meaning that their business is at risk; which we expect to have a substantial impact on the markets. The second important issue to address was managing the conflict between achieving the G20 objectives towards strengthening central counterparty clearing and the increased capital requirements associated with clearing. This is not only in the area of the leverage ratio, but also on fund requirements. We feel it would be good to see that balance restored and we would be happy to continue to work together with regulators to get that done. Given the decrease in the number of firms offering clearing, Booij was concerned that the concentration among a shrinking number of firms would result in more systemic risk among the remaining parties that are active in making sure all the obligations are being met. Credit Suisse s Alex Lenhart said that against a backdrop of very volatile markets, at the turn of the year, with very difficult market conditions, the industry is faced with the implementation of a great deal of regulation, with the start of mandatory clearing being uppermost in people s minds. So, against a backdrop of difficult markets we 7

8 THE STATE OF THE INDUSTRY 8 have a regulatory overload that is causing us to focus very specifically and aggressively on ensuring that we can meet all those regulatory requirements. Andy Ross echoed the concerns around costs and regulatory pressures, but pointed out that this climate also presented the industry with much opportunity. Shortly before his appointment as head of London Stock Exchange s CurveGlobal was announced, Ross said that such new offerings, alongside Nasdaq NLX and GMEX, were examples of entrepreneurial ingenuity that will help us manage through this. But he acknowledged that this came in a resource constrained environment where we have all got a lot on our plate. And when I say all, I mean CCPs, exchanges, FCMs, clients all trying to cope with that simultaneously. The exchange representatives confirmed that the climate was ripe for new opportunities. For CME Europe s Cees Vermass It is perfect timing to look at the opportunities and disruptive processes on the markets, especially in Europe. He recognised the challenges that market participants are facing, but felt that using the strengths of a group such as CME to find solutions was a fantastic challenge. A similar stance was taken by Nasdaq NLX s Victoria Kent, who pointed out that necessity is the mother of invention. From an exchange perspective, we look very much at opportunities to try and improve upon the situation that all of us are force to work within, and the constraints that we re forced to work within. The exchange is engaged in looking at the electronification of fixed income products and contributing where we can to some of those conversations with the investment banking desks that are relevant to that. Beyond that, there is the question of enabling capital efficiencies in the cleared space. We feel it is incumbent upon us to work in partnership to try and find some of those solutions in what is already a very constrained market where resources are concerned. Inevitably, the leverage ratio still presented a concern for the panel. Ross said that while the FIA had done a phenomenal job in putting numbers, constructs and arguments in front of prudential regulators about the impact of the supplementary leverage ratio, if the situation is not resolved, there will be clearing brokers who either downsize or leave the market. Despite all the dialogue, there are still vast amounts of uncertainty that is not being given any transparency quickly, Ross cautioned. Another area of unintended consequences of regulation, for Lenhart, was what he described as bifurcated liquidity or pocketed liquidity. He cited the development of the basis between OTC cleared products in US dollars on CME Clear and LCH.Clearnet s SwapClear, as an example. That, to me, is a manifestation of a discrepancy in terms of how underlying market participants view those two jurisdictions, because of the difference in regulatory approaches. The growing requirement for reporting was another unintended consequence, according to Lenhart. We have much greater levels of reporting that are required for us to deliver against the constraint of lowered bottom line revenues. So we have higher costs just at the point in the cycle when we can least afford to have those higher costs. He praised those regulators that have been open to dialogue. But, it s critically important for the industry that we are able to assert that influence that we need to get an adjustment, not a complete rewrite, to certain ways in which regulations are going to be implemented, because End clients are starting to divide their business over more clearers. So, you have fewer clearers and a more complicated structure. Cees Vermaas, CME Europe

9 that s going to be critically important for the FCMs that are still in business, to stay in business. Vermaas also emphasised the importance of dialogue with regulators. It is very important that we help regulators and politicians by giving them an alternative. The objectives have already been defined, so the only thing that can change is the way to get there. Therefore it is key that as an industry we articulate alternatives, to show the implications of the alternatives and then promote their embedment. Of particular concern for Vermaas are the triple reporting obligations in Europe, centred on EMIR, MiFID and REMIT, which he felt need to be addressed with some urgency. While the dialogue between the industry and regulators has become much more constructive, so too has the relationship between exchanges/ccps and FCM providers, said Ross. In the post-crisis environment, those groups are no longer viewed as adversarial and are operating as partners. Nasdaq s Kent acknowledged that trend: We ve obviously worked very closely in partnership with a large number of [clearing members]. But beyond that, we re also working with buy-side firms, because the nature of the business has fundamentally changed and we ve seen some element of a paradigm shift in terms of functions and intermediated businesses that certain aspects of the banking community don t wish to engage in equally. For a long time, disintermediation has been a dirty word, continued Kent. Now, it is getting understood that there are certain streams of businesses that can t be facilitated by the legacy counterparts. So, exchanges are looking at where they can provide innovative solutions or resolution around that. Vermaas also took the view that it was important to consider all partners in the ecosystem. The reduction in the number of clearing firms presents a concern, he said. We also see that the end clients are starting to divide their business over more clearers. So, you have fewer clearers and a more complicated structure. So, where does this place clients who are looking for clearers to enable them to meet their clearing obligations? I think it is legitimate in the context of the current environment for certain medium-sized regional banks to look at whether or not it would be more appropriate for them to become direct or indirect members of exchanges, There are certain streams of businesses that can t be facilitated by the legacy counterparts. Victoria Kent, Nasdaq said Lenhart. And the reason for that is that, historically, they would find an easy home at a large FCM or GCM firm to be able to clear their business through. Now, given the new dynamic and the new adjusted pricing that we would have to impose on them, it would probably make more sense for these types of accounts to look at direct memberships. Booij was less optimistic. I m a bit sceptical about the opportunities for those smaller firms, and also for pension funds, trying to access the market, due to increased costs, he said. This is a big concern for the industry because if they don t have access to markets or to clearing, they will not be able to hedge their risks sufficiently. Personally, I think that something like indirect clearing is not going to be a solution for them as clearing members will always be required to fully understand who their end client is as they are the guarantor for their risks towards the CCPs. On the topic of market fragmentation, Ross said: One of the challenges that GCMs and FCMs have is that we provide clients with access to exchanges via electronic means we re the plumbing if they want to access an exchange. That is fiendishly complicated and getting more complicated because of the number of exchanges and their different protocols. From a clearing side, the different 9

10 THE STATE OF THE INDUSTRY 10 Fragmentation, at a broader level, in the context of the current environment, will help stimulate innovation that s no bad thing. Andy Ross, Morgan Stanley number of account classes you can have; the number of exchanges; the fact that you can have cross production margining; the fact that you have OTC unlisted and FX etc. All this presents tremendous opportunity, but is fiendishly complicated with a non-benevolent regulatory environment. It you mess it up, it comes down on you like a ton of bricks. Ross also took the view that, ultimately, a healthier ecosystem would see not just investment banks but also market making firms enabling clients to exit in and out of products more easily, presenting a compelling future for clients and FCMs. So, fragmentation, at a broader level, in the context of the current environment, will help stimulate innovation and that s no bad thing. I think the acid test, though, is going to be whether or not fragmentation leads to a reduction in liquidity. And that, to me, is a concern as we are a volume-based business and we require high levels of liquidity. To sum up: As long as fragmentation doesn t lead to an erosion of liquidity and actually enhances liquidity over time, via innovation, then I think it s an inevitable consequence of the current environment. Booij added: If fragmentation is the result of customers deciding to trade at a certain place where they can have the product that they want, then I think that is a good thing. If fragmentation is the result of, for example, crossborder issues, where duplicate arrangements require business to be transferred from Europe to the US, or vice versa, then I think that is just a split of a liquidity which should be concentrated in one [place]. With around 40% of market volume now provided by the market making community, market participants were understandably concerned about the impact of regulatory change in that area, and its possible knock-on impact on volume and liquidity. Ross pointed out three areas of potential impact on liquidity generated by market makers and proprietary traders: new capital requirements brought about by the need to be registered under new MiFID II rules; the burden on algo/hft trading to comply with new testing, registration and transparency obligations; and the cost of clearing. A market maker will have to become a MiFID registered person, and will then have to undertake, under the current rules, bank-style Basel capital requirements. Theoretically, even if you are, say, long a thousand lots and short a thousand lots, you are supposed to have capital against both sides of that in the current regime. The additional burden on traders in the algo/hft space, where new back-testing, documentation and transparency rules, among others, will put new barriers and costs in place for that community could also have an impact on liquidity. And finally: If we don t get some margin relief, clearing costs will rise, and, instead of being an oil to the financial machine that helps everybody hedge and manage their risk, it becomes a real sand within the gears that slows down the market. Despite these concerns, the panel recognised the opportunities within the industry. ABN AMRO s Booij pointed out that the European Commission s recent Call for Evidence consultation showed that this was a time for reflection and a great opportunity to have your voice heard. As he suggested, new legislation always brings new opportunities. We saw a huge shift in the market with the initial introduction of MiFID. I m not sure that we all

11 2015 REVIEW 24.7 BILLION Global volumes in listed derivatives; up 13% on 2014 and heading towards the peak of 24.9 billion traded in % Proportion of global volume now coming from Asian exchanges 80-82% Percentage of OTC interest rate products that are now cleared 60% OTC contracts traded through SEFs FCM data Number of FCMs registered with CFTC Number of FCMs listed holding customer funds Total customer seg funds required $148.5bn $148.5bn $151bn $94.2bn Percentage held by top ten firms 73% 72% 78% 67% Number of FCMs holding customer funds for OTC clearing Customer Amount Cleared Swap Seg Required $55bn $44bn Percentage of customer seg funds held by top ten firms 95% 96% Source: CFTC expected that. Perhaps MiFID II will also bring us new opportunities. He reiterated the introduction of OTFs as an example of one such opportunity. Lenhart cited the obvious opportunity in the introduction of OTC clearing in Europe this year. This is going to be a big area of focus for us this year. Leading on from that, was the futurisation of previously OTC traded products, which will open new avenues for trading; while volatility will be a benefit in generating more volume. Volatility is not bad for the industry as long as it remains somewhat controlled, he said. Ross predicted 2016 would be a consolidation year. It s about getting clients who want to do OTC clearing started; getting them cross-product margining where it makes sense for them to do so. The product offerings of the likes of Nasdaq NLX and CurveGlobal, he said, made this a phenomenally interesting space. The exchanges agreed with the focus on futurisation of the market as an area of growth, with Vermaas adding that the European energy space was seeing structural change which would bring about increase in natural gas and power products. For Kent, there were more opportunities for exchanges than maybe some of their clients. We look to expand out some of our products in the coming year; being less fixated on some standard benchmarks and trying to get more of a diversified view of the interest rate curve, and where we can add more value. As a supporter of the principle of open access as set out in MiFID II, Nasdaq also sees a chance to consolidate locations for clearing and working with CCPs on interoperability opportunities. So, while there are clearly outstanding areas of concern for the industry, those issues are not masking the opportunities for expansion and innovation that lie ahead. 11

12 THE STATE OF THE INDUSTRY SESSION TWO THE CHANGING CLEARING LANDSCAPE MODERATOR Richard Wilkinson Contango PANELLISTS David Brown Royal London Asset Management Silas Findley Citi Tina Hasenpusch CME Group Eugene Stanfield Commerzbank Alun Green FIS Ricky Maloney Eurex Clearing From left to right: Richard Wilkinson, David Brown, Silas Findley, Alun Green, Tina Hasenpusch, Ricky Maloney, Eugene Stanfield 12 With the deadline for mandatory clearing of OTC derivatives in Europe looming, a panel consisting of a consultant, two clearing firms, two clearing houses, a technology supplier and a fund management firm gathered to discuss the changing clearing landscape. The panel opened by assessing how different participants in the marketplace were preparing for this major change in how the industry works. Ricky Maloney, Eurex Clearing, had concerns over readiness in some parts of the market. In the early days of regulatory change some buy-side participants listened to advice to find a clearing firm in order to be ready, he said. However, the market, the models available and the support from clearing members has evolved so much that even those that did engage early are not necessarily positioned for the current clearing landscape. The other half of the market has not done much at all in the way of preparation, he continued. Now, clients need to have a CCP or clearing member in place. Depending on which category they fall into, those who are members of a CCP will have to start clearing in June with front loading beginning on February 21. For the second group the front loading date is May 21 with mandatory clearing starting in December. Maloney also opined on how markets might react during this period. I think that bid-offer spreads will dislocate quite significantly. If a bank is pricing a trade that may or may not be cleared in six months time, it s very difficult to work out the associated cost of capital. The easiest way to manage that would be to force as many people into clearing as possible by increasing the price of a non-cleared swap versus a cleared swap. The CCPs themselves also need to be ready. Segregation models, for example, are still being refined and clearing agreements are evolving, he pointed out. The emerging clearing agent models will require a wholesale change to legal agreements; not necessarily to operational flows but to the general perception of a model that a CCP offers. Clearing members will have to constantly evaluate the new ideas that the CCPs come up with and if or how they might be offered to their own clients, depending on the locations that they are clearing in. All this means that it will be a very busy year.

13 Tina Hasenpusch, CME Clearing Europe, agreed: I would have said the same thing a year ago but especially if you are a buy-side client, you need to start getting ready in all aspects. We have also seen firms engaging early, talking with and choosing their clearing members and on-boarding in preparation. We re starting to see the impact of the regulatory changes. For example, your first or second choice of clearing member may no longer be available because they have already on-boarded the clients that they have an appetite for. And if you had wanted to diversify the number of clearing members available to you perhaps that choice is no longer available. Another change has been in the area of segregation. The debate over asset protection and account segregation has not intensified to the extent we expected, she added. Silas Findley, Citi, noted that the move to mandatory clearing in Europe was completely different to what happened in the United States. We know it will happen here but nobody really knows how it s going to happen, he said. There is a lot of sound and fury. All the banks that are clearing interest rate products are already clearing as much as they can. Category two market participants, like the big hedge funds, are already aggressively clearing most of their book into the United States where there were aggressive regulatory mandates that led to broad portions of the markets not being ready. We were doing tons of preparatory documentation right up to the last few days before mandated clearing came in over there. In Europe, we have had a consistent move of clients to mandatory clearing over time. For example, asset managers, most of which are in category three, will not clear unless they are forced to by economics or until mandated clearing comes in. They need to judge the cost of clearing against the performance drag that introduces to their portfolios. They are not currently motivated to clear. But it s possible that differentiated pricing might drive people to clear well in advance. The knock-on effects are numerous, said Findley, who listed the range of outstanding questions for the market. How will liquidity be affected? Will people move into some of the lookalike futures products more aggressively than people currently believe? Generally, those products are more available than they were when clearing arrived in the United States. It s a long process. For me, it will be the economics, and maybe more importantly liquidity, that will drive behaviour well in advance of those dates. Eugene Stanfield, Commerzbank, felt that much needed to be done by some of the smaller entities, especially those who were in category two. Nobody should underestimate the impact of frontloading and what that will do to pricing, he said. How do you price-in the uncertainties? At the moment everybody is being very conservative. Pricing will be a lot more conservative in bilateral trades and that will force people into clearing. Certain dealers are effectively no longer pricing for bilateral trades when that trade can be cleared. That will happen more and more. On-boarding will take time and will impact everybody, he continued. It will impact the clearing houses because they have to set up the clients and the clearing brokers because they have to go through a lot of due diligence. It will be a good time to be a lawyer because of all of the legal agreements required. Hopefully, we can learn from what happened in the USA but we never seem to fully learn from history. Many institutions will be scrambling right up to the deadline to be ready. As a representative of the buy side, David Brown, Royal London Asset Management, reflected the concerns of that community. If you are not already preparing, you will be struggling to make the deadlines, he commented. Any client with notional outstanding of over 8 billion should be ready by December. But does that really mean December or does it mean June because asset managers have a frontloading obligation from 21 May this year? That means that any trades executed between May and December will have to go through central clearing by the December deadline. You d probably be better off passing the executed trade straight into central clearing, rather than waiting to see what price and what cost you ll be submitting them into central clearing, after execution. We are making sure that we can centrally clear for any clients in the 8 billion and above notional outstanding category from May. In fact, we are already doing it to gain an advantage, he continued. Unfortunately for buy-side institutions the number of clearing members is shrinking. That means accessing central clearing is becoming more difficult and more expensive. Clearing firms are being more selective as to which clients they will take 13

14 THE STATE OF THE INDUSTRY 14 on nowadays. The biggest issue that is being overlooked currently is 21 June At that date, all clients that are financial counterparties, but with under 8 billion notional outstanding, will have to go through central clearing. Those who might not trade large volumes of interest rate swaps might find it difficult to find a clearing member. At that stage, firms might want to offer clients central clearing but could be struggling to access services from clearing members. Royal London took the decision to get the relationship with clearing members up and running at a very early stage. That long-term relationship is very important, said Brown. You need to be able to access central clearing for smaller clients as well as larger ones. Alun Green, FIS, observed that most traditional clearers had been through the process before in the US and would be well-prepared for clearing OTC products. However, he pointed to a couple of areas where things would be different. The first is with the potential alternative clearing models, he said. Many ideas have been proposed but the industry is a long way from having solutions available for buy-side firms. It is not at all certain that an alternative clearing model will be available for them in time for mandatory clearing. That long-term relationship is very important. You need to be able to access central clearing for smaller clients as well as larger ones. David Brown, Royal London Asset Management The other thing to consider is the on-boarding element, particularly with regard to segregated accounts, he continued. Clearing firms are certainly offering those but are not certain of the demand. There has not been a huge amount of automation implemented in that area. If we have a large influx of buy-side customers who want segregated accounts, then there will be a similar problem to what we had in the US, if not larger. Maloney pointed out that CCPs are adopting a very collegiate approach to developing solutions for the market. For example, I run a buy-side committee of 30 European firms with 11 trillion assets under management. It s very important that we share ideas, he said. We also work with the sell side. I encourage anybody in the marketplace with any kind of idea to talk to their clearing broker and the CCPs. While the focus has mostly been on cleared swaps, the panel also considered what will happen to those products that are not cleared. As the market evolves, there will be a period during which companies like ours will need to run centrallycleared trades and bilateral trades in tandem, said Brown. Bilateral processes have been working for a number of years. There are challenges in getting central clearing up and running, legal contracts signed and getting clearing members on board but there is also a whole operational process to build as well and this tends to be overlooked. The difficulty, during this evolutionary period, is likely to be for fund managers with interest rate swaps going through clearing while the rest of their book is being bilaterally collateralised. A lot of offset opportunities will be removed because firms margin their interest rate swaps separately from the rest of their book. If the offsets are not available that will mean that the whole collateralisation pool is far greater than when it was all bilateral, said Brown. Findley believed that a number of factors would influence the amount of clearing that people do, even for things that are not mandated to go through clearing. A number of products have been slow to come to market, including non-deliverable forwards and some foreign exchange products, he commented. If you start to see bilateral exchange in margin at significant levels in these instruments it is possible that will drive behaviour on the sell-side in the inter-dealer market. Will that in turn affect

15 I encourage anybody in the marketplace with any kind of idea to talk to their clearing broker and the CCPs. Ricky Maloney, Eurex Clearing pricing with the ultimate buy-side consumers and their behaviour as well? For the larger dealers, some collateral segregation and some custodial efforts not there previously will be required, he continued. They will cope reasonably well, although some affiliates with smaller operations may find it difficult to meet some requirements. Or they won t have the operational processes in place. That will encourage a significant build as we approach mandatory clearing. Stanfield believed bilateral margining would come into play in While the first phase will be for the largest global dealers, it will be phased in over a four- to five-year period for the others. There s an element of watch this space. There are a lot of working groups looking at the margin setup, the legal construct, the custodial construct, and so on. Because the number of people affected by phase one is quite small, I think there will be an element of a following mentality. The workflow and infrastructure will be put in place by the large dealers and that model will be followed subsequently in the next phases, he added. Various studies say that the cost differential between bilateral and cleared is a multiple of 10. You will therefore see a shift away from bilateral trading into clearing even if you have bilateral margining in place. If you are a smaller institution, you will look to tap into the resources of major firms to ensure you are prepared for the new operating model. The FCM representatives on the panel considered whether rising costs, from CCPs and technology, would be passed on to clients. Stanfield said that his firm looked first at the risk capital elements and the leverage ratio. Companies have to build their business plan around what that formula is today but with a view that there may be changes, he said. Indicators show that the CFTC are looking closely at the issues being raised by the FIA, who have been very helpful in explaining the impact and trying to pave a way forward that would work for everybody. There are also the operational and the complexity costs which utility providers are looking to alleviate, he continued. Some institutions are already outsourcing and it is perhaps bold of me to say, but clearing is clearing and really should be as standardised as possible. That will help reduce costs. It is the value-added components offered by a clearing broker that will differentiate one from another. Although costs currently look high, I think we will see a reduction over time either because the necessary risk capital will come down or the utility providers will provide efficiencies. The sheer number of models that the clearing houses are coming up with increases the complexity that a clearing broker can offer, he continued. The end client wants us to make it as simple as possible. We have to bring everything together into a simplified output for clients. They are not interested in the middleware technology or the reporting capabilities of the clearing house. There is a lot of work for clearing brokers to do and vendors and platform providers are also trying to come up with solutions. Noting that he seldom heard anyone say that they pay enough for a service, Findley remarked that the buy-side and sell-side sometimes have different perceptions of the issue. It is true to say that clearing is not a high-margin business but we do it because it allows you to sit in the middle of the liquidity, it gives you great relationships and connectivity with your major clients and overall, in terms of supporting market structure, particularly if you are a major player on the bilateral side, it makes sense to offer the service. 15

16 THE STATE OF THE INDUSTRY 16 However, we have to hit minimum returns, he continued. The rules of engagement on how we do that are evolving. Even in the past few months we have found that for all institutions that are subject to the US Basel rules, but are operating a principal to principal model in Europe, that we may be subject to a 2% additional capital surcharge on the CCP facing leg if we re operating as a financial intermediary. We don t yet have complete clarity but, all of a sudden, a new cost that was not previously considered is suddenly introduced. The continuing complexity of building new technology, coping with evolving CCP models and the need to enhance STP is all very expensive. Over the past few years we have continued to spend without necessarily having much revenue against it, so some firms have decided that the sums don t add up, Findley said. However, not all firms are subject to the same things from a capital perspective. So we have to take a gamble based on taking a view as to there being a rational basis for where those capital rules will end up and the fact that there needs to be alignment between G20 commitments to central clearing, pricing and the FCM community. Enhancing services like netting, coupon blending and compression help to reduce costs in a meaningful way. Tina Hasenpusch, CME Group It s easy to show clients what the return on assets is for their portfolios. It s also easy to show what ticket fees and basis points on initial margin generate and what your returns are. If you can have that kind of conversation in a transparent and collegiate manner with your clients and the CCPs, I believe the industry is still looking towards a good outcome. Brown agreed that fees were certainly rising. However, he admitted that clearing firms had been helpful in breaking down the fees and showing why they were rising, with the leverage ratio playing quite a large part. Most buy-side institutions look mainly at the clearing members fees, he said. But more interesting is the fees the CCPs charge. We need more competition in the market for sterling-denominated swaps, for example. Then you have to look at the models available for clearing, he continued. Previously you would have made your choice based on risk and reward. You had an omnibus account that was cheap but not secure or you could choose an individually segregated account (ISA) with an increased level of security but which would cost considerably more. Finally, you could go for the gold service, a fully segregated account, but that was too expensive. However, although fees have gone up overall, Brown has seen much less of a spread between the different models. The gap between paying for an omnibus account now compared to a fully segregated account, especially an ISA, has narrowed. You can now buy increased security for quite a small increment in fees compared to how it was envisaged a few years ago. Hasenpusch said all CME Clearing clients continue to benefit from a fee incentive programme that is waiting for the EMIR timeline to kick in. The outright transaction cost is probably less of a concern across the competitive landscape of CCPs, she added. However, the cost of capital is certainly an important factor. We have to consider margin, of course, as well as the efficient management of collateral. Enhancing services like netting, coupon blending and compression help to reduce costs in a meaningful way. The choice of account structure also makes a difference, mostly on the clearing member side, unless you re a bank client using an intermediary. The choice of the most cost-efficient structure can be made in collaboration between clearing members and clients.

17 FCMs are certainly making money but it is marginal whether they are getting the return on capital that the bank is looking for. Alun Green, FIS Hopefully, this will become more relevant as structures like individually and fully segregated accounts are adopted more frequently. Many of the buy-side wish not only to collateralise in cash but also importantly non-cash for initial margin, she confirmed. And the overlooked element is the custodial side. How quickly can a client pass on his collateral? How quickly can he effect substitutions? We have done a lot of work on this which allows, for example, for direct transfers of client collateral directly into the CCP account for both our clearing houses in Europe and the US. Of course, CCPs themselves have operating costs and costs of providing their services. These will feed into transaction costs for participants, whether they are direct or indirect. We are looking at exciting developments to make work flows more efficient and to improve levels of straight through processing. These include innovations such as the usage of new technologies. They should help such issues as when collateral is booked and how long it takes to move it. All this should ultimately lead to cost reductions for all market participants. Maloney noted that Eurex Clearing did not charge to set accounts up and also had an incentive scheme. If customers take advantage they will get the next year and a half of fee-free clearing, he said. Costs are high, but I believe they re the highest they will ever be. It s about clearing strategy. If you re an asset manager trading interest rate swaps and you ve got euro rate swaps at Swapclear then you will see some DV01 [dollar duration] correlation. Then the obvious thing to do is the cross-margining trade. You bring your swaps across into Eurex, reduce your DV01, refund on your margin from both CCPs. That s common sense. If you can then execute your securities financing trades to fund any collateral you need or you ve got the opportunity for collateral reuse within the same CCP, again, that s common sense. We offer that at Eurex Clearing. Looking at an asset manager s [liability driven investment] portfolios he might have a whole long dated book of trades that he won t need to clear for three years, backloading rather than frontloading. He s also got some inflation in there. So while he s popping those clear trades in, he can also cherry-pick the portfolios to see it s not just about these guys and their risk offsets. What existing trades does he have within the same portfolio that he can start to cherry-pick and drop into clearing? A post-trade OTC is almost medieval compared to futures. So when you futurise the OTC post-trade infrastructure, eventually you will have super-efficient post-trade processing for OTC. That will certainly help drive costs down. Green pointed out that an important factor in reducing costs would be to ensure good competition between the clearing houses and between the FCMs. FCMs are certainly making money but it is marginal whether they are getting the return on capital that the bank is looking for, he said. It is not a high investment growth business for them. Subsequently, every regulatory change and every new CCP that comes into the market is a big stretch on their budget and the amount of investment left to optimise the existing operations is very small. That is largely why we have stepped into that area, he continued. We work with our sell-side clients very much as partners. They told us they wanted to reduce the total cost of ownership in terms of their technology systems 17

18 THE STATE OF THE INDUSTRY 18 and their overall back-office costs. We felt that by offering a utility we could do this because it is our business, our core competency. We can invest in automating many of the things that are done manually today. We can make it easier for new CCPs or for new products at existing CCPs to come to the market. But without a fairly significant investment, it s very hard for firms to reap cost efficiencies on their own. The panel were then asked for their views on the new client clearing and sponsored access models that the CCPs were introducing. We are certainly supportive of meaningful innovation, said Findley. In the past, however, we sometimes had issues with CCPs pushing various models before we had legal certainty and opinions on whether they would actually achieve the capital or netting benefits that were intended. This has become much better with the collegiate approach that we have discussed. What is important, he said, is how the direct access models impact the waterfall and what that means for the mutualisation risk that the various members have to take on. Those conversations continue to evolve. It s very unlikely that structures will be available meaningfully before we get to mandatory clearing in Europe. But obviously clients can debut in one structure and move to another so that should not deter innovation in the space. Green felt that buy-side customers really needed to understand the services they were getting from their sell-side firm. Certainly the provision of their part in the waterfall is a huge part of that but there are other things as well, he noted. By no means are all buy-side firms equal. It s hard for an asset manager at the moment to see an obvious model to go to direct clearing. There may be other firms for whom the capital makes it compelling. While clearing is important, it is by no means the only part of the relationship between the bank and the buy-side customer. The CCPs are coming up with great innovations and we will do everything to support them operationally. But it s quite a complex thing that goes beyond clearing and how that is managed. It s a wider relationship. Hasenpusch agreed that not all the new models being built were solutions for everyone. Not every buy-side client will have a choice of indirect or direct clearing, she said. Some of them will not have the appetite for operational risk or to manage daily processes in the required timeframe. However, we are exploring such models with clients and clearing firms. They are only really suitable for a select number of clients who might have, for example, a sufficient basis of clearing house eligible collateral and are looking for a way to manage mutualisation and to utilise an industry solution to handle the potential operational risk. Maloney described a hypothetical solution. From the buy-side perspective you go through your clearing member selection process. If that clearing member becomes a clearing agent and the CCP is your principle counterparty, your counterparty risk is negated, he explained. Our hypothetical model would take the gross notional of the trades from your clearing member s balance sheet as they re transacting as your clearing agent, he continued. The cost of capital to those clients is much lower and that should lead to a reduced cost of clearing. It is a good thing from both the sell- and buyside perspective. The only capital preservation that the clearing agent would need to make is the capital against the default fund contribution, which is 7% of initial margin versus the entire leverage ratio plus the cost of replacement. The banks need a new model as well. They have a limited amount of balance sheet and want to earn as much money as possible from it. If they can get more clients by just paying that 7% of initial margin as opposed to the whole cost to capital charge, then that has to work for the banks, added Maloney. Stanfield concluded the panel by asserting: There is definitely a will within the industry to find a way. I m not quite as bullish as Ricky, but we are getting closer. There s a lot of work to be done in different legal jurisdictions. It s clear that the devil is in the detail and we must ensure that what we are aiming to achieve can be achieved. But we must be careful we don t create a pick and mix environment where clients can choose just those parts of the process they would like to have. If that were to happen the clearing broker would once again have added complexity with different models for different clients. We will get there, but we have to be careful how we get there.

19 GETTING THE BALANCE RIGHT Drew Shields CTO, Trading Technologies The difficult issue of innovating in the face of commercial challenges has been especially demanding in our industry for the past few years. Innovation has been at the top of our agenda since I joined Trading Technologies around 18 months ago, at a time when we were focusing on bringing a new platform to market, built from the ground up without dependencies on our legacy product. We frequently ask ourselves whether we should be building a feature to be the same as the old. Or should it be different? Should we innovate? We re continually making decisions about what to build and in what order, so that we might strike the right balance between near-term commercial success, and long-term technical and commercial scalability and supportability. Software developed quickly for an immediate need can often force a firm into a corner, making long-term innovation and commercial success very difficult. At TT, we face and work to overcome the tension between near-term and longterm on a daily basis. The size and scope of the challenge is exciting. For me, the most important lesson is that if you re not continuously learning, it doesn t matter how much or how little you innovate, commercial viability will ultimately elude you in the long run. I challenge us all to be self-aware and self-critical. Question yourself and your team relentlessly in an effort to squeeze every bit of knowledge from each project or deliverable you undertake. There s no doubt that the organisation that learns more and faster than their competitors is the one that has a better chance of longterm success. I d like to make some observations about the feasibility of innovation when faced by commercial demands by looking at the nature of innovation and some things the team can do to better innovate in a sustainable way. Innovation is an attitude. That might sound obvious. But my experience suggests that human nature resists change. If you want your organisation to innovate, you will ultimately have to battle against the instincts of your team and your customers which tell them to avoid or resist change. Innovation is trendy right now. No one wants to say they don t want to change. But the fact is that change equals risk and most people are risk averse. There is an added challenge for those teams that have already been truly innovative and successful. The success they had in the past will have been built on their own blood, sweat and tears. Asking them to change or innovate on a regular basis isn t just asking them to have a good attitude, it s also asking them to emotionally separate themselves from the thing into which they poured their heart and soul. Striking a balance between being passionate about your work and proud of the results, yet still being able to begin the next day asking yourself what you should be doing differently is not easy. Leaders need to find ways to create a culture that embraces change rather than makes people run away from it if our teams are going to be innovative. The attitude of individual team members is defined by the open-mindedness and flexibility necessary to innovate. There are a few ways to do this. Firstly, you must communicate explicitly from the top that an attitude that embraces change and challenges the status quo is valued. We recently restated our company 19

20 THE STATE OF THE INDUSTRY 20 core values and went as far as making innovation and risktaking two of the four core values to hold up to the entire firm as the characteristics we want to define how we build our product. Next, we need to lead by example and actively contribute to innovation by being able to propose ideas or new ways of approaching a task. If the leader isn t engaged enough to ask difficult questions about the big decisions the team faces, how can the team be expected to do it? Our CEO, Rick Lane, sets this example for us every day at TT. He is tireless and a very talented engineer in his own right. Rick has more ideas than anyone about new ways of building product or solving problems for customers and it s contagious. When a team sees their leader being knowledgeable and engaged, they become more passionate and committed as a result. Then, possibly more important than anything in fostering an attitude of innovation, is clear and frequent communication. The best way to overcome the issue of that successful team that may struggle to question everything after they ve had great success with a project is to be as transparent as possible about the reasons for questioning or challenging. Then the questions and the critical nature that are required to innovate are seen in the right light. And of course along the way you also have to acknowledge and communicate the successes so that people can find a sense of accomplishment in the midst of constant change. Innovation is also iterative. We use the word innovation too often and we often describe it in hindsight as bringing massive transformations to an industry, when, most of the time, what seems to be a giant leap forward started as much smaller iterations on existing ideas. Apple is a good example. It was never first to market. The ipod wasn t the first portable mp3 player. It was simply better than the ones that came before it. The same for the iphone and the ipad. The innovation wasn t to create these devices, but to create ones that were so easy to use that it felt like second nature. This repeated theme of later to market but better is what Apple does yet, because of the impact they make, we talk about them like they were seismic changes. If we see innovation as meaning inventing the next big thing, it s both intimidating and harder to do in a commercially viable way. Instead, we should think of innovation as iterating on ideas which are regularly re-evaluated and improved upon. The smaller the change, the more you can learn and adapt as you go. By taking baby steps when innovating, the cost of change is reduced, meaning that the cost of innovation and the risks associated with it are lower. This also allows you to fail fast. If a new product is a bad idea, it is best to know it as early in the investment as possible. Treating innovation as iterative gets you feedback early and allows you to adjust for greater success or failing as quickly as possible. There are two practical ways I can think of from my experience at TT to accomplish this. The first is thinking about how you and your team work and adjusting those processes to get regular feedback and adjust for change. In the software world, this is called agile development. Embracing an agile approach to product delivery, even if your product isn t software, gets you the benefit of the underlying principles of agile planning for change and frequent feedback. These then empower your organisation to become better at innovating in a sustainable way. By taking baby steps when innovating, the cost of change is reduced, meaning that the cost of innovation and the risks associated with it are lower.

21 If innovation is iterative, we also need to design accordingly. That means embracing architectures that are flexible and reduce the cost of change. An organisation that wants to innovate sustainably must increasingly look at new approaches that maximise flexibility and greatly simplify the complexities inherent in deploying and supporting large legacy software products. The last thing to say is that innovation happens in community. A recently published book entitled The Geography of Genius got me thinking about the changes that are happening at TT in terms of innovation. The author s theory is that genius is neither born nor made but it s grown in specific places at specific times. He argues that there s a confluence of triggers that lead to clusters of genius and often these geniuses are actively engaged with one another in the same location at the same time. He has a handful of examples like Renaissance Florence, Classical Athens or Silicon Valley today. This made me think on a more humble scale about how new ideas are developing at TT. Many are behind the scenes and not necessarily visible to the end user. They aren t coming out of thin air because we hire smart people, but they re rooted in research and more importantly, in a dialogue with a community of technologists, many of whom are outside of the firm. Inside TT there are many different teams doing different things. But even when they are in the same discipline, they re working on different parts of the product or the business. When these teams collaborate and engage more actively with one another, it s obvious that good things are resulting. We aren t trying to make every team operate the same, and we value a team s autonomy because we think the more autonomous they are, the higher level of ownership they ll have and ultimately be more effective. But at the same time, having these teams collaborate yields new ideas. In the same way, we are also engaging with people outside of the firm. We ve been talking to some fintech startups recently, including companies such as OpenFin in New York, Duco in London, and Green Key in Chicago. We don t do the same things as these firms, and yet by engaging with them about how they re delivering their products and services, we find that we re learning and so are they. It is informing ideas for the product but, more I encourage all of us to think about how our teams engage with a broader community outside our own organisations. importantly, how we look to deliver the product and build great software. I encourage all of us to think about how our teams engage with a broader community outside our own organisations. Are they getting exposed to new ideas that can become the seeds of innovation in their own minds? Are they looking outside our industry to find trends or ideas or business models that could influence our own products and services? Or are we an insular group that believes our problems are too complex or too challenging to be informed by the outside world? In many parts of capital markets, with technology at least, that s historically been the case. But I m hopeful that the flood of fintech startups and the fact that much larger entities in the industry are taking a real interest in cultivating a startup community, means that capital markets technology will become more creative and more innovative in the future. I ve never used the word innovative to describe myself, even in my most delusional moments, but in the last 18 months, while being part of our massive product development effort, I ve found that innovation can indeed be reconciled with performance. The key is in understanding how to innovate in a way that is sustainable. 21

22 THE STATE OF THE INDUSTRY SESSION THREE INNOVATION AND PERFORMANCE MODERATOR Brendan Bradley Eurex PANELLISTS Sam Atkins BNP Paribas Alun Green FIS Christian Nentwich Duco Drew Shields Trading Technologies From left to right: Brendan Bradley, Sam Atkins, Alun Green 22 David Setters reports on the panel of specialists discussing how to manage innovation while continuing with the day job It goes without saying that innovation is the key factor in the development and ongoing maintenance of the derivatives industry, whether that is to meet the needs of the regulatory change agenda or to prepare for a new product or service launch. But, given the commercial need to keep a business running while the innovation is put into place, what does senior management have to consider and how does it go about the change process? The Innovation in Derivatives panel at the January 2016 Infonet meeting comprised a mix of participants in the marketplace, including a bank, a post-trade system supplier, a fintech start-up and a front-end provider. Moderator, Brendan Bradley, Chief Innovation Officer at Eurex, opened up by remarking on the naysayers who say that they would love to think about innovation but they simply don t have the time, and innovation will have to be put on the back burner. Sam Atkins, COO Listed Derivatives at BNP Paribas, recognised the sentiment. I d love to say that we innovate all the time but there aren t enough hours in the day, he said. We re stuck with legacy software and systems. As much as you like to meet as many client needs as possible in the short term, you can t be all things to all people. But, if we want to continue to be in this business, we have to take the long-term view. With all of the far-reaching regulatory change we have to look at the bigger picture and be far more global. If we don t, we won t be here in a few years time. Atkins explained that his company had chosen the vendor route and that it was important to work with those vendors as partners. By doing this we are outsourcing much of the risk but we also gain best practice and can use some of our knowledge and supplement what we ve done with other firms. We have to be in partnership. Although we could operate in silos and innovate on our own, we would not gain the best practice that other firms have. We need to do that if we want to continue being in this space. Bradley asked Alun Green, FIS, if outsourcing was a good route for banks to take with respect to innovation. Innovation is not only driven by change, it thrives on change, responded Green. And, although that might be obvious, it s important to say because it s not very easy for people to cope with change, let alone to instigate it. I have led massive change projects at large, conservative institutions and we have found that change is like using a muscle. If you do it all the time, it becomes a lot easier.

23 If you don t ever do any kind of change, your muscles atrophy and it becomes very difficult. Green encouraged all kinds of market participants to try to introduce at least a little bit of change into their companies on a regular basis. Just as it is good for me to force myself to go to the gym regularly, it s very good for our minds to force themselves through the mental challenge of change, he said. For Green, one difficulty was in getting the risk/reward balance right in different types of firms. You certainly can t innovate without some level of risk. And if you re in a start-up environment, you will probably have individuals who are prepared to put their entire careers on the line for a period because of a potentially massive reward. My experience is that the potential reward within a large firm is not as large. That means that we need to take a different attitude toward risk. If we want to encourage innovation and change, then we must allow staff to perform within some kind of safety net. We should allow people to feel that they can push the boundaries. FIS believes that fintech start-ups have a big role to play. The firm invests in first and second round start-ups because there are certain things that you cannot do with the constraints of a large company, said Green. Duco CEO Christian Nentwich admitted that a start-up company such as his had to push for much larger changes and change potential than large firms. We can t just go to potential clients and tell them that they will save 5% or 10% on their costs by using our service, he explained. We look for things that fundamentally change the operating model and can potentially restructure the bank and take out some of the cost constraints that are currently driving people to exit businesses like the FCM businesses. It s a bit of a different game. There s a lot of innovation that never sees the light of day in smaller firms, Nentwich said. But, once it leaves the firm, at that point it becomes a partnership. At that point, the smaller firm has to partner with a bank or whoever the target audience is. For them the innovation process only starts once you ve done all your work. Then, they need to package and explain it. There s very little you can do at any one time. If we came out with all of our ideas, people would think we re going nuts. So once we put something out, it takes two years to get to market. A key restriction, according to Nentwich, is that much of the industry is running on technology assumptions that are two decades old. One thing we invest in a lot and I feel vendors across the board have been fairly lazy with this is adaptability of systems to reduce the cost of change, he said. You re actually absorbing change cost on behalf of your customer by putting more work into the product so you can drop it in place, in situ. Nobody is willing to sign off the 100 million migration programme nowadays. Things have to work in context immediately using smarter technology, learning, adaptive technology etc. So much change will happen in the next few years and all vendors will have to invest otherwise we ll never meet our objectives. Bradley pointed out the potential conflict of new fintech companies coming to banks with fresh, innovative ideas just as they are getting up to speed, while the new technologies might actually be alien to the infrastructure of those banks. He asked how the panellists dealt with that conflict. Nentwich explained that that is why his company offered Software-as-a-Service because Duco does not want the customer to have to worry about the technology. They should simply have to worry about the operational result of that thing in a box that does what we promise it does, he said. People are very busy. Projects that don t show return on investment and cost benefits in six months are very hard to sell. Outsourcing of a key service within regulated firms does present an issue regulators have to be comfortable with the arrangement. Nentwich explained that technology suppliers fall into scope for regulatory audits. The bank cannot absolve itself of responsibility simply because it has outsourced the service, he affirmed. We work with the auditing firms to get them to audit us, like all of you will do. Change control is also audited. We push a release to our clients every four weeks. All of these are big changes to their standard operating model. That part of the industry is fairly mature and the processes the auditors have in place do all work. Drew Shields, CTO, Trading Technologies, agreed. The auditors inevitably get to see what s inside the black box, he said. And to get to a signed contract, we have to go into some very detailed analysis of how data flows across a global backbone, for example. But, once that is done, the benefit is that you don t have to know about how it works 23

24 THE STATE OF THE INDUSTRY 24 every day. As long as you understand it from the outset, along with the change control process, it can still function like a black box, even if you happen to know how it works. Shields described his company s iterative, rather than big bang approach in relation to the launch of the new TT platform. The project is massive in size and scope, he said. And yet within that massive project, there are opportunities for small, bite-sized yet meaningful pieces of innovation. If the job is to innovate year after year, it s challenging, especially at a major banking institution. We have taken a bold approach by stopping heavy investment in the old and pivoting to heavy investment in the new. He also pointed to the FCM s inability to adopt a new platform quickly as being the biggest business challenge. It makes near-term commercial success more difficult because you have to convince people to do something that might not be in their immediate interests when they just look at the numbers, he said. You can explain why it is a mid- to long-term investment, but it s still really difficult to get on their roadmap. As a result, we ve taken the approach of focusing just as much on new business and different kinds of businesses. If we are coming up with new innovations, can we leverage these and sell new products and services that we ve never sold before? We can pursue these at the same time as we work with some of the slower movers who can t adapt quite as quickly. We re trying to strike a balance of finding near-term opportunities that might be brand new things we never could have pursued before, without sacrificing the old, he continued. That is challenging. TT has historically not been an open platform and that wasn t just for philosophical reasons, it was that the technology wasn t available 20 years ago. When you build technology that s not open, flexible and dynamic and can t be dropped in an environment very easily, it s more difficult to innovate. We are trying to put ourselves in a position where, by leveraging new technologies, we can be more adaptive and put ourselves in a better position to partner with firms for the long-term. Bradley asked Atkins for examples of where his firm had worked with a vendor and had been able to achieve things that they would not have been able to achieve on their own. Atkins explained that his firm was in the middle of such a project and emphasised the reason for the partnership. Over the next 12 to 18 months we have You have to be adaptable and able to meet the needs of the client. Because ultimately if we can t, someone else will. Sam Atkins, BNP Paribas to work together, and we need vendors to work together. If they won t, I can t work with them. You have to be adaptable and able to meet the needs of the client. You need to work with the technology firms to come up with a solution. Because ultimately if we can t, someone else will. We also want to get more business, new business and different business because there are so many things that are either free or being adapted. Being open to new technology allows a firm such as BNP Paribas to be open to new clients and new technologies. The utility model, such as that offered by FIS, could be a way to keep down costs for legacy technology rather than encouraging innovation, Bradley suggested. Users of the utility would be looking at innovating while they were customers and at some time in the future might come up with a shiny new model that they could use for themselves. Green felt that what he would call the short-term technology problem would be outsourced by using a utility. We re alleviating the burden of managing common processes that provide no differentiation for individual firms. But even within the realm of middle- and back-office processes that the utility provides, there are innovations going on such as building in business process workflows to help standardise user workflows and the accessibility

25 of data, he said. So by coming in with a utility solution we have turned it into a service. Whether it is integrating with a different technology platform or migrating to a new-generation system, the conversion and the cost of the technology become the problem of the service provider. It also provides a lot more portability of the service. The bank can then look to innovate at a different level with new products and services for their customers. Such an arrangement also allows banks to continue with long-term innovation, he continued. We tend to find that investment bank clients don t want to waste a lot of time and effort investing in the six to 12 months period. But they are willing to discuss blue sky innovation. For example, they are interested in how blockchain technology might be applied in the derivatives arena and how we are implementing big data solutions. We are certainly engaging with major investment banking groups who are looking at how that kind of technology might disrupt their business. Fintech start-ups are also proving nimble in their ability to introduce new services quickly and cost-effectively. As Nentwich explained, Duco invests more in long-term innovation than one might expect at this early stage. Even though we are a 40-man firm growing quickly and signing up customers, because the pace of evolution is so quick we re already concerned about what s going to cannibalise our own business and we need to keep an eye on it, he said. We want to maintain a reputation as an agent of change with our customers. We want them to come back to us when the next thing comes up, and therefore we re going to invest more money in these things. For example, there s a revolution going on in artificial intelligence and we are keeping a very close eye on that. However, the competition is not so much with new entrants as with established technology and manual processes. Our hardest conversations are about transforming and automating manual processes, Nentwich said. We need to make people comfortable that that can be done quickly and that they can trust us with the control of their critical business processes. Also, although Software-as-a-Service has been around for a while, potential clients still start discussions off by saying that they can t possibly send you all of their data. And, of course, it always ends up with them sending us all their data. Bradley asked Shields how TT was coping with the issue of running two platforms concurrently for a certain period of time. Balancing the costs is not easy, especially when you re hoping you ll get everyone to switch in short order, replied Shields. But massive change takes time. There was certainly no confusion about what it meant long-term for the firm. It meant a much leaner TT, one that is solely focused on end user success. The firm is also careful about how it invests in the new. Building software is the cost of people, he added. We haven t grown our team significantly as part of this effort. It s more about managing people s time efficiently. We have to manage the growth of the infrastructure and not become so optimistic that we start to over-invest before we get the buy-in from current partners and growing new business. Software-as-a-Service isn t new, but going beyond ASP and having one completely opaque backend that no one ever has to think about, is a bigger step than many have taken, at least in the trading industry. If we can manage the investment we re already making Potential clients still start to build the new, rather than just adding new expense, it gives us more flexibility. Each month a little more infrastructure is implemented. For example, we have discussions off by saying they can t staggered the opening of our new data centres. We re possibly send you all of their data. trying to manage the costs of the transition. Christian Nentwich, Duco Vendors also play a role in enabling FCMs to differentiate themselves from competitors, said Atkins. 25

26 THE STATE OF THE INDUSTRY 26 While BNP Paribas looks for innovation in the voice business, we try to use vendors in a certain way on the direct market access side. But then there is the voice side and access to other liquidity. That s where everything is far more manual and where we have to differentiate ourselves. There is a lot to do over the next couple of years. We are looking to the long-term and we are not looking to be all things to all people. That s why we need a vendor and it has to be a big technology firm. If not, you ll find yourself behind the competition in a number of ways. With all the regulatory changes we ll never be able to do it by ourselves. Innovation and change is equally important for the behemoth of the industry FIA, despite the firm owning the central plumbing of the derivatives industry. We are well aware of how quickly a franchise with a product or a service offering can disappear overnight if you don t continue to innovate or provide the service your customers are expecting, said Green. There is no issue in persuading ourselves to invest in innovation, he continued. We continue to invest heavily in innovation. Our challenge is being able to roll out that innovation in such a way that we can still provide the tried and trusted service that our clients have relied on for the last 30 years. I would love to be able to disrupt my own business and sell against myself but it s not possible because of the relationships that we have. The firm s flagship derivatives solution, GMI, was sitting on legacy technology, he pointed out. We ve made some incremental innovations to it and it is not the same platform that it was in the 1990s or the 2000s. It s getting the balance between the small, incremental change and the massive, disruptive change. When you make the massive change, you have to roll it out in a way that keeps your customers with the stable platform that they need. They don t need to be worrying about new technology and what that will mean to their business. Like their clients, vendors are keenly aware of regulatory requirements. Putting in place internal policies and managing our external commitments on risk and regulatory compliance is now an enormous part of our business, said Green. That is not a negative thing because we re meeting an important need that is widespread. Shields felt that the important thing was to have processes in place to manage and to control change appropriately. We strive for the ability to change as quickly as possible, in a matter of hours if necessary, he said. We need to deal with an issue and yet to have some kind of standardisation in how it is implemented so that people know what to expect, how it works, what kind of documentation is available, etc. New regulations are changing how our business operates. The amount of data that will be required two years from now, compared to what is required today, will grow. Change is inevitable and for us it is about managing it in a proactive and efficient manner. Managing expectations is also necessary. The tricky part is that sometimes clients will tell you that they want all the innovation now too, said Shields. They know we re building the answer to their questions in the new platform but they want it in the old. It s not realistic to build it twice and so we have to work together to balance costs and innovation. Looking ahead, the panel cited the core pieces of commercially viable innovation that they would like to introduce in the next year. Both Green and Shields said they would like to introduce tools that would ease migration issues and costs. We ve begun working on tools to ease migration, said Shields. It has become essential. In the long run, such tools would open the system in other ways, so it wouldn t just be for migration. The biggest thing is making it easier for people to begin the migration. We re also looking at new ways to monetise our investment, he continued. What other lines of business can we invest in where the incremental investment is very small, because there s already a sizable investment being made underneath that creates new opportunities for revenue growth? And the biggest area is technical analysis and charting. There is an opportunity there to take what s already started and, without a huge investment, grow it. For Nentwich, finding a way to convince people that change is easier than they think would be most important. However, with respect to technology, he had another idea. I wish we could free up time to look at how people operate in operational workflows on a daily basis and what we can do with learning technology in that space, he said. That s something we re looking at very keenly.

27 HOW DERIVATIVES CLEARING TECHNOLOGY INNOVATION TACKLES THE COST CHALLENGE solutions that can truly transform the business model for derivatives clearing. By John Omahen, vice president post-trade derivatives, FIS In today s low-margin derivatives clearing business, long-term low interest rates and high operating costs are combining to cause an enormous strain on profitability. For firms who have decided to remain in the business, the top priority is taking steps to ensure their operating model is sustainable a process that requires both adopting more advanced technology solutions and finding more cost-effective ways to perform their operations. On the cost reduction side, most firms are finding that the established techniques have been implemented to such an extent that pushing them further either does not justify the costs involved or jeopardises their ability to process the business. In short, these firms are finding that a more radical approach than they have taken in the past will be required to find the cost savings that are needed. At the same time, market volatility is driving greater requirements than ever before for real-time information, intraday monitoring of risk, and increased transaction capacity to handle the frequent transaction peaks during times of market upheaval. Both these new costs and new requirements are placing a greater pressure than ever before on existing systems and processes such that there is an unprecedented need in the industry for innovative HOW DID WE GET HERE? In the past, when investment banks were looking to alleviate costs, they turned to a combination of automating manual processes, offshoring basic tasks, integrating and consolidating systems, and outsourcing some aspects of technology and operational tasks to third parties. Although money was saved as a result of these strategies, they no longer go far enough to actually move the needle on profitability. For many firms today, these incremental improvements simply are not enough; costs must be significantly reduced, especially within the technology infrastructure firms rely on every day. And once those costs are reduced, they must be controlled moving forward. The weight of these decades-old legacy systems, combined with the diverse requirements and demands of a global client base, limit the ability of most clearing firms to allocate both technology and human resources to address inefficiencies that reside deep within posttrade processing. As a result, there is growing demand to find consolidated platforms and common solutions such as utilities to alleviate the burden. As one of the greatest contributors to rising costs, regulators are now looking more closely at post-trade practices and proposing new rules and reporting around traditional processes and procedures. In addition, new people entering the industry have little tolerance for the way legacy systems and processes have been built over the years. With little money available to invest, many firms are forced to come to grips with the inefficiencies of their post-trade processing in both exchange-traded and over-the-counter (OTC) derivatives systems that are cobbled together from a variety of technologies resulting from numerous mergers and acquisitions.meanwhile, exchanges and clearing houses are offering an everincreasing number of products, trading venues, risk management practices and trading incentive programmes. 27

28 THE STATE OF THE INDUSTRY 28 Clearing firms and system vendors are hard-pressed to accommodate these innovations in a timely manner, especially as a lack of regulatory consistency and fragmentation of trading venues and clearing has increased costs overall. With markets now global and real-time, firms need to be able to quickly respond to new opportunities and customer demands. Eliminating processing delays in reconciling trades and the difficulties in adding new products or exchanges are crucial to achieving this. Newer, more innovative technology is needed to make the business more agile and management decisions more informed. These include consolidated, process-driven platforms, which can also be leveraged by utilities, and the emergence of big data analytics. STANDARDISING BUSINESS WORKFLOWS In the past, firms viewed their process as unique or differentiating, but that view has been changing as of late. And continuing to band aid old technology means increased reliance on more staff to run the process. In order for firms to keep pace with and nimbly adapt to industry change, they need real-time, open systems that capture and standardise business processes. Senior managers want assurance that their business processes are in the system itself rather than solely in the minds of expensive staff. Their goal is to guide users through a workflow that ensures any breaks or operational risks are drastically reduced. Modern technology enables that, by providing a tested, best-practice business process out of the box, readily customisable to the firms specific requirements. A system that uses business process automation encapsulates and enforces the firm s workflow, which reduces risk and costs, and drives users through the activity of completing a task by guiding them along the way. A key example is the process of setting up a clearing instruction feed with an unknown product. Traditionally, a user would have to go through a fragmented procedure of opening multiple screens to complete the task: entering the clearing instruction into a table, then opening a screen to see exception messages, another screen to create the new product, another screen to select the clearing instruction, and yet another to verify it. In a business process-driven environment, the user completes this process by following a single workflow task that efficiently guides them through the appropriate actions to take. Each action triggers a defined workflow to automatically create the new product and process the clearing instruction. Once the necessary steps and approvals have been completed, the system automatically creates the new product and restarts the stalled processing. BIG DATA ANALYTICS AND THE NEXT GENERATION OF POST-TRADE PROCESSING Making the business more efficient, attracting new customers, and understanding the balance sheet implications of customer activity are imperative to ensuring long-term profitability and competitiveness. In addition, understanding the health and cost of operations on an ongoing basis is essential to identifying, reducing and controlling costs over time. There is certainly no shortage of data to tap; the challenge, though, is in capturing the data from the many disparate systems that create it and then viewing it quickly in a digestible, meaningful way. As technology environments have expanded, so did their size and complexity to the point where today, most firms have their key data spread across a wide range of in-house, vendor and clearing house-provided platforms. Bringing that data all together can be extremely difficult, but doing so is essential to understanding both costs and revenues. This is the promise of big data and it is crucial for the clearing community. There are really two approaches to solving the problem: either create a large data aggregator system that collects data from those many separate points and run data analytics tools over that system, or migrate into a newer platform(s) that consolidates functions or asset classes that were previously handled separately. Creating data aggregation systems was at one time the only option, but with the cost of maintaining that structure and thanks to its many integration points, not to mention the cost of running those many systems, the approach is hardly ideal. The good news is that the next generation of financial systems is being built with the goals of achieving both system consolidation and providing data analytics. Through modular components, cross-asset class coverage and modern system design, it

29 is now very possible to migrate off the mess and onto a much more centralised platform. With data captured and stored in one place, data analytics tools and dashboards can be easily applied to report on operational costs, identify problems due to errors and breaks in the process, and drive more automation improvements. In short, managers and executives can make better decisions because they have more information with which to make them. LEAVING LEGACY THINKING BEHIND There are two main legacy issues in the derivatives industry holding many firms back from profitability and growth. The first is dated, antiquated processes driven by derivatives product silos, and the second is the legacy systems that follow this thinking. Even the largest global clearing firms admit that they struggle to wring inefficiencies out of their still manual core processes. Because the benefits of modernising the process are so significant, firms must be prepared to accept some level of change. Modern technologies will enable businesses to operate more efficiently and serve customers at a reduced cost. Firms would be wise to think about this as they evaluate new technology. For example: What customers are driving the greatest operational costs? Am I even covering those costs based on the charges back to that customer? How many more of these types of customers can I take on before I have to hire additional staff? These questions are surprisingly hard to answer for any clearing business, yet the answers are the most useful for driving informed strategic decisions. The world of clearing is changing rapidly. While the cost-saving strategies being leveraged today are not completely new or novel, the scale and scope of data and processes to which they are now being applied is more ambitious than ever before. With the emergence of consolidated platforms to standardise processes and improve data analysis, and utilities to mutualise the cost of commoditised tasks, a more sustainable operating model and cost structure for the derivatives clearing industry is now within reach. How can I help FFK? You can help on a corporate or individual basis Organise your own open external events Organise your own internal events Sponsor/support/ help us sell existing FFK events Encourage individual/staff team challenges Contact David Setters on david@contango.co.uk to get things rolling Make FFK your charity of choice for physical challenges Hold a collection for FFK at your corporate event Set up an FFK team at your company for teambuilding and fundraising purposes Participate in Walk to Work 29

30 THE STATE OF THE INDUSTRY EVOLUTION OF MARKET MODELS AS A RESULT OF MIFID II REQUIREMENTS 30 By Stuart Deel-Smith, Head of Market Structure and Product Development, Nasdaq NLX Against the backdrop of the wave of regulatory reform affecting the markets today, the challenge for market participants is how best to adapt to meet the demands of investors, shareholders and regulators alike. Derivatives remain an important tool for investors and traders to access or hedge risk in a focused, liquid and capital efficient manner. However, this benefit comes at the expense of complexity, granularity and diversity of the product set. With MiFID II s non-equity instruments including derivatives, there is industry-wide concern that the regulations do not take sufficient account of the specific challenges regarding complexity and liquidity. There is also the broader question of how to meet the regulatory requirements while managing the time, effort and expense incurred. One of the key objectives of MiFID II is to develop robust investor protection and transparency. The transparency principle encompasses everything from price and volume pre-trade liquidity all the way to trade execution and will have a major impact in the way the OTC derivative markets function. MiFID II lays out specific transparency requirements for investment firms and trading venues. It also extends the concept of trading venues beyond the Regulated Market and Multilateral Trading Facility (MTF) to the Organised Trading Facility (OTF) which has been dubbed the EU SEF, and the Systematic Internaliser (SI) that was applied to the equity markets by MiFID I. The SI concept is an important change in the derivative space investment firms conducting business outside a venue over voice or through electronic means will now have myriad new transparency obligations placed upon them. There are various exemptions and waivers for these obligations but they involve relatively complex calibration calculations using data that, at the moment, simply doesn t exist. One issue that is creating significant discussion within the industry is the requirement for SIs to publish firm quotes to their clients and trade on those within certain objective and non-discriminatory limits. Additionally, where an SI provides a voice quote on a bilateral basis to a single client, there is an obligation to make that quote available to their wider client base. There are further pre-trade and post-trade transparency requirements that attempt to differentiate between the different trading approaches including voice, CLOB, IOI and RFQ, among others. Another high-level objective of MiFID is to promote orderly markets. This is implemented through regulatory reporting throughout the price discovery and trading lifecycle in order to allow the competent authorities to monitor market behavior for potential systemic risks and abuse. Should each trading venue and SI develop their own protocols for meeting the MiFID II pre-trade transparency requirements, the additional complexity in the market infrastructure, caused by proprietary publication and consumption of this data will result in a massive increase in both regulatory spend and ongoing technology costs within investment firms. Additionally, the ability to aggregate information across the marketplace as a whole will be hindered, creating challenges to price discovery the exact opposite of the regulatory intent. Nasdaq, as a leader in the provision of market technology services, is well positioned to offer OTF structures to investment firms, as an alternative to SIs. The benefits include the independent management of the platform, allowing the investment firm to employ their

31 own capital in principal matching, using standardised protocols and data uniformity, while execution of orders are carried out on a discretionary basis. Furthermore the operator will be able to offer standardised transaction and regulatory reporting. MiFID II s best execution rules will apply to OTF platforms. This would allow market makers and investment firms to meet their pre-trade transparency obligations more easily across their different electronic channels, and also allow all investment firms to consume this data more easily, and to greater standardisation. Even greater challenges await for investment firms when it comes to maintaining reference data. Not only is there the issue of different participants attaching a different meaning to the same fields but a mismatch of the data values could arise. Both of these will not only make it more challenging for investment firms but also place a greater burden on the competent authorities. MiFID II has provided the opportunity for investment firms and vendors the market as a whole to begin the long process of standardising both the market model and model for data in financial markets and the values themselves. The new regulations offer both challenges and opportunities to the market, as they evolve from voicebroked OTC trading towards greater transparency in an electronic environment necessitated by MiFID II s transaction reporting and transparency requirements. The opportunities, when approached through standardisation and collaboration, allow those challenges not only to be met but also to create a richer market infrastructure, based on open standards that will improve the functioning of the market for the benefit of its participants. 9 th Annual IDX Gala Dinner in aid of Futures for Kids Join FIA for the 9th Annual IDX Gala Dinner and spend the evening supporting a valuable charity and forming deeper connections with your fellow IDX attendees. IDX2016.FIA.org. DATE: Wednesday, 8 June 2016 VENUE: The Artillery Gardens at the HAC, London EC1Y 4TW TIMINGS: 6.30 pm Cocktails 7.30 pm Dinner, followed by after dinner drinks & dancing Midnight Carriages DRESS CODE: Black Tie 31

32 THE STATE OF THE INDUSTRY DEFINING REAL INNOVATION firms across the finance industry to cut costs, cope with regulation and simplify business processes. Our story is about bringing fundamental research from the university lab directly to operations in industry, and I would like to tell you more about how our innovations have brought the Duco Cube service to life. 32 By Michael Marconi, CTO and Co-Founder, Duco Not a day goes past without more articles, blogs, white papers, opinions and views on fintech innovation and what that popular phrase really means; it seems that everybody is either an expert or has a crystal ball. This bandwagon keeps picking up speed, as those in need of services try to sort through the analyses of opinion makers and separate the hype from true leadership and innovation. Let the buyer beware: There are vendors trying to get away with slapping lipstick on a pig, to use a well worn phrase, when they label as utilities good, old-fashioned off-shoring projects and try to dress their aged legacy products and services in hipster clothing to claim a place at the innovation table. This short paper is intended to give some real examples of the way we at Duco have differentiated ourselves, from inception to delivery, in a manner that explains the use of real innovation where it is applied to the fintech sector. The world has changed significantly since we launched the Duco Cube service in April 2013: best of breed hosted services have gained traction and are helping STARTING WITH A FRESH PERSPECTIVE When we decided to build a data reconciliation platform, the decision was shaped by the very poor experience of trying to apply existing solutions to a wide range of data. The existing tools were built to solve very specific problems, for example reconcile bank balances, match FX trades, perform depot reconciliations, etc. While they can be good for dealing with one kind of data, they tend to be poor at solving the wider problem of establishing data controls across an entire organisation. These tools also require substantial effort and resources to deploy and maintain, and are completely intimidating to nontechnical users. Today, it is clear that the rise of consumer technology is heightening expectations that all members of staff should have access to powerful and usable technology. When you deliver this technology via a self-service model, you also empower your employees to help themselves, which is highly cost-effective and increases efficiency. Our goal was simple: put the power to establish these data controls in the hands of business users who need them most, and enable the business to cope with a wide array of different types of data, all on one platform. It turns out, however, that bringing consumer-like levels of simplicity and sophistication to the enterprise is incredibly challenging. The slick consumer apps we use every day focus on simple business models. By contrast, the existing infrastructure, complexity of products and regulatory pressures in the finance industry conspire against this kind of simplicity. Nevertheless, we have accomplished our goal of allowing non-technical users to reconcile any data by scrutinising the myriad challenges facing them and innovating in order to keep things simple. Let s take a look at some of these challenges next. COMPARING APPLES AND ORANGES The data you wish to reconcile is rarely in the same

33 format. The traditional response to this is to employ complex IT tools to transform it, but these are both expensive and unusable by most business users. Our response was to create the Natural Rule Language, which traces its roots back to Computer Science Ph.D. research. This language enables business users to write straightforward rules that manipulate data, using English sentences. This makes it easy to overcome differences in data format, removing the need to use IT tools entirely. Since they are effectively English, the rules are clear to everyone, and they are easy to maintain. GETTING RESULTS QUICKLY It often takes many months to see the first results when you use traditional reconciliation tools. To control implementation risk, companies resort to processes demanding lengthy business requirements gathering, multiple iterations and long testing periods. Business users are often involved only right at the beginning and the end of such projects, while much can go wrong in the middle. Our response was to invent a novel, self-optimising algorithm capable of matching very large sets of random data quickly and accurately, in memory. This empowers our users to take a much more iterative approach to reconciliation projects, as they get initial results immediately and can quickly fine-tune the matching rules in small increments. This algorithm learns the form of the data and optimises itself as it works, allowing users to tackle very large data sets (e.g. millions of trades) and deliver meaningful insights in hours or days, rather than months. COPING WITH COMPLEXITY Many systems dealing with complex data are themselves complex. There are too many buttons on every screen, making the user experience unpleasant, cumbersome and confusing. When was the last time you read the manual of a mobile app? By contrast, Duco Cube is modern and simple. It takes advantage of the latest web technologies, is responsive and scales to mobile devices. We spend a lot of time streamlining the interface and ensuring it is clear and approachable. We also make use of strong visual metaphors, such as time or our change tracking in process configuration, making it easy to spot differences. This leads to an intuitive experience for all users. Many people talk of bringing consumer based technology notions into the fintech world. By adopting features that call for behaviour similar to how we use the internet, our phones and our laptops, we demonstrate just what this means to the end user, the consumer of our service. If projects become too complex for our users, they can call us and we will come to them, at no charge. We are happy to make this investment, not only because it keeps our users satisfied but because our products require so little training that we can keep the focus of most visits on helping our clients meet the unique challenges that face them. COPING WITH A CHANGING LANDSCAPE The world is not a static place. Our customers need the ability to react to the market, so they need their partners to be able to deliver value quickly. Since Duco Cube is a service, we can upgrade all customers monthly, without them having to perform any testing themselves. How do we manage this? Built-in regression testing that uses our customers production data to ensure results are identical before and after a software upgrade. If this is not the case, we immediately roll back the upgrade, so stable service is guaranteed. The best part is that our customers don t pay for new feature development on our platform, as the hosted model allows us to amortise the cost of development across all subscribers. CLOSING THOUGHTS We are excited about the possibilities of the technology foundation we have built and the talented team we have assembled. Duco has received a fantastic reception and growing recognition from the buy-side, service providers and some of the largest banks in the world, despite the fact that we are often competing against larger and more established vendors. Our philosophy continues to favour fundamental innovation over short-term solutions, which we re convinced will pay dividends for us, our customers and the industry at large. our time machine for seeing how results change over 33

34 THE STATE OF THE INDUSTRY INTERVIEW: DREW SHIELDS 34 Emma Davey, FIA s Senior Vice President, Global Communications, interviews Drew Shields, CTO, Trading Technologies Trading Technologies next generation platform, TT, is being rolled out over TT s Chief Technology Officer, Drew Shields, who joined the firm in May of 2014, describes the offering as a hybrid solution between ultra low latency co-located execution and cloud technologies, delivered as Software-as-a- Service (SaaS). Shields says the company first broached the project two years ago, when the distinction between cloudbased technology and SaaS was not as great. In truth, he says, the SaaS tag is more accurate. The emphasis is more on how we deliver the software. So, inevitably, this includes some cloud technology. The new platform will have more co-locations than TTNET, its predecessor. The co-location infrastructure is larger than TT has ever had, says Shields. The reason for this is to provide the lowest latency trading experience for their users despite leveraging the cloud model for non-latency sensitive components of the platform. There is a lot of latency involved if you actually support trading from the cloud, so leveraging co-lo is important, he says. He emphasises that the cloud is not part of the trading workflow. The cloud is great for scaling up lots of data but it is not fast. That is where co-lo comes in, to deliver speed. The platform was unveiled a year ago at FIA s Boca conference in March TT has spent a lot of time educating the market about the solution, and the role of the cloud. Banks are less concerned about performance, says Shields. It is the traders and the ultimate end users who care most about speed. The old platform was not as scalable as the new version, he says. It lacked the agility and was very siloed in its architecture. And the hybrid of traditional and cloud-based technologies is appealing in the new trading environment. The whole process of rolling out the new TT platform will take time, Shields acknowledges, with other co-lo deals being built into the third and fourth quarters of this year. There were 12 co-lo centres under TTNET, and by the time the new platform is complete, there will be 18 data centres. Shields describes the process of rolling out TT as building infrastructure incrementally adding hubs as it expands. For some users, the service is already delivering what they require. If you trade Autospreader on CME, for example, you are already able to do that at lower latencies than any other vended solution. By the end of Q1 2016, TT expects to have achieved market parity with the current platform, TTNET. The response to date has been positive, says Shields, with users of Autospreader and the back end, for Shields describes the process of rolling out TT as building infrastructure incrementally adding hubs as it expands. For some users, the service is already delivering what they require.

35 example, remarking on the reduced latency. The challenge is getting brokers and clearing firms on board. This is a big project for them and they have to schedule it into their long term plans, explains Shields. The good news is that migrating users onto the new platform is easier than ever before. The change offered by TT is leading to a change in the client base too. Because we are changing, we are appealing more to brokers who are concerned with more than just latency, says Shields. As an example, TT offers a better user experience for block trades on more markets and Green Key s Voice Box will soon be accessible via TT. The new platform also offers more control and transparency for brokers and FCMs with flexible account hierarchies and native support of non-disclosed accounts for introducing brokers. Shields is fully aware of the significance of such milestone developments as MiFID II on the firm s clients, and therefore on its own service. He believes the new platform will help meet the data and control challenges presented by MiFID II. On the question of data, the new structure allows users to specify more easily what format they want their data in, for example. It offers more ways to search and mine data with queries from the front end, says Shields. Users can also write drop copies in and out of TT to leverage its potential for data mining even if they do not use the platform for execution. Allowing clients unique and easy ways to leverage data is something this platform excels at, Shields says. Other MiFID II obligations that the new platform should be able to help firms meet include position limit management where the risk manager component can aggregate positions as users require and global timestamps on every transaction synchronised to sub-100 microseconds. Technology is freeing us up, says Shields. On the old platform, if you did not use us to trade, it offered you little. The new platform allows you to leverage different aspects of the service. More of an a la carte menu, says Shields. Shields recognises cybersecurity as a key issue for today s markets. We hope we will lead the way in FIA Tech which collaborates with the industry with the aim of improving operational efficiency via web-based software systems, may provide an opportunity to set industry standards. an area that has not historically been a focus for our industry. We have made security a top priority for the new platform. There are various approaches to meeting the challenges of cybersecurity. Internally we are doing a few things. We have a Chief Information Officer (CIO) with cross-functional teams looking at all aspects including operations, legal, engineering a security team as Shields describes it. The end user of the platform may be more concerned about internal views, not just protecting from hackers but also from TT employees. TT is partnering with third parties who provide penetrating testing etc. and is also looking at broader industry standards. We can be a leader as an early adopter of the cloud and leveraging the public internet for trading services, he believes. He also suggests that FIA Tech, FIA s wholly-owned subsidiary which collaborates with the industry with the aim of improving operational efficiency via web-based software systems, may provide an opportunity to set industry standards. We would be open to this. The industry should come together more and the FIA is in a good position to make that happen, says Shields. Sydney and Singapore are the newest data centres for TT; it already has Frankfurt, New York, Chicago and Aurora, Illinois. Indeed, Sydney and Singapore were the first Asia Pacific location, with Hong Kong, Tokyo and London to come. The firm continues to see opportunity in Asia, says Shields, and the new technology of the next-generation TT platform should create opportunity where the heaviness of the old platform was a challenge. 35

36 THE STATE OF THE INDUSTRY THE EMERGENCE OF A NEW NORMAL 36 By Steve Grob, Director, Group Strategy, Fidessa Innovation, partnerships and customer differentiation are all part of the brave new world for Fidessa. While increased optimism and growing trading volumes are becoming more apparent in the derivatives industry, even as the ongoing market infrastructure upheavals continue, the precise nature of that recovery is perhaps becoming clearer, according to Steve Grob, director of strategy at Fidessa. He recently spoke with FIA Infonet about why this is important for the industry and how his own company is responding to the emerging environment. The idea that there will be a return to the good old days is just a fantasy, he said. People are now accepting that nothing less than an entire reshaping of our industry is taking place and a new normal is emerging that places renewed focus on efficiency and on the value of differentiation. While this is unfolding in different ways and at different speeds across asset classes and geographies, that new mindset is beneficial because it means that all market participants are now focusing on how to be successful in this brave new world. That obviously includes the independent software vendor (ISV) sector, observed Grob. In the past, a wide array of ISV services was available. Often one ISV would have a following in one particular asset class area or instrument type while another would specialise in a different area. If a customer or star trader wanted a specific system, the FCM would be very happy to provide it. But, in the reshaped environment, that way of working has become too expensive. Looking at the fabric of the industry there are many different types of participant, from the large global investment managers to energy producers, right through to the cattle farmers in Iowa, he continued. All have very different requirements and we believe there is money to be made in reflecting those differences, but you need to do it in such a way that you don t have to have a different infrastructure for all the different types. Access has to be normalised as much as possible from a cost and scale point of view, but the front-end trading experience must be dynamic enough to reflect the different types of user. Derivatives instruments reflect a different array of real assets and each of those trades in a different way, he continued. When you develop algos, for example, each one has to be thought about differently because the future behaves differently depending on the asset class. In the equities and fixed income world, however, everything is much more vanilla. You have to balance the cost of meeting that diversity with the revenue that you are able to generate. You re not simply solving a problem for futures instruments in general, you are solving it for a range of different derivatives across a range of asset classes. With this in mind Grob confirms that Fidessa is indeed starting to attract new clients from outside of its core customer base in areas such as the tier 2 firms and the energy trading sector. You need to have a balance between incorporating things like the gateways, the risk management, the infrastructure access etc, in a scalable way, but at the same time, you must address the subtleties of the requirements of different customer segments, he said. Deciding how to service such companies creates an interesting challenge, Grob says. Should they be on Fidessa through having their technology provided by one of the large FCMs who could then provide add-on services such as specialised algos written in the Fidessa