"Back office investment can be justified on its own merits" - Gary Koche, Openlink
In an ideal world, the front office of a trading organisation would trade any product and the back office would process any product. The reality is very different. Competitive pressure often pushes management to focus on the front office in isolation. The front office of today is fighting not only for success against its rivals but also competes for the resources of its own organisation. Firms have little problem justifying front office spending but back office initiatives are much more difficult. After all, it’s often said that money is made in the front office. Back office inefficiency is the consequence. The disconnect between the ideal and the reality of buy-side companies is indicative of a range of problems – but the fundamental challenge is the lack of interest in supporting the back office beyond the level of ‘functional’. The front office is perceived as ‘growth’ and the back office as ‘cost’. Support for the front office need not come at the expense of back office efficiency. Back office investment can be justified on its own merits. The modern trading environment encompasses a broad range of often complex products. Derivatives trading for example, requires counterparties to be aware of all aspects of the trade, far more than simply checking that the trader has the cash or securities needed to complete a bond or equity trade for example. The processing requirements and costs increase with complexity. Making deals is one thing but they must then be correctly confirmed and processed. Failure to do so incurs cost.Derivatives trading highlights the potential for failure. It is far from clear that the industry, especially the buy-side, has made the investment in the back office that would prevent back office bottlenecks from occurring. In the UK, the FSA has indicated that it believes there is little if any extra capacity in the back office. Front office trading systems naturally multiply as the products traded multiply, and this adds support costs and systems integration cost to the mix. But by purchasing technology reactively rather than strategically, individual firms are actually each increasing their own exposure to risk.To tackle these challenges will require the right investment from IT and senior management, not only in finance but in strategy. Looking at the whole IT pipeline from front to back office, the case for a single, straight-through processing system is fairly straightforward. But problems do not occur at the same time, nor do opportunities. So fund managers often find point solutions to meet specific requirements and this actually creates a cumulative problem.This approach was understandable in an immature market where technologies were being created as challenges cropped up. But much of this functionality is now normal and the technology adoption strategy used by the buy-side ought to reflect this maturity. To take a strategic view, the system should be configurable to handle newly emerging assets and combinations of products. Why should adding new products to the trading mix require new systems to handle the back office processing requirements? Regardless whether the product is a swap, bond or commodity-linked note, there is no technical reason why confirms, settlements or accounting entries need be processed by multiple systems.Many of the current technology issues will evaporate as fund managers begin to address IT infrastructure as a whole. By handling the entire processing of a trade – across all assets – from the front office to the back in an automated manner through a single system, the organisation will see improved efficiency and decreased costs. It will also be able to improve security, audit ability, and control. The organisation could expect to implement consistent processing mechanisms across products to handle all events in the trade lifecycle. As a consequence, the data will be more accurate, complete and plausible. Reconciliation will become dramatically simpler. Generating alerts for exceptions and other risk conditions will become a trivial automated initiative. However, the drive to improve must come from the top.Chief technology officers are often able to spot the challenge here but the inevitable division between business and IT in the fund management space means that they can find themselves at odds with chief operating officers, who see immediate challenges and seek immediate resolutions. By enhancing dialogue between these two groups and their immediate reports, such challenges can be overcome.
Markets will continue to grow in volume and complexity. However, looking forward, chief risk officers must consider the nature of the technical architecture that reflects their business. Risk and cost are increased with incremental separate systems. In the trading business, risk ought to be married with reward – not mounting up as a cost of doing business.
• Gary Koche is global head of Findur, at OpenLink