Middle men – the new aces in the derivatives deck

Lewis Richardson is derivatives business development manager at Fidessa

In today’s high-risk, cost-conscious world, buy-sides are demanding the next step in straight-through-processing, becoming increasingly impatient with the multiple screens and manual workarounds they’ve been presented with to date. Those FCMs that can meet this need will immediately become more competitive and create clear distance from those that lag behind, writes Lewis Richardson.

Derivatives workflows are complex, not least because the middle office processing should ideally be done within 20-60 minutes of a trade. A trade is created, the trader often handling several different brokers for execution; traders write allocations on paper tickets, put them into spreadsheets or enter them into a separate system, and pass these down to the middle office folks who process or monitor them manually. If the trader gets busy with something else she’ll often find middle office people breathing down her neck for allocations, and the reverse is true too – middle office staff can find themselves being chased by traders, who are in turn being chased by PMs or clients asking where their trades are.

These manual workflows have forced FCMs to come up with their own client-facing allocation systems. While these may be good as stand-alone systems, they add yet another interface to an already crowded workflow. Where a buy-side has multiple FCMs they will often have an allocation system for each, an imperfect solution that quickly becomes very complicated and increases the risk of error.

Traders and middle office staff both feel the frustration of chasing each other around with paper tickets, while everyone is trying to monitor the progress of allocations and settlements on multiple screens of varying quality.

In smaller brokers without middle office staff, trade allocations, once received, are entered on to spreadsheets and sent to FCMs by email or FTP – both of which are prone to system gremlins. If the information is received, not only do the FCMs have to rely on that information being perfectly correct, they then need to communicate by email, FTP or phone back to clients to confirm or check details. Then they need to monitor whatever screens are relevant to that client to ensure matches are made. Headcount has to be available to monitor each of these many screens – an expensive and inefficient use of manpower.

The nature of global markets adds further complexity as ‘follow the sun’ trading leads to ‘follow the sun’ allocations. Where trades remain unallocated, managing allocations across time zones makes for a minefield of manual processes, reconciling against multiple screens and chasing colleagues in disparate time zones by phone and messaging systems. Then in the back office all the information is replicated again for settlement. Yet more processes are piled on top of the front and middle office processes.

The whole system is fraught with operational risk and stressful for all involved. A better way must be found.

The technology needed to solve these issues is evolving, but slowly. What’s needed is for the middle office to integrate with the front office on the client-facing side, and with straight-through systems on the other.

Deploying middle office terminals to buy-side clients is a half-way point, but then the buy-side can’t see what’s going on within the context of their own OMSs, and now they have two (or multiple) systems to keep track of, neither (none) of which talk to each other at all. That’s been the issue through time with proprietary solutions – they don’t communicate well with existing systems and require a whole lot of external expertise to maintain. Running and maintaining multiple systems is a headache the industry is constantly grappling with and any constructive moves need to be away from that and towards a properly integrated approach.

Some firms have attempted this by patching together the data from multiple sources to give a single view. This means collating the data from multiple feeds, each in a proprietary language, then consolidating them down into a single normalised feed. It’s a start, but not ideal. It requires a lot of manual work and processing to create and maintain, and if it’s not correctly set up will result in trades failing to process.

It is in fact possible to integrate the paper ticket/spreadsheet system, as well as all those disparate vendor feeds, into a buy-side’s existing front office system in a vendor-neutral way that doesn’t involve risky processes. This gives the trader just one additional screen in addition to her OMS, providing an automated way for her to handle multiple broker post-trade relationships, just as an EMS does for order routing. In this screen she can see all her trades and enter the allocations herself, then keep an eye on them in real-time as they match and drop away. This way she can communicate efficiently with her clients and/or internal stakeholders about the status of her orders. This function can even be built directly into the OMS.

The way to achieve this is to use existing open-source protocols to drive the development of acceptably fast and accurate processing of derivatives workflows. A great candidate for this is FIX because it starts at the order level and, following the natural direction of the workflow, removes the hassle and risk of adding information all the way along. This persistence of information is an achievable goal. Once this is in place, the rest is pretty easy.

While most FCMs are still running older versions of FIX, workarounds and selective upgrades are possible to enable derivatives processing without a full firm-wide upgrade. Enabling FIX in this way does two important things for the buy-side. Firstly, it provides that persistence of information that will so drastically lower risk. Secondly, it puts the power back in the front office’s hands, enabling the desks themselves to manage and keep watch on allocations.

Offering clients the opportunity to have a better trading experience, as well as cutting operational risk, is a powerful selling point for an FCM. The middle office may indeed soon become the place where business is won or lost.