Transforming cleared derivatives markets

DDuring a panel at the Arab Capital Markets Federation conference in Bahrain in March 2022, Anna Theorin, Head of Clearing Technology at Nasdaq, discussed how technology can help clearinghouses meet the challenges of management of collateral in cleared derivatives while improving operational efficiency.

Collateral plays an important role in market liquidity as it mitigates credit and counterparty risk and thus enables participants to access organized markets and contributes to liquidity. However, collateral is in greater demand than a decade ago due to mandatory over-the-counter clearing and the phasing in of uncleared margin rules, meaning firms must post margin on products that were previously not guaranteed.

For clearinghouses, this shift emphasizes optimizing margins and collateral to properly manage risk without requiring more collateral than necessary. Some clearinghouses offer cross-margining between OTC and exchange-traded derivatives. Meanwhile, many clearing houses are moving from SPAN to a VaR-like methodology to use a more refined metric to calculate margin requirements.

Also, the type of collateral to be accepted is an important aspect that the clearing house must take into account. By using non-cash collateral, such as gold, the clearinghouse releases cash collateral that can be reinvested in the market. This is a delicate balance, however, as they are less liquid. With recent massive increases in margin requirements in energy markets, standby letters of credit can be considered as a form of collateral, although regulations limit their use.

Finally, depending on market conditions, it may be necessary to post collateral intraday, which constitutes an operational burden for the clearing houses. This becomes even more concerning given the proliferation of 24/7 cryptocurrency trading.

Theorin developed four technological aspects and transformational moves that would help improve collateral management and operational efficiency in derivatives clearing:

Improve visualization: From a technology and usability perspective, visualization is an often overlooked but powerful way to help collateral managers and other trading operators better understand and anticipate margin requirements and collateral in order to make informed decisions about use of collateral and position management. By optimizing the user experience when operating in these complex environments, which is especially important during times of market stress, we can reduce the cognitive load on business operators and facilitate timely decision making.

Leverage emerging technologies to make warranties more accessible: The fragmented custody network with delays and cuts across the globe results in slow collateral management and difficulty in accessing collateral. This leads to operational risk and fuels cost inefficiencies. Distributed Ledger Technology (DLT) is an emerging technology that could solve this problem by giving participants instant access to collateral. Central bank digital currencies (CBDCs) could also be used to facilitate more efficient access to collateral, which several governments are exploring how to implement.

Adopt industry standards: The move towards standardization is essential for efficient and streamlined operations while focusing efforts on innovation and business development rather than infrastructure maintenance. An example of such industry standardization is APIs for connecting to clearing house services, which were traditionally proprietary. As a technology provider for over 100 market infrastructure operators globally, we have seen a clear shift over the past five years towards a desire for standardization as customers update and improve their technology infrastructure. While operators may have previously feared that standardization would lead to a loss of service stickiness and competitive advantage, many are now seeing the benefits of standardization and how it helps improve agility and focus. on innovation and business transformation. The Futures Industry Association is working to launch an independent standards body called Derivatives Market Institute for Standards (DMIST) in Q2 2022, an initiative that Nasdaq is involved in developing.

However, Theorin also stressed that it is essential that the industry agrees on the areas that can be standardized. From a tech vendor perspective, it would be great if everything was standardized, she said, but that’s not going to happen. There will always be unique characteristics and factors, as well as the practical need to accommodate regional differences – which are always imperative to consider.

Transformation with cloud operations and managed services: The cloud will be a major driver of change for market infrastructure over the next decade. According to a Nasdaq-commissioned Celent study, market infrastructure CIOs plan to increase their investments in modern technology, and nearly two-thirds, 65%, see cloud technology as a fundamental and expanding part of their business. software development. At the end of 2021, Nasdaq announced a partnership with AWS to move its US markets to the cloud. By moving from on-premises operations to the cloud, market infrastructure operators can become more agile in setting up and testing new initiatives, as well as effectively managing fluctuating transaction volumes.

This goes hand in hand with a growing interest in managed services and SaaS, Theorin concluded, which again allows resources to be focused on business development rather than technical operations.


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