A worldwide wave ofregulatory change-exemplified by the Dodd-Frank Wall Street Reform Act in the United States-will bring "massive changes in terms of technology" in the securities industry.
"Virtually every new regulation brought about by the Dodd-Frank Act is going to require new technology solutions," said Tim Ryan, president and chief executive of the Securities Industry and Financial Markets Association, addressing the 2011 Financial Services Technology Leaders Forum and Expo.
The act "touches every corner of our industry," Ryan said, through the 243 rulemakings that it has spawned. Of which, only 21 have been completed.
Randy Snook, executive vices president of SIFMA, added: "Preparing for each of these is a daunting task. On the one hand, we need innovations that comply with regulations while providing customers with choice. On the other hand, we need to shore up the foundation of our financial system to make it more resilient. We need the right balance of responsible innovation coupled with responsible regulation."
Two key initiatives that SIFMA will work on are creating a worldwide "single system" for identifying counterparties in trading; and, setting up new markets in what have been over-the-counter derivatives securities. The single system of designating who a counterparty is in a transaction is known as Legal Entity Identifier, or LEI.
This new system will create a single ID to be used for comprehensive regulatory reporting, Snook said. LEIs also have the potential to make reconciliation between systems easier and offer ways to improve efficiencies in processing and settlement as well as corporate actions management.
"Bottom line, this is the tool that is going to let systemic regulators do their job and, over time, allow firms to manage data more efficiently," Snook said.
With over-the-counter derivatives such as interest-rate and credit-default swaps, "we are experiencing a paradigm shift to a more complex regulatory structure that will require massive investments on behalf of each of your firms," he said.
There will be mandated centralized clearing of OTC derivatives, plus post- trade price reporting that "will provide increased transparency over a range of products used day-in and day-out," he said.
After that will come creation of what Dodd-Frank designated as "swap execution facilities."
Snook said rules from the Securities and Exchange Commission and the Commodity Futures Trading Commission could come as early as this month.
"We're working with regulators to implement these new rules while ensuring these valuable products remain available and cost-efficient to end-users," Snook said.
Stock markets are also experiencing changes that are spawning system changes, he said. Short sale price tests, single stock circuit breakers, and a limit-up/limit-down mechanism that is expected to be coming out of the SEC "are driving updates to trading systems," he said.
"There will be opportunities that this change and technology will create," said Richard J. Daly, CEO of Broadridge Financial Solutions. "Technology will be the great leveler of the playing field."
Rule changes brought on by the Dodd-Frank Wall Street Reform Act are expected to produce the most change in the way contracts involving interest-rate commitments are traded.But, at least for sell-side traders, technology is expected to produce as much change in the trading of interest-rate products. Which, in turn affects how corporations handle risk, since hedging dominates trading of those products.Those are expectations elicited from conversations with 46 senior-level rates market participants conducted by Wall Street consulting firm Tabb Group. The firm spoke to senior-level fixed income-related portfolio managers and traders on the buy side; and executives and sales traders responsible for market-making and developing rates derivatives products on the sell side.Forty nine percent of buy-side traders expected regulation to cause the greatest change, but only 29% expected technology to create the greatest change in what Tabb called "the largest risk transfer market in the world."On the sell side, 50% of executives and traders said regulation would cause the most change. But 50% also said technology would cause the most change, putting it in a theoretical dead heat.The importance of technology is not due to any "race to zero" speed in executing trades, like in stocks. Instead, "in fixed income products you have a lot more structures that need to be put in; two, three, four, five, and six-legged trades," as one "small-sized" asset manager put it."Automation can do wonderful things, but it still lacks the intelligence to respond to rates traders' unique needs," wrote the Tabb report's author, E. Paul Rowady, Jr., a senior analyst. In trading of interest-rate derivatives, there is still "custom handiwork" done manually, even if manually now means phone calls, electronic mail or instant messages.This is especially true in the swaps market, Rowady said, where only 12% of rates swaps are traded electronically, compared to 48% in the rates futures market.The sell side has adopted electronic execution more quickly than the buy side, but a majority of both buy-side (89%) and sell-side (60%) rates traders believe that the best model for swaps execution is electronic.A key set of provisions of the Dodd-Frank reform legislation calls for swaps of all kinds that can be standardized to be traded on electronic exchanges or, alternately, new venues called "swap execution facilities."Notably, the Tabb study found that only 40% of rates traders have begun actively preparing for reform measures.The rest are monitoring progress of converting the legislation into formal marketplace rules. But the Securities and Exchange Commission and the Commodity Futures Trading Commission are both behind schedule in finalizing those rules.The Tabb Group estimated the global trade in interest-rate derivatives at $665 trillion. This compares to trading in equities derivatives of $69 trillion --TST.
