Over one year on from the pandemic-driven volatility last year, Joanna Davies of OSTTRA takes part in a Q&A that explores how buy-side firms can gain greater visibility and efficiency in exchange traded derivatives markets.

Jo, it has been over a year now since the first wave of the pandemic rocked global markets. Can you cast your mind back and tell us about what this unpredicted period of volatility was like for OSTTRA clients?

Imagine this, the head of equity futures for one of the world’s largest asset managers is trying to navigate clients through the worst trading day since the 2008 financial crisis. Dow Jones futures tumbled more than 1,300 points, and executing brokers are subsequently scrambling around trying to work out how to fairly allocate an order for over 1,000 Dow futures across multiple funds.

This COVID-19 induced global volatility reinforced just how painful the give-up process is for our clients, and the impact on operational resources when things go wrong. This isn’t a new problem either – give-ups have been a thorn in the side of market participants for decades.

What were the specific challenges that the buy-side side had to overcome during this time?

Typically, asset managers placing and managing large orders across multiple funds can only allocate across these funds once they know the final quantity and average price of the entire order. Sometimes, it is the choice of the asset manager in terms of how long it takes to complete an order. This can be achieved through using algos, good ‘til cancelled (GTC) orders, or limit orders that sit at the edge of trading ranges – which can create a huge backlog of unallocated fills.

In addition, while an asset manager may be highly efficient in the allocation process during times of peak volatility, there could still be multiple allocations being communicated within minutes of the market closing. This creates an entire myriad of problems, with which the industry continues to wrestle.

Interesting, so what is the knock-on-effect on the sell-side?

Even if the asset manager allocates early in the day, the challenge for executing brokers is to identify the exchange fills (executions) associated with a single order. These executions at different price levels must be average priced before they are given up. To compound the challenge, in keeping with their mandate, asset managers are executing multiple orders during volatile periods to manage the risk within their portfolios.

Executing brokers play an important role by providing buy-side clients superior execution quality through strategies that reduce the market impact of buy-side activity, but often get hit with a hefty capital charge when the allocation of give-ups are not successful. They must clear these overnight and absorb the cost with no recourse to pass on the charge. This poses a risk to smaller executing brokers, in particular. In addition to average pricing complexities, inconsistent data models, and the lack of common symbology all complicate the allocation and matching process for all market participants.

Aside from the executing brokers, who are the other market participants effected by the give-up process?

Clearing brokers also are on the hook for clearing trades that are covered by a give-up agreement but have limited visibility or control of the upstream process. The industry challenge is more than just inefficiency in the give-up workflow. Checking give-up agreements and commissions are dealt with at the clearing member’s end of the workflow where timing and lack of quality data conspire to make trade acceptance hazardous and resource hungry.

Moreover, issues can occur due to the sequential nature of the give-up workflow where trades are still sitting with the executing broker before the clearing broker accepts them. Fills accumulate on the executing broker’s account at the clearing house until allocated. Once a client disseminates its allocation, the client remains in the dark until the clearing broker confirms the trade back to them.

One hiccup in this workflow will delay or prevent the give-up from completing. During this process, the trade is cleared in the eyes of the clearing house but is not cleared from the perspective of the executing broker or asset manager – which leaves unallocated exposure. All the while, the client is oblivious to any issues.

Ok, so what does the industry as a whole need to do to overcome this longstanding challenge?

The goal of any process improvement should be to reduce the operational, financial, and capital cost for executing brokers and must give the buy-side client real-time transparency into the status of the executions and control over the allocation of the risk to the correct accounts at the clearing brokers.

For the clearing broker, the process must provide real-time visibility into give-ins so the members can assess the risk of the positions in a timely manner. Improved transparency and greater control of risk will ensure timely processing of give-ins. Several CCPs provide standardized and real-time workflows for average pricing, give-ups and give-ins that serve as a good foundation to meet the goals of the buy-side, executing broker, and clearing broker. Each participant has a crucial role to play, and it may simply be a case of re-assigning responsibilities to the corresponding change in the workflow.

The exchange view of the trade should remain the immutable record, but the buy-side clearly group and reference it from a very different perspective. Relatable data points, like common order IDs, from all sides would allow the two perspectives of immutable record versus a client copy of the allocation, to be matched.

What is the role of a vendor like OSTTRA in helping the industry finally overcome this challenge?

OSTTRA has an extensive network of executing and clearing brokers that service over 100 buy-side clients. Our established ETD ClientLink service not only normalizes client allocation messaging but enriches them with fills from the executing broker. The service also manages the nuances between different broker requirements, helping to negate complexities arising when dealing with multiple executing and clearing brokers.

We have applied in-depth industry knowledge to encourage change from buy-side partners to help allocation processing. A key part of this is the work we are already doing to capture relatable data from all sides in order to unlock efficiencies. OSTTRA are extending existing ETD ClientLink functionality to meet many of the challenges under industry discussion, with a view to utilizing new technology and services as they become proven.

As mentioned previously, buy-side clients need flexibility, and it is impractical to constrain their needs to achieve the operational efficiency of timely allocations and give-up processing. We at OSTTRA believe we can bring operational efficiency, transparency, and timely processing whilst giving buy-side firms the necessary flexibility to meet their mandates.

Conversations with multiple industry participants indicates this approach as the most pragmatic and expedient way to solve the functional issues. Our experience in the reformation of OTC clearing workflows, only adds to the support of our participation in this complex debate. Success in achieving these goals requires us to collaborate on designing the workflows with buy-side clients, executing brokers, and clearing brokers and leaves the door open for other service providers to join forces to solve. What is becoming increasingly clear, however, is the transformation of the workflow should be the main goal for all parties.

As an industry, we need to ensure that we let the workflow determine the technology, not the other way around.

Since we last spoke, how have your engagements with industry participants progressed?

We have discussed our proposals with a wide range of industry participants including asset managers, clearing brokers, executing brokers and clearing houses. As we previously discussed, it is important to understand the different needs of the various market participants and to make sure that any technical solution takes their specific challenges into account. We have been involved in some fantastic debates and have received great support and encouragement to push ahead with the enhancement of our existing ETD ClientLink service in order to address the long-standing industry challenges previously discussed.

What has been really encouraging is the feedback we have received from the clearing houses, where everyone is agreed that the processing of allocations is where the bulk of the problems lie and should be an area of focus for the industry. Our discussions have allowed us to focus our technical strategy on those areas that will deliver the most benefits in the shortest amount of time, with minimal disruption. Everyone we have spoken to agrees that change is required and are keen to monitor the progress of our technical developments.

So, in conclusion then Jo, exactly where are you with these technical developments?

Things have moved rapidly in the last few months, and we are continuing to work on a Proof of Concept (POC) that addresses many long-term issues. We have established connectivity to the first clearing house, CME, for the receipt of core trade economics and the subsequent submission of client allocations including additional execution and clearing broker fees, where applicable. We’re now at the stage where we are presenting our progress to industry participants for their valuable input.

We have been able to leverage our existing network connectivity to create an enriched master record comprising trade details collated from multiple market participants and we are now looking to expand on the population of this data through engagement with additional service providers, as well as waiting to receive the output from the FIA group working on agreed industry standards. We believe that this collegial approach is the truly the best way to deliver real and tangible results to the industry.