With both the European Commission and the US Congress having derivatives firmly on their regulatory agendas, the need for tools for firms to reduce market and counterparty risk, as well as increase transparency and improve market integrity has never been so crucial.
Usage of OTC derivatives continues to rebound with the Bank for International Settlements (BIS) recording that total notional amounts for OTC derivatives stood at $615 trillion by the end of 2009, heading back towards the peak of $684 trillion in 1H 20081. Usage has rebounded across most asset classes and has been boosted, in part, by OTC derivatives now being allowed under the UCITS III fund structure.
With the return in activity has come an increased demand for solutions that increase transparency and enhance management of the complex investment risks associated with these instruments. The quality of recorded OTC derivatives trade data continues to be a concern in the industry. The lack of a specialist, cost-effective and comprehensive software solution, means that the processing of OTC derivatives trades has remained largely manual. The lack of audit and visibility of recorded OTC derivatives trade data means that there is a potential high level of operational risk and, therefore, the need for the mitigation strategy of trading caps.
Sean Sprackling, Partner, Investment Solutions Consultants LLP, a specialist in the OTC Derivatives market, comments âOTC derivatives are becoming an increasingly indispensible component in the makeup of investment products. With the inevitable increase in trading volumes come operational hurdles that need to be surmounted which many managers are not currently set up to do. The efficient management of collateral and counterparty risk requires clean and accurate data, and the imminent onset of central clearing will only exacerbate this need. Managers will therefore need to create an internal trade warehouse to store validated and audited OTC data to feed the plethora of trading, risk, and management information systems that require it.â
The OTC Lifecycle Manager has been specifically created to help investment management firms and Asset Servicers to cost effectively mitigate data quality issues of captured OTC derivatives trade data. Firms trading medium to high quantities of OTC derivatives with several staff who manually process OTC trades, can now consider the OTC Lifecycle Manager solution as an attractive alternative offering a specialist stand-alone and highly cost effective tool designed to minimise the data quality problems associated with OTC trade data capture.
Asset managers and asset service firms are taking account of their OTC derivatives operations and the need to establish the base building blocks for operational governance for OTC derivatives trading and administration.
Geoff Harries, Global Head of Asset Servicing at DST Global Solutions IMS, believes that successful OTC investment control depends on the use of a central internal repository of validated contracts. He commented: âAction now for internal motivations, whether it is for operational efficiency, control of the investment process or to meet compliance requirements, can be better thought through and managed with the use of a centralised storage mechanism for OTC contracts. This would allow organisations to piece together the OTC operational jigsaw in a more coherent fashion.â
âA robust OTC trade capture facility needs to be the first piece of the operational jigsaw to be considered in an OTC improvement project.â
Purpose-built for the buy-side in response to market need, DST Global Solutions IMSâ OTC Lifecycle Manager addresses many issues that the asset management and asset servicing community are currently facing in the investment control aspects of OTC derivatives, from execution over the entire life of the contract; which in the case of an inflation swap could be over 25 years.
Arun Sarwal, Chief Executive Officer of DST Global Solutions IMS commented,: âOTC Lifecycle Manager is designed to fill a gap in the derivatives market, supporting the control and visibility clients require to fulfil their for operational governance, exposure management and regulatory compliance requirements. Our solution automates and streamlines the OTC lifecycle by enabling the downstream processes such as, affirmations-confirmations, collateral management, and resets and novations, to work off simple repositories of validated and audited contract information.â