Experts say pandemic is accelerating derivatives industry innovation

Firms focus on post-trade modernization, cloud and machine learning applications

18 March 2021


Industry experts at FIA's International Futures Industry Conference on March 17 agreed the adoption of innovation in derivatives markets has shifted into a higher gear as a result of the pandemic. They also agreed that three key factors were behind this change, including a step change in trading volume, pressures created by the abrupt shift to remote work and a change in mindset that is more receptive to innovation.

Step change in trading volume

Brenda Hoffman, head of technology, U.S. markets systems and investment intelligence at Nasdaq, noted that her exchange saw a peak of 60 million messages a day in its options markets during pandemic-related volatility last year. And while things eventually settled down, she said, "messages are in a new normal that's still two times to three times prior peaks before 2020."

Hoffman said Nasdaq had to "create more capacity and more headroom basically overnight. That's not just the marketplace itself, but other parts of the ecosystem where clients are required to take in message traffic and consume in real-time." She said a new work environment that featured remote collaboration only added to the challenge.

But while she admits the early days of the pandemic were uncomfortable, she says Nasdaq and other derivatives markets emerged resilient and more confident about their ability to solve problems and seize new opportunities. "There is a new appetite to adopt new technologies in the last year" and "to just try new things and find out what works," she said.

Donna Rudnicki, managing director of capital markets data strategy at RBC Capital Markets, said that she sees a similar change in attitudes in the banking industry. Rather than building solutions internally, firms are more receptive to partnering with external vendors. "We’re much more open to those solutions," she said.

Operational efficiency and regulatory costs

Mark Beeston, a partner at venture capital firm Illuminate Financial that focuses on start-ups providing solutions for the financial services industry, said the resilience of derivatives markets in 2020 showed "the art of the possible," and noted that he has seen a big change from the empty rhetoric around innovation in the past to a true commitment to problem-solving right now.

boca panel 2
Charlotte Crosswell, CEO of Innovate Finance (left), moderated a panel discussion on trends are shaping the markets of the future, and whether they present a revolution or evolution. Speakers included Mark Beeston, Partner, Illuminate Financial; Brenda Hoffman, SVP, Head of Technology, U.S. Markets Systems and Investment Intelligence, Nasdaq; and Donna Rudnicki, Managing Director, Capital Markets Data Strategy, RBC Capital Markets

"Industry rhetoric has really changed to a conversation that is about digitalization 2.0, where the 1.0 was the original expansion" driven by the rise of electronic trading over traditional open outcry, Beeston said. He noted that the first generation of big technology investments in derivatives markets were often characterized by long-term, internal efforts bespoke to individual firms -- while nowadays, firms demand interoperability and ready-made solutions. The current environment is characterized by a thriving ecosystem of smaller vendors and innovative start-ups that can help major players "do a heck of a lot more, a heck of a lot faster with a lower failure rate," he said.

"Right now, there's just no market tolerance to take on a five-year project that ultimately might not even get you where you want it to be," Beeston said.

Donna Rudnicki of RBC agreed that this dynamic is exciting for the industry. After the financial crisis of 2008-2009, banks were forced to allocate a large portion of their technology budget to addressing regulatory mandates, she explained. Compliance is still a key driver for decisions on how to allocate technology resources, but she said firms in the sector are showing more commitment to investing in ways to grow the business.

"I'm from a firm that's highly regulated, and a lot of the investments have gone down the path of the work we had to do," Rudnicki said. "Investment in innovation and the things we'd like to do have been cannibalized by the things we've been forced to do."

Mark Beeston at Innovate Financial added that in addition to the internal challenges that firms must face on their own, in modern and interconnected derivatives markets there must be a focus on the entire ecosystem.

"If I have collateral with 4,000 counterparties, I can only be as post-trade efficient as every single organization I work with," Beeston said.

This need for cross-industry collaboration has become a top priority for FIA and its member firms. In his opening remarks at the Boca-V conference on 16 March, FIA President and CEO Walt Lukken discussed an increased focus on market infrastructure issues including post-trade processing and collateral management.

"While the clearing system has proved itself resilient, these events have uncovered some areas in need of modernization to ensure trades are properly risk-managed and settled," Lukken said. "If we truly want to improve as an industry, we must address such issues head-on – even if they aren't easy."

Cloud, data and machine learning

Derek White, vice president of global financial services at Google Cloud, discussed how technological advances in areas including big data, cloud computing and machine learning are stepping stones for innovation in capital markets.

Modern financial markets require "interconnectivity between regulators, data providers, traders, exchanges and others in real-time," White said. Those demands come alongside ever-increasing amounts of data flowing through both individual firms and the derivatives markets as a whole. As a result, the only realistic way to manage all this information and stay in control is to use predictive analytics and machine learning technologies, he said. These tools can help with trade surveillance, regulatory reporting, liquidity reporting and settlement failure, among other areas.

Deploying these solutions isn't immediate and isn't always easy, he said, as big data and machine learning projects typically run in parallel with legacy structures for up to a year as they are tested and validated. As a result, firms need to address these innovations with "organization-wide commitment" to truly see them through, transform the culture and ultimately move operations fully into a digital age.

"There has to be recognition at the top of the importance of the change, but also an appetite for learning and understanding the power of technology," White said. "Many of these tools have evolved to a point where what was not possible a decade ago and required human and manual intervention is now possible."

Donna Rudnicki of RBC said that her firm is "beginning to harvest" vast amounts of data inside the organization, but the challenge is organizing that data and extracting insights. She said banks will be competitive based on their ability to provide "customizable actionable insight" for clients.

Added Mark Beeston of Innovate Financial: "data is not an afterthought, it's a foundational layer."

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