Credit Derivatives Trading and Processing Tech In Demand, but Buyers Still Hesitate

With the average daily trade volume of credit derivatives doubling since 2004, according to a new report from Celent, Wall Street firms still are shopping for trading technology, particularly back-office processing automation to handle the huge increase in their credit derivatives business, just as many firms were shopping for similar products at last year's SIA show.

According to the Celent report, authored by Harrell Smith, manager, Institutional Securities & Investments Practice, more than $10 billion of credit derivatives products are traded in the United States each day.

But despite recent reductions in the number of unsettled credit derivatives transactions, following the Federal Reserve Bank of New York's demand that many of the largest dealers in the U.S. clean up their processing of derivatives trades, thousands of trades remain unsettled at any given time, says Brad Bailey, a senior analyst at Boston-based Aite Group. Bailey is the author of a just-released report on the electronic trading of credit derivatives.

The efficiencies that could be gained with automated processing of credit derivative swaps (CDS) not withstanding, many investment managers are reluctant to invest in the technology, report a number of technology vendors at the SIA show. "The technology is available to solve many of the industry's problems," says Kevin Covington, director of product development at BT Radianz (booth 1509). "But there is a lack of a consensus in the industry" when it comes to communications standards. The lack of standards is holding back many institutions from making substantial investments in technology for credit derivatives, he adds.

In addition, many investment managers do not see a financial benefit in automating a few CDS transactions, especially if the investment goes to back-office processing, says one SIA attendee from a Boston-based hedge fund that has more than 50 percent of its funds in so-called exotic investments, including credit derivative swaps. "Back-office automation usually isn't a compelling financial gain."

But if the market keeps growing at the rate it has grown over the past few years, firms will need to invest in automation. "For the past decade the market has doubled every year or two," Aite's Bailey says, pointing out that there is more than $17 trillion in notional value outstanding in the credit derivatives market, although credit derivative swaps only account for about 8 percent of the overall OTC swaps market. "You will see the market continue to grow at this rate as newer products are offered. But I don't think what is happening in derivatives is different than any other market," he says. "All of the innovation usually happens in the front office, and it puts a lot of strain on the back office. The short-term solution at many firms was to throw more bodies at the solution. Now the question is having the right technology in place."

More from the floor of the SIA Show Greg MacSweeney is editorial director of InformationWeek Financial Services, whose brands include Wall Street & Technology, Bank Systems & Technology, Advanced Trading, and Insurance & Technology. View Full Bio

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