Failed trades – or the threat of them – are pushing the issue of back-office investment to the fore and it is time businesses looked at how they can address the situation. But if concepts such as operational risk aren’t making a full transition from banking to broking, will it require the regulator’s heavy hand to make the back office a more stable place?
There are already plenty of straws on the camel’s back in the stockbroking business, but different requirements from industry players are fragmenting technological advances. “The pressure is there for STP [straight-through processing],” says Piers Farbrother, product manager at Rhyme Systems, although he points out that full automation is only being applied to small and medium-sized brokers. “If you look at Tier 1 or Tier 2 firms, STP is not the answer. These are the guys that have got the funds and they’re looking at workflow systems – they need manual intervention at some point. Workflow is almost stockbroking back office by numbers.”
To see a broad advance in back-office technology will require some degree of standardisation. Initiatives from industry bodies, such as Financial products Markup Language (FpML) development by the International Swaps and Derivatives Association (ISDA), seem the only route to achieving this. Brokers’ appetite for further investment is limited.
Back-office inefficiencies
The markets that are currently struggling, such as equities, understandably don’t provide much motivation in improving the back office, says Dush-yant Shahrawat, senior analyst in the securities and capital markets practice at TowerGroup. “[In] the areas where the banks are doing well, such as credit derivatives and foreign exchange, it is easier for the guys in the back office to argue that they need investment. That’s ironic because one of the reasons that equities may not be making money is because the back office has not wrung out all of the inefficiencies,” he says.
In the credit derivatives market, UK and US regulators have expressed concern over trades staying unconfirmed for months at a time. John Lewis, CEO of technology supplier Scrittura, explains that confirmation of non-exchange traded derivatives is still proving problematic: “In the past nine months, this has become a very serious topic. Typically, the buy-side thinks that the brokers will provide the automation and processes for them. But with the type of instruments they are, the brokers really get the lopsided risk equation if they do everything,” he says.
“This requires the buy-side to be a more active partner rather than passively using the technology provided by the broker. That’s where you get the disconnect. The buy-side are used to dealing with exchange-traded instruments.”
This situation needs defusing before the increasing volumes of trades make it unmanageable. As a result, brokers are investing in more STP technology and workflow systems. Arguably, an increase in staffing could improve confirmation levels and some in the broking community believe that risk is best handled by ensuring the right people are in the right positions.
Sparse expertise
Mr Lewis is sceptical, however: “Volumes are growing by 40%-80% annually – how are you going to hire the right people? Are you going to double your staff every year?” When the products are the latest over-the-counter (OTC) derivatives, a level of expertise is required that can be thin on the ground.
In these circumstances, technology seems the obvious solution and as long as the market is still profitable, it is feasible for brokers to invest in their back offices. There are economic routes to investing in additional systems. Mr Lewis notes that FpML is aiding development of messaging systems and ASP (application service provision) is also being discussed with a number of brokers that are trying to create a complimentary workflow with their buy-side. “There is a certain level of technology spend that’s required on the buy-side for a messaging system to get the economic terms back and forth, less for a portal and there’s much less if you’re sending emails with documents back and forth,” he says. “The messaging would be strong but I think the portal meets the right level of technology spend and gets the confirmations processing done.”
Client-money segregation
Lack of automation also means that brokers are losing out unnecessarily in the area of client-money segregation. Client money must be kept separately from a firm’s money to protect the client in case of the company’s failure. Currently, brokers are often playing ‘too safe’ by overestimating the money needed for segregation during the cash reconciliation process.
Alistair McGill, product manager at Smartstream Technologies, says the problem is due to an attitude of “if in doubt, segregate it”, and a lack of accuracy originating from current procedures. “It’s usually a very manual process and a few years ago, the FSA began getting on to [the brokers] telling them they had to become more organised. For the most part, people began using Excel or access-based solutions. The FSA is now pushing again, getting stricter on the ways and means by which brokers are forming the calculation.”
There is a good reason for businesses to be motivated in this respect without having to be pushed. Mr McGill says the amount of money oversegregated within an institution can be hundreds of millions of pounds, severely hampering liquidity. To enhance this procedure is complex, as disparate processes must be run through to arrive at the final figure. In Tier 1 banks and brokerages, 20 to 30 data sources, such as reconciliation systems, may provide the initial information. This is then fed to the lines of business so that exceptions can be viewed and marked ‘segregate’ or ‘don’t segregate’. In automating the process, the data can be formatted, combined with the history of a break giving an auditable view of the procedure.
“A system like this can help not just with making the calculation accurate and so improving liquidity but also highlighting who decided what, when and why,” says Mr McGill. “This means people who are currently occupied with the manual aspects of reviewing exceptions can get back to looking at the underlying causes of exceptions. Your exception count reduces, your STP rate goes up and your requirements of segregation drops as well.”
Finding growth
The patchwork automation currently occurring does not surprise Mr Shahrawat, given the different speeds at which change is occurring. “The broking market has already worked very hard to reduce expenses for the last five to seven years. Equities are flat, so what are you going to do? That’s when you look to areas like derivatives for growth. Once you have increased that business by, say, 10%, it is harder to make another 5% growth on top of that. This is the time to start looking at the back office to reduce costs.” For this to have any major effect will require some development across the industry and not just within the silos of individual organisations. Industry bodies are assisting with this through the creation of standards, and until these are realised, the current piecemeal trend of automation is likely to continue.
Mr Shahrawat believes that only standards can lead to more rapid progress. “Whatever you do internally needs to be matched by a certain level of standards across the industry. In the derivatives space, we do not have those standards yet. ISDA is trying to spearhead those initiatives but that’s a slow process. Until we have those standards, even the very aggressive firms can only achieve so much,” he says.
