Major US broker-dealers must move towards automated front-to-back solutions for over-the-counter (OTC) interest rate derivatives to fully embrace imminent regulatory changes proposed by Congress, according to new research from consulting firm TABB Group
The research, ‘OTC Interest Rate Swaps and Beyond: The Path to Electronic Markets’, contends that automation of the OTC derivatives market will lead to greater price transparency and more efficient trade processing.
Following the financial crisis, the US government announced a series of proposals to tighten up OTC derivatives trading. The proposed changes centred on four aspects: the standardisation of OTC derivative instruments; the creation of central data repositories to monitor volumes and values; central counterparty (CCP) clearing; and execution of OTC derivatives on public exchanges.
According to TABB, 90% of interest rate derivative exposures can be standardised to enable electronic trading, clearing and reporting to trade repositories. The consultancy also claims that there is no OTC derivative asset class, including interest rates, foreign exchange, credit, equities and commodities, with aggregate post-trade workflow automation greater than 57%.
“Not only does e-trading provide a more efficient and effective way to execute OTC derivatives transactions, without it full workflow automation is impossible,” says Paul Rowady, senior analyst at TABB and author of the report.
The study also noted that interest rate swaps have the most trade errors of any OTC asset, largely because of manual affirmation and confirmation processes, another area that TABB argues would drastically improve with front-to-back automation.
However, Rowady observes that major US broker dealers – specifically the top five US banks – have a 97% share of commercial bank exposure to OTC derivatives and are the counterparty to nearly every trade in these markets and as such, are focused on maintaining and protecting their OTC franchises.
“The main challenge is to convince these dealers as well as an equal number of other global banks, to give up their phones in favor of a more automated execution environment,” said Rowady.
According to the Bank of International Settlements’ bi-annual survey, the total notional value of outstanding OTC derivatives contracts among the G10 countries plus Switzerland stood at just over US$604 trillion in June last year.
Rowady has become the latest analyst to join TABB Group’s research team, having co-authored and contributed to the firm’s studies since early 2009. Rowady joins from Alphacution, a provider of real-time business intelligence systems, where he was managing director. He has worked at Quantlab Financial and multi-strategy hedge fund Ritchie Capital Management. Rowady will be based in Chicago and report to TABB’s director of research Adam Sussman.
“Paul’s 20 years of hedge fund industry experience on and off the trading floor will be a tremendous asset to our research and consulting client base,” said Larry Tabb, founder and CEO at TABB Group. “His excellent background includes a unique mix of research, trading technology and software development as well as hedge fund management expertise at a corner office executive level.”