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OTC Reform Causing ‘Big Data’ Challenge

By Ciaran Henry, US country manager for Rule Financial

In 30 years the OTC derivatives landscape has not faced such sweeping changes as it does today. Dodd-Frank, EMIR and the Volcker Rule are all new regulations in the capital markets devised to protect US and European consumers from ‘bailing out the banks’ again. As these various pieces of regulation are passed through as legislation, we are witnessing first-movers re-engineering their infrastructures to deal with the new real-time reporting regulatory requirements.

New research by Rule Financial has found that a staggering 85% of OTC trading systems components and functions will be touched in some way by the requirements of Title VII and the Volcker Rule. TABB Group estimates that market participants will spend $3.4 billion this year on clearing and back-office technology in order to deal with the consequences of the OTC reform rules.

Infrastructure replacement, augmentation and reconfiguration are not the only issues to contend with however – data volumes are also a growing concern. Data volumes are already significant and will only continue to grow over time. The surge in data will not only challenge the dealers, but it will also cause headaches for central entities such as swap data repositories (SDRs) and derivatives clearing organisations (DCOs), who will be receiving and retaining data from multiple market participants.

The sheer scale of this challenge has given rise to the ‘big data’ megatrend – where data moves from conventional, product silo-driven databases to very large scale data warehouses and appliances that combine software and hardware to improve processing power. According to a recent TABB Group report, OTC derivatives reform implementation will cause data levels to surge as much as 400% (Technology and Financial Reform: Data, Derivatives and Decision Making, September 2011).

There are of course benefits to be reaped from having all of this data in one location. Dealers will be able to use business intelligence tools and analytics to examine their trading activity for areas of concentrated risk, or on the flipside, for potential opportunities. For example, dealers may be able to develop and back-test algorithmic trading strategies which can be implemented in the execution flow and for their clients. Also, having a more complete view of positions and how they are performing across asset classes will inform the process of collateral optimisation and margining. Real-time data can be used in the development and implementation of control and surveillance functions within the flow of the trading activity, as opposed to offline and after the fact.

If the prediction of anywhere between a fivefold and twentyfold increase in the number of trades turns out to be accurate, firms who have not streamlined and automated their trading processes could be leapfrogged by early adopters who are armed with the process and technology improvements to gain additional market share.

Those lagging behind in integrating data across product silos will also be disadvantaged on the client and prime services side of the business, in competing with clearing services, cross-margining and optimising use of client collateral.

Agreed, many rules have already been delayed, and there are a few market participants who believe that political challenges to Dodd-Frank in an election year could weaken or even repeal the legislation. However, this view is not widely-held and the majority of doubters are grudgingly beginning to mobilise around executing the changes to the new centrally cleared, electronically executed market model – albeit at a slower pace. Those institutions who are still opting to take a ‘wait and see’ approach will very likely lose competitive edge altogether.

My advice to those dealers, clearing houses and buy-side firms who are in hibernation mode would be that OTC derivatives reform is not going away and immediate planning and action needs to be taken. Implementing the technology changes needed to comply with Dodd-Frank and EMIR will be a very complex and risky feat, with a significant cost element which could run into millions of dollars, depending on the scale of the business and the level of flexibility of incumbent legacy systems.

There is also the very real risk of supply shortfall as the whole industry will be mobilising to implement systems overhaul. It is a fact that the talent pool of people with the right product skills and real-world experience implementing large-scale change in a complex product space is not infinite. Technology resources are already much in demand, even in today’s down economy.

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