Two Key Ways to Tackle the Derivatives Cost Challenge
By John Omahen, vice president - post-trade derivatives, FIS
In today’s low-margin futures and derivatives business, low interest rates and high operating costs in the clearing community are causing enormous strain on profitability. For firms who have decided to remain in the business, their top priority is ensuring their operating model is sustainable by implementing more efficient technology and finding cost-effective ways to perform their middle- and back-office operations.
However, doing more of the same will not be enough for most sell-side institutions in the derivatives clearing business. They will need to take a more radical approach to find those cost savings than they ever have before. With the “keep the lights on” costs increasing every year for firms, the issue has never been so critical.
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 have gone only so far in moving the needle on profitability. For many firms, incremental improvements 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. As a result, two relatively new strategies are emerging to create long-term sustainability and competitive advantage: embracing utility models for operational processing and the emergence of so-called “big data” analytics.
Embracing the Utility Model
Utilities are predicated on the basic assumption that many of the operational functions performed today at clearing firms and investment banks are essentially the same from firm to firm. Institutions throughout the industry have slowly come to realize that middle- and back-office functions are commoditized tasks that provide little differentiated value from their competition, as evidenced by their increasingly common practice of outsourcing certain technology and functions.
However, where there is repeated infrastructure, expertise and technology, there is opportunity for significant savings through economies of scale and mutualized cost. This is where utilities come in, to take the wildly inefficient status quo and bring it to a well-oiled central machine that can help businesses operate more efficiently and improve the quality of their operations. When those benefits are combined with technology innovations that are emerging (such as FIS’ cleared derivatives solution), you have a game-changing offering that only a central utility can provide.
The use of utilities can offer not only a more sustainable cost structure; reducing costs and streamlining the work also lets firms return focus to their core business strategies. Those day-to-day tasks that consume budget, oversight and resources can be redirected toward acquiring new customers, entering new markets and focusing on competitive differentiation.
But by far the greatest positive impact that utilities can make is easing the tremendous cost burden of regulatory change. Most IT departments are faced with having to allocate the cost to support regulatory
change in their yearly budgets, with many revealing the amount as well over 30% of the total, at a time when profits are down and their overall budgets are shrinking ¾ a pretty tough position to maintain.
Utilities can also create the standardization across firms that reduces the cost of compliance. Once it “solves the requirement” for one firm, it can apply that same knowledge, code and expertise to the rest of the utility participants. Additonally, since utilities have the potential to represent so much of the industry, they can serve as a collective “industy voice” with regulators and other industries bodies, resulting in greater leverage than is possible today as individual voices. As cited in a recent industry report, “Collaboration and Utilities ¾ Drivers of Derivatives Processing Transformation,” there is a clear desire among global clearing firms for industry-wide collaboration and utilities to eliminate redundant and inefficient processes, drive the standardization of data, and migrate to systems that are more modular, open and real time and provide better data analysis.
”Big Data” Analytics and the Next Generation of Post-Trade Processing
Understanding the health of operations and the total cost of ownership (TCO) 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 today where most firms have their key data spread across a wide range of in-house, vendor and clearinghouse 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 is now very possible to migrate off the mess and onto a much more centralized 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. 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 are questions that are surprisingly hard to answer for any clearing business, not just the large, global banks. Yet it is this information that is the most useful in order to make 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 clearly more ambitious than ever before. With the emergence of utilities to mutualize the cost
of commoditized tasks, and consolidated platforms to improve data analysis, a more sustainable operating model and cost structure for the derivatives clearing industry is now within reach.
For more information on FIS’ post-trade derivatives solutions and services, visit our webpage or contact us at CM.PostTradeMarketing@sungard.com.
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