The evolution of F&O clearing workflows: Let’s talk allocation!

July 12, 2024

Key Takeaways

  • Inefficient post-trade operations carry risks and potential costs
  • Clearing and allocation workflows improving but still fragmented
  • Technology has evolved to address industry pain points

The importance of allocations in the trading lifecycle of exchange-traded Futures & Options is often understated, and the focus is skewed toward how trades are most efficiently executed, leveraging algorithms of ever-increasing complexity.

Exchange clearing members hold client and house omnibus accounts, and end-client accounts are not disclosed at the clearing house. Until the executed trades are allocated to the end beneficiary account within their internal books and records systems, they remain adrift on the broker-holding accounts. This results in the broker carrying unnecessary risks and potential additional costs, negating the ability of end clients to have an accurate intra-day view of their positions and related financials, including margin requirements and commission charges.

Post-trade workflows in the cleared derivatives industry are notoriously complex due to the intricate relationships between the buy-side and sell-side organizations and exchanges, compounded by the lack of standards and fragmented clearing practices. Executed trades navigate their way through a maze of actors, communication channels, and mapping steps, after which they are eventually allocated and cleared.

Traditionally this part of the workflow has been manual and paper-based; traders wrote allocations on paper tickets or promptly forgot about them, expecting them to be dealt with by the middle office. No news was good news. However, it frequently was not, with information miskeyed into one or disparate systems and incorrectly interpreted splits or late allocations, resulting in extensive remediation work on T+1.

Death by a thousand emails

As technology advanced, chat and email communication became common. Firms started scraping allocation information from emails and manually inputting it into spreadsheets. Sell-side systems also provided tools for traders to split and allocate trades themselves, helping to reduce risk. These advances have undoubtedly improved efficiency, particularly when compared to paper-based methods, but they still rely on manual data entry, lack automation, and result in little or no progress toward standardization. Each buy-side sends the allocations with their preferred product symbology, their preferred set of trade information, and in their preferred format. And they often send most of these files around the market close time–which might be the only thing they do have in common–to perform averaging of all trades executed during the day.

FIX in allocation

In more recent years, the industry has shifted significantly towards the adoption of electronic methods, and FIX protocol has emerged as a standard for electronic communication between buy-side and sell-side firms. The benefits were clear: real-time allocation messages between counterparties and reduced manual intervention, leading to faster matching and clearing, increased straight-through processing rates, reduced operational costs, and a large step towards standardization.

FIX workflow for orders and allocations

Sadly, practices of email scraping and individualized spreadsheets remain a feature of middle office daily life for many firms. Late allocations are still an industry-wide issue causing unnecessary operational risk and high inefficiencies for sell-side organizations whenever the business cannot be cleared “top day”.

The FIA is leading the charge on improving the timeliness of trade give-ups and allocations and average pricing via its DMIST initiative, but what can be done to raise the bar further on standardization and automation of clearing workflows? Are firms resisting the technological leap? We know this can’t be true as adoption in the front office has been high, and automation is the standard. So, what is holding the middle office back?

Solutions for an imperfect world

The electronification of clearing and allocation workflows is underway. However, it is following a gradual and fragmented path. Many clients can now send allocations over FIX in addition to files. The sell-side must leverage technology with advanced matching capabilities that can ensure full automation under different scenarios and the ability to process the differing levels of information provided by clients to match the allocation instructions to fills and orders.

The challenges firms must navigate include differences in product symbology across execution and clearing, inconsistent IDs, and specific allocation processing requirements depending on whether it is average priced or best fit. They also need to scale efficiently when thousands of allocations are sent in bulk within a short timeframe and, after allocation, be able to automatically confirm the same information back to the client.

ION’s allocation and clearing technology has evolved to address these pain points and offers natively comprehensive FIX allocation support and file-based integration capabilities. It removes the need to build and maintain multiple complex solutions to process the disparate means currently utilized by clients to send their instructions. We have achieved this by re-engineering our technology stack and integrating workflows that were once fragmented across different vendor solutions. Now, they are all under one roof, bringing together clearing solutions from different acquisitions.

The ION CTAC Allocation module and XTP Clearing middle office platform have been designed to achieve the highest end-to-end STP rates across all allocation and clearing workflows, removing manual interaction whilst leveraging a sophisticated rules engine. The built-in exception management capabilities empower users to perform troubleshooting and repairs on the spot, with reporting tools offering insights into trends and causes of automation breakdown, which can then be used to eradicate root causes and further increase STP rates.

ION CTAC Allocation instrument resolution tool

ION CTAC Allocation matching tool

While common workflows and communication standards are still far off, we have proactively adapted our offering and enabled sell-side organizations to overcome fragmented ancillary, legacy clearing technologies as the industry advances in standardizing the end-to-end full allocation and clearing lifecycle.

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