Institutional
asset managers have obtained client mandates that allow for
the use of derivatives, including interest rate, total return,
credit default, asset, basis, commodity, and currency swaps,
as well as swaptions. Firms currently support this business
with a variety of manual processes and homegrown systems that
are not scalable. Because transaction volumes and complexity
have grown significantly, many firms are assessing whether
they should build or buy a derivatives processing system.
If derivatives processing systems are not enhanced, asset
managers must either limit the use of derivatives or face
significant operational and financial risk.
It's About the Data
The challenge of derivative processing starts with trade
capture. Existing trader order management, accounting and
data warehousing solutions lack robust data models to record
the details of all but the most straightforward derivative
transactions. As a result security master data required
for securities processing is maintained in spreadsheets.
In many cases there is no gold copy, and different security
master data is used to perform front, middle and back office
processes.
With transaction details on paper and in spreadsheets,
the confirmation and affirmation process is frequently manual.
Pricing, payment processing and collateral management all
require human intervention and often rely on a single or
small number of mid-office professionals who understand
the complex mechanics of these instruments.
Vendor Solutions Fall Short
For the most part available vendor solutions have their
origins in supporting the business models of sell-side firms
and banks, and they have not developed fully functional
systems to support the asset management business. There
are eight to ten established vendors offering front, middle,
and back office functionality for derivatives. Initially
these systems were developed to provide trade capture, analytics,
and risk management capabilities for interest rate derivatives.
Over time they have evolved to support multiple asset classes
and new types of derivatives and were expanded to provide
straight-through processing for trade settlement, collateral
management, and accounting for the broker dealer community.
With the increase in derivatives trading at investment
management firms and the need for systems to support complex
transaction processing, vendors are just beginning to take
an interest in traditional buy-side firms. They have robust
functionality that can be used by asset managers for trade
capture, analytics, stress testing, pricing and risk management.
However, because vendor solutions were developed for
firms with a single pool of capital, the concept of a separate
portfolio is lacking, and the systems do not support buy-side
straight-through processing. Most of the vendors do not
consider this overall structure a problem, claiming that
portfolios can be created through a hierarchical structure,
using rules, parameters, and workflows to establish controls
for data processing from trade capture through accounting.
Trade Impact and Trade Evaluation
A few vendors understand the business requirements of this
market and have made significant changes to their systems.
However, we believe that there are significant questions
about the vendor commitment to the buy-side. Most vendors
remain focused on their core business with banks, brokers
and the hedge fund community, and they are not making the
systems enhancements to meet the business requirements of
asset managers. Until vendors complete those requirements,
asset managers will need to fill in the gaps with proprietary
solutions and workarounds.
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