In this episode, we discuss post-trade improvements since COVID, and how the expansion of digital trade exposed significant technology shortcomings: from outdated infrastructure to fragmented risk systems and the challenge of incorporating new asset classes, like cryptocurrency, into aging, legacy systems.
Ali Curi: Markets Conversation is a new ION podcast where we discuss topics of importance to capital markets participants with product owners, subject matter experts, and industry leaders. Hi everyone and welcome to Markets ConversatION. I’m Ali Curi. On today’s episode, we’ll discuss the types of post-trade improvements in technology since the Covid Pandemic. The Covid Pandemic greatly affected and disrupted every industry in the world. And since technology drives most of the world’s financial transactions, these technologies were put to the test in order to keep businesses running and expanding. This expansion of digital trade exposed significant technology shortcomings from outdated infrastructure to fragmented risk systems, and the challenge of incorporating new asset classes like cryptocurrency into aging legacy systems. We’ll unpack these issues, but also we’ll discuss how firms can overcome these digital trade challenges in the post covid world.
Ali Curi: Our guests today are Bruce Roberts from the Markets division at ION and Will Mitting, CEO of Acuiti, a management intelligence platform. Let’s get started.
Ali Curi: Hi, Bruce, welcome back to the podcast.
Bruce Roberts: Hi Ali, great to be here.
Ali Curi: I’m really glad you’re back on the podcast and ready to discuss some new topics and Will Mitting from Acuiti, thank you for joining us.
Will Mitting: Thanks for having me.
Ali Curi: Before we get to our conversation, I want to point out Will and Bruce, you both have worked with each other before in a client vendor situation. Bruce, can you share a little more about your working relationship with Will in Acuiti?
Bruce Roberts: Will and I have been, uh, working together the last couple of years in terms of some of the marketing that we do, but it’s great to have him here today.
Ali Curi: Also Bruce, for those who may have not listened to our podcast where you were our guest, can you tell us a little bit about what you do at ION?
Bruce Roberts: So I am part of the global management team in cleared derivatives at ION and also doing global business development.
Ali Curi: What’s one exciting aspect of your job? Something that you really enjoy doing?
Bruce Roberts: So it’s been great to see how the market continues to evolve and the dynamic nature that, uh, that we’re in in terms of, you know, when you look at the different events that have happened over the last few years and how resilient the market has been and the caliber of people that are in the industry.
Bruce Roberts: So that’s what really energizes me, and I enjoy having the opportunity to work with a, you know, a great class of people.
Ali Curi: Great. Thank you for sharing. Now let’s learn a little bit more about Will.
Ali Curi: Mr. Mitting, thanks again for joining us. Tell us a little bit about your career and what led you to where uh, you are today.
Will Mitting: Thanks, Ali. I launched Acuiti back in, uh, February, 2019. My background is business to business publishing. I worked at Euro Money Institutional Investor for eight years. And prior to that I worked in Malawi, set up a magazine publishing business there. So slightly, uh, circuitous road to, to where I sit today, um, with Acuiti
Ali Curi: Will tell us what do you find most exciting about your job currently?
Will Mitting: As I mentioned, we launched in, in, uh, March, 2019, which for a research and events business was a challenging time pretty quickly. So I think what’s exciting today is just the operational environment that we work in is normal for the first time in the four years since we set up.
Will Mitting: And it’s exciting. I think when you start to think about the potential of the business. And also to echo Bruce, I think it’s to cover and to comment on a market that’s so integral to global affairs. Um, and so focused on operational, uh, resilience and improvement.
Ali Curi: Thank you for sharing Will. Now let’s talk about technology and finance specifically during pre and during covid.
Ali Curi: So I’m gonna set the stage here a little bit, gentlemen, given your experience from the client and solution provider side of these issues, I think it would be very helpful to hear opposing perspectives and we’ll also explore how proposed solutions benefit both sides. So let’s start with issues and challenges exposed during covid.
Ali Curi: In the markets, FCMs, or futures commission merchants, saw their back office processing come under significant pressure, causing disruption across the market.
Ali Curi: Bruce, let’s start with your take on what specifically was causing these process disruptions, and Will, please chime in and share your take on these issues during the pandemic.
Bruce Roberts: Thanks, Ali. So my observations in terms of the challenges within Covid were not that any firm previously had prepared for this in their disaster recovery plans. The scenario. So it mean, it meant that not only did their primary locations become inaccessible due to staff not being able to travel, But so did their secondary sites in other locations.
Bruce Roberts: So for all firms, this presented a new scenario. And again, you know, the real solution that people fell back to was to work from home. And the initial work from home had a number of obstacles as we all saw in terms of technology that was not either robust or there were access issues or other, you know, barriers.
Bruce Roberts: But, you know, the market at the start of Covid in early 2020 saw, you know, some of the most volatile trading in recent periods. in addition to that, trading volumes, technology, staff illness, you know, and historical differences or deficiencies, some may characterize in the front to back process flow, all contributed to, you know, the challenges that the industry found themselves in with elevated risks due to unclear trades .That, in a very short few days, started to expose, you know, a number of different firms in the market. And so that became, you know, a period of dislocation that went on for some period of time, and that took a while to recover from. So I think those are some of the interesting, you know, activities that happened during the event.
Bruce Roberts: But maybe, uh, Will, you know your views and what happened after, you know, the initial impact.
Will Mitting: I think that’s absolutely right, but um, it was a double whammy that nobody predicted of unprecedentedly high volumes and that operational challenge of shift to working from home, but I think it would’ve come unstuck at some point anyway, with the volumes alone, I historically, there had been an underinvestment in post-trade.
Will Mitting: If you think some financial institutions were able to execute trades in thousands of trades in the blink of an eye, but those trades were then cleared into, uh, green screen based post-trade processing, uh, software. There was a lot of manual fixes. I think another failing as well recognized across the industry was, as in particular, banks grew through mergers.
Will Mitting: Technology was patched together rather than wholesale replacements. So you had different solos across different teams, but then entirely different ways of working, entirely different software processes across different banks. And as they merged, no one was investing long-term in post-trade. So I think the events of the market disruption of 2020, which was to some extent a failing of, of process and to some extent of failing of technology, was the day of reckoning that it was inevitable as a result of industry-wide under investment in post-trade. And what’s interesting, I think, is how that’s changed. So if you compare the volatility of March, 2020 to the volatility of February, March, 2022, in the wake of the Russia invasion of Ukraine, volumes were significantly higher then, even higher then than they were in, um, in the initial outbreak of Covid.
Will Mitting: But the ability of FCMS to deal with that, to process those trades stood up far better. Their back office processing, give ups, allocations all worked far more smoothly than they did back in 2020. And that’s a result of deliberate investment and analysis of the processes led by FIA, but enabled by vendors in the market.
Will Mitting: And absolute focus on resilience stemmed from the, uh, events of Q1, Q2 2020.
Bruce Roberts: I would completely concur with that too. Will, I mean, I think the kind of key in terms of looking at what improvements have been made over the last several years and what some of the efficiencies that have resulted, I think, you know, what you highlighted are exactly some of the key, you know, drivers.
Bruce Roberts: And with that, you know, I would also. You know, kind of highlight, you know, the ability to work from home, building out the infrastructure. You know, we didn’t see that as an impact with last year and the invasion, you know, things moved along at pace with people managing a process that needs to be managed on a real time T zero daily process. Others, I think around risk management in terms of, you know, the ability to manage risk and moving from more T plus one to T zero. And you know, again, that’s been a challenge for a lot of firms and we’ve seen it with the volatility in the market where we’re seeing increased intraday margin calls, which has been, you know, one of the big challenges I think for, you know, the cost of doing business in the derivatives industry. It’s interesting to see how the market has evolved in terms of, you know, its ability to cope with the volume, still inefficiencies in it, but the impact of volatility now driving increased cost through margin.
Will Mitting: Absolutely. I think that’s one of the lessons of 2020 that perhaps hasn’t been learned or, or maybe can’t be learned. And I think for FCMS, there’s two challenges there that we identify. One is the inherent pro cyclicality of margins. So you see, because of the methodology, the look back periods that CCPs, for example, and the VaR models that they predominantly use to calculate margin.
Will Mitting: Inevitably, when you have spikes in volatility that results in spikes in initial margin and then medium term higher margins. And the markets of today are dominated and defined by these spikes of intense volatility. You’ve seen that in the last few weeks with the fallout from the, the UBS Credit Suisse proposed merger and also the collapse of SVB and, um, other banks in in the US.
Will Mitting: So on the one issue, FCMS have to deal with calling margin, higher margins from clients and managing that process. But on the other hand, I think there’s a general view that certainly in some areas the margin being called by CCPs isn’t high enough and doesn’t reflect the actual risk in the market. So for example, in energy markets in particular, uh, we did a survey around midpoint last year about the impact of the volatility in energy markets, and we found that almost 80% of FCMS were calling more margin from their clients than was required by the CCPs. So there’s that almost, uh, contradictory pressures facing the FCMS that initial margin spikes are too great, but also CCP margin is often too low. That doesn’t reflect the actual risk. Obviously FCMS call for permanent, some certainly prefer permanently higher initial margins, but that has a knock on effect on the clients who have to post those margins, and we find consistently with hedge funds in particular, they’re having to hold back more cash. They’re having to trade less. They’re having to reduce their exposure to lower margin strategies as a result of the higher margins. So that creates a drag overall on their performance. They’ve got dead cash that they have to keep back, that they can’t deploy.
Will Mitting: And again, asset managers face a very similar thing, but also some of their higher margin strategies, which may be more popular, they have to reduce their exposures in that or retire them. So there is an issue. The cost of risk is increasing as risk increases, and it’s not clear to me how that circle is squared apart from potentially with more intraday margin calls, better real time risk management.
Will Mitting: But that again, also poses its problems. Intraday margin calls are on the increase, but they’re seen as an exception rather than a desired process, so it’s very difficult to see what the answer is for that. Ultimately, fundamentally, risk is more expensive in 2023, and capital has to be allocated to that.
Will Mitting: This episode is brought to you by ION. At ION our cleared derivatives solutions, automate your complete trade lifecycle and deliver actionable insights whenever and wherever you need them. We offer execution and order management, post-trade processing, and a complete front to back business solution. To learn more, visit us at ion group.com/markets or email us at [email protected]
Ali Curi: Bruce, what kind of impact have you seen in the market due to an increase in margin costs?
Bruce Roberts: One of the other areas that I also saw as a response to the increase in costs was some clients trading less, which is an interesting phenomenon when you consider that, you know, a lot of them are trying to hedge out their exposure and by not trading then, you know, their risk leaving themselves exposed.
Bruce Roberts: And you know, SVB, I think as you referenced earlier, a good example of that, you know, taking in loans or taking in deposits and then placing that in deposit within treasuries, but then not hedging the interest rate risk or the duration risk. So, you know, it’s a good example of, you know, where, you know, some clients maybe choose not to trade due to the cost, but then others, you know, maybe not also, you know, looking at the risks of, you know, what’s happening, uh, in the market in being able to predict those risks. And I guess, I mean, maybe just kind of ask a, a broader question in terms of, you know, rising rates and, you know, changing the economics of clearing, do you feel that’s going to have a impact from your perspective Will, from the conversations that you have?
Will Mitting: Yeah, I think, I think all these trends ultimately pose opportunities for FCMS.
Will Mitting: You know, we’ve certainly seen the FCMS and banks in particular, building out liquidity lines to clients to enable them to deal with the margin calls that come intraday to deal with the volatility, so that’s one area, but fundamentally, yes, absolutely interest rates going up is great for FCMS in the market.
Will Mitting: If you look back pre 2008, Some anecdotally, and you’ll know better than than me on this Bruce, but potentially up to half or more, half or two thirds of revenues were made by FCMS based on the interest on client margin. So that’s, you know, if you, that was taken out entirely for over a decade, taken out the industry completely.
Will Mitting: So that’s coming back, but coming back in a different way. Was certain in clients demanding rebates on the margin, and FCMs typically are granting some rebates to certain clients. So ultimately, I don’t think that that money will ever come back to the full extent it was pre-crisis, but certainly it’s a massive boost for, um, for FCMS uh, revenues and balance sheets.
Ali Curi: Will, do you think that presently competition is stagnant or will we see a comeback. Also, if there were to be a comeback, who would be the growth driver?
Will Mitting: I think to your point on, just to take the first point on the competition side, I think absolutely competition is gonna come back because the economics of providing a clearing function have changed dramatically with interest rates at 4 or 5%.
Will Mitting: It’s an entirely different business. Interest rates, 4- 5% volumes at the levels they’re at currently. It’s a very attractive business to be in. I think what you’ll see probably is the competition will come from strengthening non-bank FCMS and new entrants into the non-bank FCM market. I think the consolidation that we’re seeing amongst the banks will continue potentially one or two of of the major players historically that pulled out, firms like State Street, retreated from the market may come back in, but I think this in the non-bank FCMS that you’re gonna see the most activity, and that’s for several reasons, but predominantly they’re far more nimble than the banks. They’re able to make decisions far easier. But also if you look at the business model of a non-bank FCM, they’re only exposed to the, uh, to the tailwinds that the current economic situation presents in terms of higher interest rates higher volumes. Whereas a bank has concerns about the real economy, has concerns about its lending book, it’s mortgage book. So it’s not as straightforward as a decision to go for growth at a bank. They might be more conservative. Even if their markets business and their clearing business is powering ahead, they might be less willing to invest over own into the overall profile of profitability across the bank, whereas non FCMS don’t have that at all.
Will Mitting: I think also we are seeing the sophistication of firms that are native to the crypto market in terms of the sell side. What, what’s being built in the sell side, I’m thinking about firm firms like Hidden Road, for example, that are providing effectively prime brokerage services in a market where there is no traditional prime brokers.
Will Mitting: I think they’ll start to look at traditional asset classes much more keenly, um, as they look to scale and grow and potentially the, the volatility in the crypto markets diminishes and they want to diversify. So again, I think that’s gonna cause at the lower end of the spectrum, I think you’re gonna see a lot more competition coming in there.
Will Mitting: But I think your point on risk, I think. You know, you can never, no one can predict the next crisis, otherwise they’d solve the problem. And the weakness is always in an area where you, you don’t expect it. What matters, I think, to the derivatives market is it is able to absorb risk wherever it comes from.
Will Mitting: And I think certainly as we talked about at the beginning, the investments in, uh, the improvements in processes has created a far more resilient, scalable business than has existed previously. And you are right, I think on the technology side for new firms entering the market. It’s a big lift to develop an entire technology ecosystem to clear.
Will Mitting: A lot of firms will want to test the market, potentially build out on one or two exchanges first before they scale up to a more wholesale clearing operation. So having a a lower entry point technology solution that’s industry standard, I think it will be key to enabling those firms to enter the market and grow.
Bruce Roberts: Thank you for sharing that. I mean, I, I think your observations are very insightful. I mean, the big takeaways from what you’ve said and what I guess I’ve also seen in the market are that, you know, one, it’s hard to predict where the next risk is going to come, which means, because of the ability to identify it, you know, we have to assume that, you know, risk is always gonna be there and we need to be able to prepare for those unintended consequences that may not be immediately visible to markets and the firms. For me, you know, that really means that, you know, Two kind of key things. One is, you know, our technology and infrastructure, you know, it has to be strong and we need to invest in it as you outlined earlier, and that we’re only as strong as our weakest link and that firms that aren’t investing can create exposure for others, but, You know, the real need to move, you know, over time to real time processing and risk management has to be a continued goal for all members.
Bruce Roberts: And that agility to act in real time is becoming evermore pressing to manage risk and take that away from SVB in the kind of three days and the outflows that had happened, it was very rapid. The other is just around collaboration in the industry and how we strengthen our front to back as a whole. And that includes cybersecurity, our margining practices that you alluded to.
Bruce Roberts: And there’s no easy answers or regulations, but we need to look at all the participants to how we strengthen the walls of the entire industry. And it should not be any particular, you know, kind of individual or risk, but it’s a collective industry problem we must solve for. I mean, and I don’t know what your view is, but you know, coming away from Boca over this last couple weeks, I mean, one of the things that I’ve been continuing to be impressed with is the caliber of people that we have in the industry, and ultimately it’s that huge amount of experience and knowledge in the futures industry with individuals like yourself.
Bruce Roberts: That, you know, really allows us to identify the risks and how do we wanna mitigate them, you know, when they do arise. And you know, you’ve seen that. And that’s something I guess I’m very proud of to be part of in the industry. And that, you know, we need to make sure that we’re investing in our next generation of futures members and empowering our risk managers to act on the risk indicators that they observe.
Bruce Roberts: Because ultimately, you know, it’s through their actions that, you know, we’ve been able to mitigate what’s happened in the industry, you know, with recent events over the last several years, but even looking further back.
Will Mitting: Absolutely. Yeah, I think it’s, yeah, it is testament to the people in the market that it is as resilient as it is, but I think there’s definitely always more scope for innovation.
Will Mitting: I think one of the fascinating things about the crypto market is you go to traditional events, less so this year than last year, but traditional events where you hear new ideas about market structure and, and the role of the FCM. Now, a lot of them are potentially unworkable or undesired, you know, should exchanges own the FCM? I can see some benefits for getting products on the market, but there’s very limited use cases and potentially the risks to comp or the threat to competition outweighs the benefits. But having firms and having executives coming in, questioning how the industry runs, I think is a very, very healthy trend, and one, I hope that doesn’t fall away because of the slightly damaged reputation of some of those people that suggested the changes. I think we need to be constantly questioning how we operate. I agree with constantly investing, but we need to be always asking, especially with blockchain coming on, what is the potential for blockchain in the market?
Will Mitting: It doesn’t necessarily mean that the FCM is gonna die out. It doesn’t mean that the FCM’s going to be disintermediated, but it does change the role of the FCM, and it will create a more efficient market in the long term, to the benefit of the FCMs and the benefit to all participants. And I think there is a risk in some areas of, or hostility to innovation from some of the areas in the industry who prefer the status quo, which is by no means perfect.
Will Mitting: So I agree with that point on investment and I agree with the quality and caliber of people in the market, but I think we need to be bold in the questions that we ask ourselves when we look at long-term improvent.
Bruce Roberts: It’s, uh, definitely a key point in terms of no industry, I, I agree, survives without innovation.
Bruce Roberts: And if you look at, you know, blockchain and DOT, there’s a lot of opportunities in terms of the use cases, um, as they develop. I agree because more capital efficiency, you know, much better margin optimization, much more efficient, uh, processing, which can take cost out of the overall ecosystem. So there’s a number of different factors, as you said that, you know, can benefit clients as well as the participants that are there. And again, actually expand the number of participants that are in the market. Because I think one of the things that we see is some participants aren’t hedging, you know, their exposure and whatever industry they’re in, and a good example I would side is the energy sector, which you alluded to earlier.
Bruce Roberts: When you look at, you know, the, you know, the war that’s occurred and the amount of volatility and some of the, you know, exposure that’s gone past probably what they had expected, but also whether they had fully hedged themselves out. I agree. I think innovation’s key and technology’s gonna continue to be a key enabler to the future of derivatives and you know, what that model looks like is gonna be exciting to see as it evolves with, you know, different players moving into different parts of the industry.
Will Mitting: Absolutely. Yeah. But those that resist innovation tend not to survive to see the benefits. History teaches us that.
Bruce Roberts: Agreed.
Ali Curi: Okay, bruce, let’s change topics for a minute. I know you’ve done career questions before, but I have a new question for you. Share with our listeners, what is your favorite productivity hack?
Bruce Roberts: I like OneNote is probably the best, and if you haven’t used it, I would definitely explore it. It’s one of the Microsoft applications.
Bruce Roberts: It’s very, uh, flexible and if you like to visualize things, it’s a great way of doing that.
Ali Curi: Also Will, what is your favorite productivity hack?
Will Mitting: I’m a big fan of to-do lists. I think this I, if something’s not on my to-do list, I don’t do it. And I hate to say it, I also think working weekends. That’s, you know, that’s, I get more work done on a Sunday afternoon than I do in two days. So it’s sad to say, but when you run your own business, there’s no escaping that.
Ali Curi: Well, gentlemen, Bruce Roberts, Will Mitting, it’s been such a pleasure having you both on the podcast. Please come back and visit us again.
Will Mitting: Thanks for having me.
Bruce Roberts: Thank you, Ali.
Ali Curi: And that’s her episode for today. You can follow ION Markets on Twitter and LinkedIn.
Ali Curi: Thank you for joining us. Until next time.
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