Wednesday, September 17, 2008

Back to the back office

With banks' front offices copping most of the flak from the credit crunch (the trading room was always considered to the money-making machine while the back office was the expense centre), back office operations and processing is at the top of the agenda again.

Reconcilitiations, matching, confirmations, exceptions processing and settlement may not be sexy, but it appears banks are slowly waking up to the fact that if they had invested as much in their back office processing as they had in front office trading applications, then perhaps they wouldn't be in the mess they are in now.

The benefit of hindsight is a powerful thing, but nevertheless the back office operations guys, which are Sibos' bread and butter, are chomping at the bit to get their hands on some of the money that has historically gone to the front office.

"There was so much IT spend on the front office, that now needs to be rebalanced with more investment in controls, risk management, the effectiveness of the back office and improving support systems, because they are just out of control," says Ken Archer, CEO of SmartStream.

SmartStream is looking to extend its Transaction Lifecycle Management solutions for trade processing into the OTC derivatives space. With a lot of information pertaining to complex derivatives being stored on spreadsheets and new instruments being devised more quickly than the back office is able to process them, the challenges in the OTC post-trade space are not insignificant.

SmartStream says it will initially focus on bringing efficiencies to "vanilla" derivatives, and in the current climate where the unravelling of complex CDO deals got a considerable number of banks into hot water, Archer believes that there is likely to be a market backlash against more "esoteric" instruments.

Meanwhile, at a Sibos panel session entitled, Breaking the FX bottleneck, most of the panellists agreed that the operatinal capabilities and capacities of sell-side banks and the cost per ticket were creating bottlenecks in the FX market.

While FX trading volumes continue to rise on the back of the emergence of the FX prime brokerage market, retail and algo trading and increased trading of emerging market currencies, banks' back offices are struggling to keep up with the pace of change and the number of trading tickets.

Phil Brittan, global business manager for FX and Economics at Bloomberg summed the current market situation up by saying that unless the bottlenecks were addressed it could result in increased systemic risk. Sound familiar?

Rob Close, CEO of CLS Bank, was the only panel member that did not want to concede that a bottleneck already existed in the FX market. However, he added, "that if we don't do something as an industry, there could be restrictions on how the market grows."

One can only hope that in this current climate, CFOs and CEOs are not tempted to postpone some much-needed back office tinkering.


Patrick Lefler said...

One of the most important issues facing banks in the “cost per ticket” discussion is the wide disparity in trade processing costs between the large FX banks and some of their smaller competitors - the Tier II and Tier III banks. Studies show that the most efficient FX banks can process their FX trades (all-in cost) for less than one dollar per trade. The cost for those same trades processed by Tier II and III banks can be as high as $10 to $15 per trade (or even higher) – that’s a huge competitive advantage for these larger banks.

It’s clear that in order to stay competitive going forward, the Tier II and III banks must lower their trade processing costs. The big question is how do they accomplish this? While getting “their hands on some of the money that has historically gone to the front office” may seem like the obvious answer, this is easier said than done. For most banks, ripping out and replacing existing back office systems takes time, money and exposes the bank to high IT project risks.

A better solution might involve the adoption of a scalable post-trade processing utility with a pay as you go pricing model that involves minimal up-front investment. The pricing model is most important here because it directly aligns the bank’s primary interest (lowering their all-in trade processing cost) with their actual cost structure. Additionally, the minimal up-front investment reduces significantly the project risks normally associated with back-office upgrade projects.

Patrick Lefler
Director, Banking Solutions
Wall Street Systems

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