Technology experts at brokerage firms, exchanges and software vendors see the exchange-traded derivatives industry making "evolutionary" changes in the technology infrastructure that supports trading and clearing, rather than adopting revolutionary new technologies such as blockchain and crypto.
Speaking at FIA's annual Asia Derivatives Conference, executives from J.P. Morgan, Nasdaq, OSTTRA, the Singapore Exchange and Trading Technologies identified several areas where they would like to see improvements in the way that futures and options are traded and cleared, and they pointed to several examples of innovative fintech solutions that are already in use. But they cautioned against taking a technology-centered approach, and they emphasized the need to build within existing infrastructure.
Alison King, a senior executive at the Singapore Exchange, gave an example of the issue. She explained that the exchange implemented a collateral management API when it upgraded its trading and clearing systems to the Titan platform several years ago. Even though the API functionality is based on widely used technology, only one clearing member is actually using the new functionality. The lesson, she said, is that the pace of innovation hinges on adoption by the clearing members, also known as futures commission merchants or FCMs.
"As an exchange what we struggle with is that we can innovate until the cows come home, but at the end of the day we need to bring everyone with us," said King, who is responsible for the strategy and development of the exchange's trading and clearing platforms. "We can't make changes that then impact the FCM community. We need the FCM community to come with us."
The key challenge for the exchange-traded derivatives industry, the experts explained, is its network structure. Brokers, exchanges, clients and vendors are all tied together in a network of relationships. As a result, the introduction of technological innovations depends on industry-wide adoption. Individual firms can use new technologies to improve their internal workflows, but more fundamental change requires support from a wide range of players across the industry.
Several executives pointed to blockchain as an example. The proponents of this technology, also known as distributed ledger technology, have argued that it has the potential to revolutionize clearing and settlement. In practice, however, several well-funded efforts to migrate to this approach have not succeeded in replacing existing systems.
Guy Rowcliffe, co-chief executive officer of OSTTRA, a technology provider focused on post-trade solutions, noted that blockchain has not been adopted successfully even in the over-the-counter derivatives markets. OTC markets are far less standardized than exchange-traded derivatives and therefore they should be better suited, at least in theory, to the efficiencies promised by blockchain. But that hasn't happened, he said.
"There's been a huge amount of investment, effort and focus on ledger [technology] in the OTC world," he said. "After six or seven years of work, there isn't a single example of adoption at scale by the industry."
Rowcliffe added that getting a critical mass of market participants on board is essential. "Focusing on just the technology is not recognizing the full problem. The problem is effectively the network that supports that industry...If you don't have all the participants connected into that network, the new technology is not much use to you."
Neil Newby, an executive in J.P. Morgan's Singapore office with responsibility for operations, provided some insights on how brokers have changed their approach to technology. A decade ago, large firms like J.P. Morgan relied on their own in-house technology teams or looked outside to the established technology vendors. Now there is another approach -- the operations team is building its own "intelligent automation tools" using machine learning and natural language processing.
He pointed to email as an example. Years ago email messaging was a huge improvement over fax machines for communicating with clients. Now, however, the solution has become the problem. Operations staff are spending too much time digesting email and it has become a "huge drag" on efficiency, he said.
To address this issue, Newby said the operations team is using a natural language processing tool to automate this process. For example, when a client agrees to pay a margin call, the NLP tool can read the email, understand the content, and book it in the margin platform.
Search for Standards
The impact of this type of technological improvement is limited, however. The bigger challenge is tackling certain inefficiencies in the post-trade process that arise when trade processing is not completed on the day of the trade. Sorting out the trades requires information sharing across executing brokers, clearing firms, clients, exchanges and clearinghouses, and the lack of standardization puts a heavy load on operations teams.
Newby noted that the surge in volume at the onset of the pandemic in 2020 highlighted the need to address these inefficiencies, and he stressed the importance for the industry to support the work of the Derivatives Market Institute for Standards, FIA's recently established standards body.
One area where Newby said he would like to see standards emerging is in the rules of post-trade processes across central counterparties globally. He mentioned in particular position transfers and give-ups, and he added that the industry would benefit from having those standardized so that exchanges can build their solutions to those standards.
King also made a call for market participants to get involved in DMIST. Individual exchanges such as SGX find it difficult to get their members to focus on a particular technology solution, she explained, so having a global standard for something like average pricing will make it easier to get FCM support.
Keith Todd, the chief executive officer of Trading Technologies, only partially agreed, however. He said his firm, one of the largest providers of trading and risk software for the industry, is already moving forward with more technologically advanced solutions for its clients, rather than waiting for standards.
"I applaud the work on standards that FIA is doing, but frankly I'm not waiting for it," said Todd. "My experience is that standards take a long time to get to. We haven't got that time. We need to make changes now."
Revolution in Payments?
Despite the skepticism regarding disruptive new technologies, two executives pointed to areas where big changes in technology are on the horizon.
Ulf Carlsson, the head of Asia-Pacific and Japan at Nasdaq, said his exchange is in the process of migrating the matching engine for one of its exchanges to the cloud. Although cloud computing has been around for many years, it has been used mainly for data storage and analytics. Trading is a much more complex case because it is so sensitive to latency, he said. As a first step, Nasdaq is moving one of its US options markets to a "hybrid model," he said. The matching engine will be in the cloud, but market participants will remain connected through the existing co-location center in New Jersey.
King looked even farther out on the horizon. She noted that there are emerging technologies in the payments world that could have a "revolutionary" impact on cash flows between exchanges and clearinghouses and their members. For example, there is work underway on settlement in central bank money that can operate in real-time on a 24/7 basis. She said this could be especially important for exchanges when trading remains open during bank holidays and payments cannot be made through conventional commercial bank channels.