For the past half-dozen years, the world’s over-the-counter (OTC) markets have had to adjust to a radically new regulatory environment. Ever since the Pittsburgh Declaration by Group of 20 leaders in 2009, which called for member countries to require trade reporting and tougher capital rules for OTC derivatives trades that weren’t centrally cleared, participants have been grappling with major uncertainties about what exactly the final regulatory rules might look like and what the outcome might mean for them.
As the i’s are being dotted and the t’s crossed in MiFID II documentation, the regulatory uncertainties are nearly at an end. But the hard work is hardly over. Between now and 2017, when MiFID II comes into force, market participants will need to make many more choices about what, where and how to trade. Never has the choice of a technology partner been more important for the prosperity – or survival – of a trading firm.
It boils down to a simple formula, what we might call the OTC equation. Opportunity plus Technology equals Choice. There may be markets where a firm feels it has an edge (Opportunity), but it still needs the right tools and systems (Technology) to allow it to trade in the place and manner that suits it best (Choice). In the shifting OTC market, this is critical as new venues and products are constantly being launched to offer firms possible cost savings or greater liquidity.
Having choices can make an enormous difference. What assets does a firm want to trade? Can the firm’s trading system handle multiple trading styles, from voice to fully automated and everything in between? What venues and jurisdictions make most sense? Without the right technology partner, any of these questions can become a fait accompli rather than a strategic choice.
Nowhere is the question of choice more relevant than in terms of best execution. Achieving best execution requires connectivity to the widest possible marketplace. Here, technology can make all the difference. If your system can’t access the right counterparties in the right way, you won’t get the best prices.
Choice matters in the post-trade world as well. The BIS reports that the share of outstanding contracts being centrally cleared has risen in the latest six-month period. But depending on how current regulatory discussions pan out, some clearing houses may not be considered eligible in the EU. So even if a firm was set up for central clearing it might still be required to set aside extra capital if its clearer did not meet EU standards.
Finally, choice is important not only in terms of external connectivity with the right clearers and venues. It also matters internally. To make the most of the OTC transformation, firms will want to achieve savings via automation and straight through processing. That means front, middle and back office connectivity and seamless integration with risk management systems.
Despite all of the upheaval, data from the BIS show OTC trading is still going strong. Gross market value for outstanding OTC derivatives contracts jumped 24% in the second half of last year.
No sector has proven itself better at doing the math than the financial sector. But which firms out there are doing the real math and answering the real OTC equation?