Transforming the Cleared Derivatives Markets
During a panel at the Arab Federation of Capital Markets Conference in Bahrain in March 2022, Anna Theorin, Head of Clearing Technology at Nasdaq, discussed how technology can help clearinghouses meet collateral management challenges in cleared derivatives while improving operational efficiency.
Collateral plays an important role in market liquidity as it mitigates credit and counterparty risk and thereby allows participants to access organized markets and contribute to liquidity. However, collateral is in higher demand than it was a decade ago because of mandatory OTC clearing and the phasing in of the Uncleared Margin Rules, which means firms must post margin on products that were previously not collateralized.
For clearinghouses, this evolution puts focus on margin and collateral optimization to properly manage risk while not requiring more collateral than necessary. Some clearinghouses offer cross-margining between OTC and exchange-traded derivatives. Meanwhile, many clearinghouses are moving from SPAN to a VaR-like methodology to utilize a more refined measure to calculate margin requirements.
Also, what type of collateral to accept is an important aspect for the clearinghouse to consider. By using non-cash collateral, such as gold, the clearinghouse frees up cash collateral that can be reinvested in the market. This is, however, a delicate balancing act as they are less liquid. With the recent massive increases in margin requirements in energy markets, standby letters of credit may be up for consideration as a form of collateral, although regulations limit their use.
Finally, depending on market conditions, collateral may have to be posted intraday, which is an operational burden for clearinghouses. This is becoming even more of a concern given the proliferation of 24x7 cryptocurrency trading.
Theorin elaborated on four technological aspects and transformational movements that would help improve collateral management and operational efficiency in derivatives clearing:
Improve visualization: From a technology and usability perspective, visualization is an often overlooked but powerful means to help collateral managers and other business operators better understand and anticipate margin requirements and collateral to make informed decisions about collateral usage and position management. By optimizing the user experience when operating in these complex environments, which is especially important during times of market stress, we can reduce the cognitive load on business operators and facilitate timely decision-making.
Leverage emerging technologies to make collateral more accessible: The fragmented custody network with time limits and cutoffs across the globe leads to collateral management slowness and difficulty accessing collateral. This causes an operational risk and fuels cost inefficiencies. Distributed ledger technology (DLT) is an emerging technology that could address this issue by providing participants instant access to collateral. Central bank digital currencies (CBDCs) could also be used to facilitate more efficient access to collateral, which is something that several governments are looking at how they can implement.
Adopting industry standards: Moving towards standardization is key to efficient and streamlined operations while focusing efforts on innovation and business development rather than infrastructure upkeep. One example of such industry standardization is APIs for connecting to clearinghouses’ services, which traditionally have been propriety. As a technology provider to more than 100 market infrastructure operators globally, we have noticed a clear shift in the last five years toward a desire for standardization as clients are refreshing and upgrading their technology infrastructure. While operators may have previously feared that standardization would result in the loss of service stickiness and competitive edge, many now see the benefits of standardization and how it enables improved agility and focus on innovation and business transformation. The Futures Industry Association is working toward the launch of an independent standards body called the Derivatives Market Institute for Standards (DMIST) in Q2 2022, an initiative that Nasdaq is involved in developing.
However, Theorin also pointed out that it’s critical for the industry to agree on the areas that can be standardized. From a tech vendor perspective, it would be fantastic if everything was standardized, she said, but that’s not going to happen. There will always be unique features and factors, as well as the practical necessity to fit in with the regional differences – which continue to be imperative to address.
Transforming with cloud operations and managed services: The cloud will be an important change driver to market infrastructure over the next decade. Market infrastructure CIOs plan to increase their investment in modern technology, and nearly two-thirds, 65%, see cloud technology as a fundamental and expanding part of their software development, according to a Nasdaq-commissioned Celent study. At the end of 2021, Nasdaq announced a partnership with AWS to move their U.S. markets to the cloud. Shifting from on-prem operations to cloud, market infrastructure operators can become more agile in setting up and testing new initiatives, as well as efficiently managing fluctuating trading volumes.
This goes hand in hand with a growing interest in managed services and SaaS, Theorin concluded, which, again, are enablers to focus resources on business development rather than technical operations.
MarketInsite
Nasdaq
Nasdaq’s Marketinsite offers actionable insights on a variety of market-moving topics. Learn from our thought leaders who are driving the capital markets of tomorrow.
Read MarketInsite's Bio
Anna Theorin
Nasdaq
Anna Theorin serves as Head of Product for Clearing Technology within Nasdaq Marketplace Technology. Based in Umeå, Sweden, Anna is responsible for developing the long-term vision for Nasdaq's clearing technology product portfolio while leading a team of post-trade technology professionals in their work to ensure the high-quality delivery of clearing solutions addressing the evolving needs of the industry.
Read Anna's Bio