Catching up with the front office: The evolution of post-trade functions

Key Takeaways

• Post-trade functions the weakest link in listed derivatives chain
• Front office tends to grab the limelight and bulk of investment
• Volatility requires front-to-back workflow automation

The front office has always been seen as the more glamourous end, with buy- and sell-side firms spending significant sums to ensure trading systems keep pace with exchanges that are increasingly behaving like technology companies. By contrast, post-trade functions tend to be neglected but this dearth of investment is taking its toll on firms’ ability to compete in cleared derivatives as well as other asset classes.

This is far from a new problem, but one that was easier to ignore when interest rates were bumping along the bottom and markets were steady. Fast-forward to today and volatility is omnipresent due to unexpected events and fluctuating predictions over the direction of interest rates, as well as ongoing conflicts in the Middle East and Ukraine. Organizations’ resilience has been further tested by impending regulation, particularly T+1, Basel III, and the EMIR Refit.

In this environment, the more sophisticated and technologically advanced players that can integrate digital capabilities have pulled ahead, leaving behind those still dependent on outdated legacy architecture. If they do not close the automation and modernization gap, they will fall even farther behind.

The number of market participants grappling with these obstacles makes for sober reading. A recent study by Nasdaq and Value Exchange — Financial Market Transition — shows that 78% of financial market infrastructure (FMI) investment budgets are dominated by maintaining and upgrading legacy, while a third of post-trade firms are operating with legacy platforms more than a decade old.

The study, which canvassed 300 executives from exchange groups, custodians, brokers, and other service providers, found that simply keeping the lights on was occupying 44% of infrastructure investment capacity. Moreover, an additional 34% was allocated to the transition and replacement of legacy systems.

Post-trade buckles

Post-trade was cited in the Nasdaq study as one of the most vulnerable areas in the financial ecosystem, mainly due to the patchwork of systems built through the years of acquisitions as well as organic growth. Despite the buy- and sell-side’s best efforts at building post-trade capabilities, increasing levels of automation, and boosting operational resilience, it has not been enough. Their infrastructure is still riddled with too many manual processes that are unable to cope with ever-changing market dynamics and the surge in exchange-traded derivatives (ETD) volumes.

The last few years have seen a steady rise although there have been bumps along the way. Figures from the FIA ETD Tracker | FIA showed worldwide ETD volumes at 14.84 billion contracts in March, down 8.9% from February 2024 but 40.4% higher than March 2023. The tally for Q1 was 47.91 billion contracts, up 74% from the first three months during the same period last year.

The cracks in the cleared derivative system also came into sharper focus during the periods of extreme stress following Russia’s invasion of Ukraine in 2022 and the US mini-banking crisis last year, when volumes soared up to three times higher than in March 2020 in some markets. Those having to deal with errors, delays, and data failures do not just lose time but money and a hit to the bottom line.

It is no surprise given the backdrop that senior derivatives-focused executives polled at 57 firms voiced their concerns over the low levels of automation in the listed space and the threats this posed in the recent report by Acuiti OSTTRA — Futureproofing Derivatives Post-trade: Building Operational Resilience Across the Market.

Front to back

Addressing these challenges is not that straightforward as there are many piecemeal solutions on the market. However, the common goal is to both streamline workflows and protect infrastructures during periods of market turmoil. This is why the ideal response is a full front-to-back suite that provides fully automated trade workflow with integrated order management, advanced order execution, and connectivity to global markets.

In other words, the entire trade lifecycle and derivatives clearing process would be automated on a 24-hour cycle for the global trading day. Large volumes of data would be aggregated at high straight-through processing (STP) rates with no impact on performance. Operational risk would be minimized with exchange as well as regulatory deadlines met.

On a more granular level, this means a platform that aggregates trade and order flows across the back office, trading platforms, and clearing systems, as well as monitors user-defined risk measures and generates alerts on limit breaches. Other requirements include the capacity to store risk indicators and limit breaches to support client behavior analysis and replicate margins calculated by central counterparty clearing (CCPs) across more than 60 exchanges.

A comprehensive data offering that provides analytics, data, and research services is also mandatory. Risk management should be part of the package, along with a wide range of analytics, including margin calculation, scenario analysis, hedging, pre-trade and post-trade, normalized, enhanced, and aggregated data, swap execution facilities, and market insights.

Equally as important is that the platform should be flexible, scalable, and modular in order to adjust to ever-changing market dynamics, as well as to help a firm achieve its growth ambitions.

This may sound aspirational, but technology providers are capable and now delivering to meet these requirements across the front-to-back trading lifecycle of cleared derivatives. The bigger challenge is building the organizational momentum to fund the technology investment in the post-trade world to catch up with the investment that has been made over the last several decades in trading technology. However, the door is now open in more and more derivatives firms, so leaders need to take the opportunity to push for a transition to the next generation in technology.