With a flood of regulations and new margin rules, the resurfacing of electronification couldn’t happen any sooner. In this Q&A, Robert Gray, OTC Derivatives and Market Expert at Numerix, breaks down the role electronification plays in exotics and structured products and gives his take on how electronification of these products will continue to automate and streamline business processes.
Question 1: What are the big trends & key challenges impacting the industry for the year ahead?
Robert Gray: Let’s start with the challenges, shall we? A raft of regulation. Banks are currently wrestling with the new margin rules. After that they’ll be looking at MiFID II which is going to be implemented in January which is months away. Then you got FRTB, certainly on the structured products side there’s all the documentation that has to be worried about as well with PRIIPs and KIIDs and term sheets if it’s for corporates in OTC derivatives. All of that whilst reducing costs and try to increase flow. Banks are changing, there’s no more prop desk because of the Volker rule. So traditional banking is back in focus customers, high networks, corporates by market making. Therefore, the trend is automation through fintech, which is actually now been split into two. You’ve got Reg tech and Fintech, so from solutions for FRTB to wealth management ecommerce, e-platforms for investing, the electronification of the remaining processes in the dealing room and parsing multiple venues into one blotter.
Question 2: What is the cause for market movement towards Electronification now? What factors make this move different from others? Are there different regional drivers for this movement?
Robert Gray: Many markets will believe to be un-electronifiable, if that’s a word, due to their complexity, exotic options, structured products. A fun enterprise of multi-leg FX option, a strip for example, it would take some time. Even longer if solving for certain outcomes, but new technology, faster processing of models and methodologies has changed the landscape. Customers can have a real-time price, deal on it, download supporting documentation from the market maker with minimal, human interaction. The regulator is forcing the change requiring audit trails and documentation with proof of suitability. In previous, it was cost, in equities, in futures, easy to go on screen, relativity. Standardized contract specifications, then you’d get a reduced headcount, reduce cost, so faster execution and more business. Trades also need to be processed as quickly as possible to calculate real-time risk, VaR, and even before quoting certain suitability tests need to be met; has the customer got the funds, the margins, the credit, and all the XVA calculations priced in as well. Add in real-time risk, and in effect, many traditional complex markets are now becoming a flow business. Especially in FX, interest rates, and equities.
Question 3: Are there banks out there doing this now? And if so, how has this impacted them?
Robert Gray: I’d say banks have been doing it for many years in other asset classes, certainly in the more vanilla products. So, they’ve already gone through this experience even in the 80s, 90s, and 2000s, in equities, in financial futures, in foreign exchange, spot foreign exchange, and forward foreign exchange. It’s now looking at the opportunity to do that in OTC derivatives and structured products and as far as how it’s changed the banks, I mean there was a recent statement by Daniel Pinto from JP Morgan, who sees a quarter of all market revenues now coming from electronic trading, five and a half billion dollars’ worth in revenue in fact, and stating that in interest rates ninety percent of his business is now done electronic. So, nearly all of it and you’ve even got the retail guys, the big retail guys, Saxo Bank, CMC, have been offering fantastic cross-asset, electronic, execution to people like you and I for quite a long time as well. So, people are used to it, they expect to see it, and let’s face it, our whole lives are now electronified when it comes to checking in on a flight, or sending a birthday card or a Mother’s Day card or even buying your groceries online, auto-checkout, they’re even talking about driverless cabs, so, we’re no stranger to automating processes.