Moving OTC Derivatives to 5G | Views on the Future
A recent speech by Scott O'Malia (CEO ISDA) exhorts firms to move much more quickly to modernise the market infrastructure. Here are my views on the time horizon for change, ledgers and central processing.
At the 2019 ISDA Tech Forum Scott O'Malia (CEO) made a speech about accelerating change. Research by ISDA shows that processing OTC trades is plagued by reconciliations, manual processes and fails. The underlying causes relate to the vertical client-server approach to building software.
Fig 1. The current industry processing model
A problem ISDA wants to solve is the absence of an industry rule book on how OTC trades work. The solution is the Common Domain Model (CDM). Using FpML as the data dictionary, the CDM adds definitions of the events and calculations that occur over the lifetime of a trade. The goal being to define once and for all exactly how an OTC trade functions over its lifecycle.
Builders of existing OTC processing systems haven't had the benefit of the CDM so their systems are best efforts at implementing the OTC trade lifecycle. But each builder won't have reconciled their system to every other system, so slight differences become the problem of the end-users. And given the number of vendor and in-house processing systems, making them all CDM compliant and interoperable will take many years.
What we need is a common processing platform?
The promise of ledger technology is a horizontally aligned approach to processing OTC trades such as this:
Fig 2. A ledger based processing model
Key features would be:
A common database where a trade is stored once for both parties – no need for reconciliations
Common processing logic and applications
A common UI to achieve common tasks
Two examples of platforms which aim to achieve this for different markets are the CHESS project funded by ASX delivered by Digital Asset. The ASX project will be a replacement for the current CHESS platform processing the Australian cash equities market.
Another example is the re-write of the DTCC Trade Information Warehouse with Axoni. The TIW is a rare example of market infrastructure that can (if you wish it) process an OTC CDS trade from matching to settlement. Axoni is working with DTCC to create a new version of the TIW using distributed ledger technology.
But what about all those internal processing systems?
I don't believe there is a commercially available DLT processing platform for OTC products at the moment. I'd be the first to applaud the launch of such a platform, but I doubt it will happen soon. DLT is still unproven, and for such a system to achieve commercial success a great deal of testing will be needed.
But, one bank using a DLT back-office won't make much difference to the current landscape – it needs a consortium of banks to commit as a group.
An example of a consortium success is WeTrade (https://we-trade.com). This business provides a platform to enable trade finance and is owned by a consortium of banks. Via their shared ownership they direct the development of the platform.
Yet a recent departure from We-Trade of the founder and COO left a sting. Roberto Mancone said "I have not yet seen something that shows the ultimate benefit of the technology. We are building solutions that are perceived as valuable by the providers of the solutions, not the users.”
Is there any other platform which provides common processing?
Yes there is – LCH SwapAgent. It exhibits the same logical approach as DLT with a common database and common applications. The UI is left to customer banks as SwapAgent isn't meant to be on people's desktops.
SwapAgent isn't a central counterparty, but it is a full-service processing platform for a wide range of OTC products. SwapAgent is a de facto standard for OTC processing which all users are bound into. Does SwapAgent deviate from the ISDA CDM? An interesting question which will be resolved in private I'm sure.
More here: https://www.lch.com/services/swapagent
Where does this leave the market?
In my view the promise of new technology has a long time horizon. The OTC market has taken over 25 years to create the current environment, re-plumbing and re-wiring will probably take just as long.
In the meantime, I believe fundamental change will need a group of banks to commit to a completely new approach either via a platform like SwapAgent, or with DLT, to move the needle on cost and efficiency. This could happen – if cost pressure is strong enough and banks can find a method to fund and direct such a project. They've created consortia before and could do it again – a big enough lever is what is needed.
Moving to 5G
At the end of Scott's speech he hopes the OTC market will hurry up and adopt a '5G' vision of the future. But perhaps 5G is too scary, as a small town in the UK banned 5G over health concerns. Let's hope OTC 5G delivers a healthy, cheap and efficient route to the future market.