Over the counter (OTC) derivatives are presenting unique challenges to dealers and technology suppliers, but they are driving healthy growth in trading technology sales.
Financial analyst TowerGroup predicts that spending by institutional brokers on derivatives trading technology applications will rise by a compound annual growth rate of 9.5% over the next five years, from £481.5m to a total of £684m.
TowerGroup says broker dealers require a trading platform with a wide range of specialised tools, including risk analysis, decision making support, trade entry, execution, and operational support to take advantage.
But there is currently no single system in the OTC derivatives trading space that provides enough structure and processing capabilities to be called a single solution for a broker dealer, said the analyst
TowerGroup says certain "vanilla" OTC derivative products can be handled effectively as they are.
However, processing hybrid derivatives in a standardised manner will continue to challenge broker dealers.
"While the reality of OTC trading is more advanced than most believe, institutional traders confirm that there are significant areas of inefficiency that dealers need to address," said Stephen Bruel, an analyst at TowerGroup.
"Due to the fast moving nature of the OTC derivatives environment, the industry is seeing increased spending on technology as well as increased pressure on technology firms to keep up with derivatives innovation," he said.
For firms looking to become major players across all asset classes in this space, TowerGroup recommends implementing a trading system incorporating a well-defined strategy including the following
*Combining the derivatives trading implementation with a service-oriented architecture (SOA) framework to aid in the integration of disparate trading and technology systems.
*Implementing more powerful computational resources.
As OTC products become more complex, risk measurement requires more computing strength - putting the use of grid computing high on the solutions list.
*Developing a vendor management system. While trading vendors tend to partner with intuitions to develop new products and workflows, institutions need to ask themselves if they want to participate on the OTC front. If not, they must determine which vendors have developed modules that represent emerging industry standards.
*Removing legacy systems that don't support new volumes and products.