Taken together, two key surveys provide a snapshot of how you and your fellow market participants are allocating your financial technology dollars in 2012. Not surprisingly, the regulatory overhaul of over-the-counter (OTC) derivatives trading is the single biggest budget driver. It’s also no shock that the buy side is still dragging its feet on the OTC front.
The London-based consultancy Rule Financial recently found that as a result of its study of the impacts of Dodd-Frank sell-side firms are overhauling their operations and IT infrastructures, and “investing heavily in client execution and clearing propositions that will become operational in 2012.” By contrast, the buy-side is relying on the sell-side to help them out with solutions to ease the problems caused by Dodd-Frank regulations. The enthusiasm gap is rather shocking: 70% of sell-side firms have done business process redesigns while only 20% of buy-side firms have even bothered to do the analysis.
“On average, spending by sell-side banks with aggressive OTC strategies has been in the order of $10 million to $50 million annually, since 2010,” according to the Rule Financial report. “At the other end of the spectrum, those banks planning to adopt a ‘franchise protecting’ minimum day-1 offering have spent less than $5 million annually over the same period. As expected, buy-side spend has been negligible in comparison, and is estimated to be in the order of $1 million to $2 million for each participant this year.”
The regulatory overhaul of the OTC lifecycle has compelled the sell side to review operating models with some banks converging OTC, exchange, prime and collateral businesses into “a single organizational entity,” according to the report. Rule Financial has also found that collateral management departments are growing in stature as Basel III is fostering closer ties between securities lending and repo units. The collateral management groups are getting “heightened attention and investment.”
Rule Financial also reports that sell-side banks are pragmatic in their support of execution venues and the buy side appears to “overwhelmingly” favor Bloomberg over the execution venues of Tradeweb and ICE. “There appears to be little appetite to use the interdealer brokers that are currently readying their swap execution facility (SEF) platforms,” according to the report.
Part of the problem with buy-side firms is that they are so confused by OTC mandates.
For instance, Rule Financial survey respondents were not certain of OTC clearing timelines and they cited “a range of deadlines from 1st September 2012, through to 1st September 2015.” This translates into a buy-side view that Dodd-Frank is a burden and not a means to revamp flawed OTC business models, says the consultancy. Of course, the overwhelmed regulators have not been able to provide clarity on deadlines and time-frames, and have been shifting the goal post, which only adds to the buy side’s confusion. The only clarity for the buy side appears to be a looming price tag.
“The cost to the buy-side of trading OTC derivatives will certainly increase, with the expectation being that charges for collateral will have a significant impact on their returns,” says David Holcombe, a specialist in markets and trading for Rule Financial, in a statement. “Consequently, buy-side firms are looking to clearing brokers and futures commission merchants to minimize the increase in cost of the central counterparty (CCP) model, via collateral optimization and pricing.”
Despite the cloudiness, the sell side has been pretty much full speed ahead. “The ‘golden circle’ of large banks seeking high market share have, on average, spent over $100 million each in building their propositions, to date,” Holcombe says.
Sadly, there is more cloudiness ahead, according to the International Securities Association for Institutional Trade Communication (ISITC), the trade group that takes on standards in transaction processing. (ISITC will be holding its annual industry forum and vendor show on March 25-28, 2012 at the Renaissance Boston Waterfront Hotel.)
On the upside, the ISITC annual member survey found that 71% of those firms polled (investment managers, broker/dealers, custodians and vendors) expect IT spending to increase over the next two years. On the downside, the survey found that 82% of respondents say the future of the industry is “cloudy” and they have no idea what the market will look like in 2020. I guess the import of that finding is a general unease about the markets rather than a blissfully optimistic outlook.
The ISITC survey also found that:
• 45% of respondents say that the economy is “not poised for recovery but for continued slow growth;”
• The Great Recession compelled the industry to fix infrastructure and processes, according to 68% of respondents;
• A whopping 90% of respondents say the industry has made progress toward improving standards by adopting best practices even though there is a need for improvement;
• The top priority in 2012 for 40% of respondents is an adherence to new regulations;
• And nearly half, or 45%, say that regulations will have “the greatest impact on operational risk management” while 43% say that new regulations will have “the greatest impact” on their overall operations and on derivatives clearing (29%).
So, it looks as if spending will be going up in 2012—at least under the guise of OTC derivatives reform. I also think the surveys tell us that firms have weathered a very bad storm and are sadder but wiser.
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