Risk Management

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OTC Derivatives Market Still Lacks Transparency, Efficiency

Robust processes and better technology are needed to support the risk inherent in the market, according to findings of a survey carried out by TowerGroup and SunGard.

The OTC derivatives market is in a critical state of transition as regulators and other industry participants try to create a market structure that reduces systemic risks associated with this product. But the market still lacks transparency and efficiency, according to a new survey from TowerGroup and SunGard.

The study found that the multiple forms of risk assumed when trading these instruments continue to be a major concern. Eighty percent of survey respondents cited risk management as a top driver compelling their organizations to improve OTC derivatives processing.

Technology and operations will be a major factor in improving risk management in the OTC markets, the study found.

"We thought some problems had been solved, but they haven't," said Stephen Bruel, TowerGroup research director and author of the report "Addressing the End-to-End Risks and Inefficiencies in OTC Derivatives," which saw the participation of 60 risk officers at leading OTC derivatives firms, including buy-side, sell-side and asset management firms.

Part of the inefficiency has been that systems have been built around different processes, Bruel said in an interview with WS&T.

"Valuation drives lots of other processes. If you can't value you can't collaterize positions. We're seeing recognition that it is difficult to create straight-through-processing, people are trying to move away from islands to end-to-end processing management to improve operational efficiency."

A prerequisite to addressing risk concerns are "robust processes and better technology to support the risk inherent in the OTC derivatives market," Bruel said.

Ultimately, operational risk is seen as the most acute problem for OTC derivatives firms because of the manual nature of trading and post-trade processing, the survey found.

Risk officers also are likely to demand greater visibility into and stronger controls associated with market, liquidity and credit risk. But the market will also see an intense focus on counterparty risk, which will need to be addressed through better operational processes and technology, according to the study.

The introduction of central clearing is meant first and foremost to reduce counterparty risk, the study found.

"But in spite of all attention dedicated to clearing, the industry isn't ready for full clearing yet," Bruel said.

Overall, technology can improve transparency and efficiency in OTC derivatives in three areas: risk management, counterparty exposure and compliance, the survey found. Immediate areas of focus are on valuations, collateral management and clearing.

The yet-to-be-finalized nature of regulatory requirements makes planning for compliance a challenge. But "it is clear that players will need to undertake considerable work on both technology and operations fronts to address these requirements," Bruel said.

"The OTC Derivatives market will remain a vibrant market, if you can start to remove some obstacles," he added. "People need to invest [in technology]."

Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio

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