The Buy-Side Drags Its Feet On Regulatory-Driven Investments

Powerful economic headwinds and the battle raging in Washington over how to implement the sweeping finance reform bill are enabling Wall Street firms to put off the costly infrastructure upgrades that were expected when the Dodd-Frank Act was passed a year ago. Over the past year, financial services firms have been setting aside money to beef up compliance and risk management operations before the new regulations were scheduled to take effect. But with balance sheets being pressured across the industry by a weak trading environment, and with new compliance requirements still unclear, many firms are opting to put off regulatory-driven investments in their middle and back offices as long as possible, industry sources say.

At the moment, it appears those upgrades may not be necessary for quite some time. As of July 1, 2011, only 38 of the projected 400 Dodd-Frank rules had been written, according to law firm Davis Polk & Wardwell. A progress report produced by the firm showed that as the one-year anniversary of the law approached, 104 rulemaking deadlines had been missed.

Republican lawmakers, who widely opposed the Dodd-Frank Act, have compounded matters for regulators by drafting dozens of bills that could dismantle portions of the law. So even as firms look to trim costs by laying off employees and reining in infrastructure spending, the continued lack of clarity from regulators on Dodd-Frank gives Wall Street even more of a reason not to improve its compliance, risk management and trade reporting software for the time being.

Hurry Up and Wait

"Nobody wants to spend money on infrastructure when growth is 1 percent," says George Michaels, a former Goldman Sachs vice president and founder of software provider G2 Systems. "And if you think you can get away with doing it later, everybody is going to do that, because you want to show your investors that you have a nice net income. Infrastructure spending definitely affects the bottom line."

In addition to more-sophisticated trade reporting systems, a large chunk of regulatory-driven infrastructure spending was expected to come from buy-side firms preparing for the new OTC derivatives trading landscape. For the buy-side, those expenditures would cover changes ranging from alterations of front-end software to accept input from a trader on where a deal must be cleared, to a physical connection to central clearinghouses, to mechanisms to handle variation margin payments.

But a SimCorp survey released in July shows that the buy-side apparently is putting off those upgrades as long as possible. In a poll of more than 120 executives at 60 capital markets firms based in North America, SimCorp found that 77 percent said they don't have the right systems in place to comply with the new regulations governing OTC derivatives trades.

In addition, only 23 percent of those polled felt confident that they were ready for Dodd-Frank from a systems perspective, according to the investment management systems provider. Further, one out of two respondents said they weren't sure they could capture all OTC derivatives position, transaction and contract data in a single place to get a full view of risk and performance.

"The tools to manage the life cycle of derivatives -- most of these asset servicing firms don't have that in place yet," says Mark Israel, vice president at Sapient Global Markets, a provider of technology and operations consulting services to the capital and commodity markets.

Spending should get a kick-start, however, from either resumed growth in the equity markets or a rise in inflation, which will prompt companies to spend since money will lose value the longer firms hang onto it, according to G2's Michaels. Currently, "There's not any incentive for anybody to spend their money," Michaels explains. "As long as the purchasing power of the dollar in terms of goods and services remains static, nobody is going to spend." As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio