 Matthew Nelson
Director, Market Intelligence
In the first quarter of 2009, Omgeo interviewed over a dozen of our largest U.S. clients, representing all segments of the industry. The purpose of these interviews was to better understand how institutions are coping with the current conditions, how they are planning for the future and to gather their opinions on the future of the industry. Six common topics emerged from these interviews; planning and prioritization, the changing role of operations, relationships, risk and regulation, changing business models and emerging as a stronger industry. This series of articles will discuss each of these topics and our discussions with the participants.
Operations has, in many firms, taken on a new level of visibility and importance as a result of the economic crisis. Operations executives were the focus of the interviews conducted during this project and although very few of the interviewees suggested that their departments were ever considered “second class citizens” in their respective firms, most did indicate that Operations has achieved a heightened role within the organization.
Several factors have contributed to this change. In some firms, Operations’ has gained in notoriety because they were proven in a trial-by-fire. When Bear Stearns collapsed, Lehman came under fire and eventually filed for bankruptcy and AIG stood on the verge of ruin, it was Operations that was able to steer the firm through these major counterparty failures by providing concise and timely risk exposure reports to the organization. These reports allowed the firms to determine if quick and decisive actions were necessary to mitigate their risk and avoid significant financial loss. However, it’s likely that few firms were actually able to do this as the disjointed nature of their global organization did not allow for that level of reporting.
Second, most firms are realizing now more than ever, that data is indeed the lifeblood of their organization. Operations’ role as the owners and stewards of critical client, counterparty and security data means that they are responsible for the bulk of the data that feeds the hundreds of mission-critical downstream systems. Perhaps highest among these systems in terms of importance and visibility to firm management today are risk systems. Being able to tie positions back to issuers and trade counterparties is critical in navigating today’s highly volatile market environment. When massive intra-day price movements are common and the viability of corporations and counterparties is as questionable as it is today, being able to identify risk exposures across the firm on short notice is paramount.
Hedge funds are being forced to increase the importance they place on Operations in light of industry scandals and expecting future regulation addressing the hedge fund industry. Many believe that these will require transparency, which will in turn, require more robust operational and reporting capabilities. Further, thanks to sweeping mandates for independent third-party providers from large institutional investors and fund-of-funds managers, many hedge funds are being forced to outsource their middle and back office operations. While a boon for hedge fund administrators and outsourcers, executing on new outsourcing relationships will be a costly and time consuming process.
Finally, every firm has been forced to focus on mitigating the risk from failed trades. This includes shortening trade lifecycles, automating processes wherever possible and carefully monitoring exception reports to minimize the number of exceptions and reduce the amount of time that any exceptions remain outstanding. Firms are more thoroughly analyzing trade errors and “near misses” to better understand how they occurred and who was involved. In some cases, post-mortems are being communicated to stakeholders within the firm to ensure that everyone knows the successes and failures or Operations and what (if any) the downstream impacts were. A new era of accountability seems to have dawned on the industry which is being tied to incentives and compensation.
As mentioned earlier, when significant price swings and volatility have become the standard, not the exception and we question whether our trade counterparties will be in business tomorrow or next week, ensuring quick settlement of trades is the best possible protection against one side failing and the other side getting in line with the rest of the creditors. An open question that came out of many of these discussions was around the permanence of this change; is it just temporary while the industry is at a heightened level of concern, or is this a permanent change to the DNA of our industry?
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