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IT Spend in Derivatives to Soar; Pricing and Analytics a Key Driver

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It will come as no surprise to learn that Wall Street made more money from derivatives products and structured instruments in the first quarter of 2006 than ever before. Into the growing hype about derivatives wades TowerGroup this month, with a raft of reports on the subject, including predictions of annual growth rate in derivatives IT spend of 18 percent annually. But what impact will the burgeoning derivatives business have on market and reference data?

According to TowerGroup analyst Dushyant Shahrawat: “Market and reference data have enormous significance in the derivatives market, as this business is very data hungry and consumes massive amounts of it for pricing, trading, processing and reporting of derivatives. A huge number of market data feeds across asset classes are required for pricing derivatives. For example, pricing an equity option would require not only stock prices, but option prices of other maturities and other comparable derivatives.”

In one of the three reports on derivatives Shahrawat produced in September – Technology Demand in the Derivatives Market: Poised for Growth – the analyst writes in a section on Analytics, Pricing and Data Provision, “Analytics and pricing of derivatives are critical functions in the derivatives market and complex tasks to perform. Valuation and analytics are closely related functions that require many similar inputs and data feeds. For both pricing and analytics, the challenges are speed, product coverage and adequate flexibility and openness of the system.”

A lot of the work done in the cash business is transferable to the derivatives market, says Shahrawat. “The challenge though is there are different vendors playing in the two markets which makes it difficult to take work from one area and transfer it to the other.”
TowerGroup warns that if derivatives automation doesn’t improve, the market will seize up. Fortunately it looks as if automation will improve considerably, if TowerGroup’s predictions are correct. It reckons total IT spending in capital markets on derivatives software and related services will increase from $3.6 billion in 2006 to $5.75 billion by 2009.

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