Magazine Issues » November 2013

INSIDE VIEW: The single source of truth

TypewriterThe investment book of record is replacing the trading book of record. John Mayr at SimCorp explains the reason for this.

Portfolio managers and traders rely on high quality and up-to-date information to make the right investment and trading decisions. But in recent years, the unprecedented pace of change in the financial markets has resulted in some investment managers being unable to provide or obtain a single, trusted and complete version of data on their positions. This heightens the risk of unexpected outcomes, which is a concern to both investors and regulators, and leaves the portfolio manager ill-equipped to make informed decisions.

This has not always been the case; rather, it is an issue that has escalated over time. Historically, portfolio managers and traders were able to base their decisions on the information contained in the trading book of record (TBOR). Their day would start with a set of position records. These positions would be adjusted by front office systems to reflect trading activities as they took place, and then refreshed by middle and back office accounting systems overnight. As such, TBOR provided an acceptable view of positions.

But the nature of trading and investment in today’s financial markets means that TBOR is no longer adequate and investment managers are turning to a different kind of operating model, an investment book of record (IBOR).  

Analysts estimate that an average of 9% of total revenue spend in the financial services industry is on IT – a figure that is markedly higher than in most other industries. It is perhaps surprising, therefore, that some firms are operating on systems that are no longer able to fulfil their core functions, let alone add value – so-called legacy systems. An investment manager using a legacy system is akin to him or her listening to music on a Walkman or drafting documents on a typewriter, in that outdated technology impedes performance.

Even as the economic situation arguably improves, the instinct of most firms is to reduce or avoid capital expenditure, but if the internal infrastructure within an organisation is not fit for current or future purpose this represents a huge gamble. It undermines the business and may cause irreparable damage.

The global financial crisis – and in particular the collapse of Lehman Brothers – highlighted the importance of systems that could (or conversely, the danger of systems that were unable to) provide firms with an accurate and timely view of their investment positions and counterparty risk exposures. For some of Lehman’s counterparties at the time of its default, the consequences of operating on disparate systems and manual processes were all too keenly felt: loss of client confidence, reputational damage and financial losses, all of which collectively shook the stability of financial markets – and that was a time of supposed economic boom.

A legacy of the financial crisis is that investors, board members and regulators are now more interested than ever in the operations that support and have the potential to remove unwanted risk from an investment manager’s core business.

As part of this legacy, new regulations aimed at increasing transparency in the financial markets and mitigating systemic risk are being implemented. In particular, the overhaul of the derivatives markets – which policymakers considered risky and opaque – has resulted in new regulations such as the European Market Infrastructure Regulation (Emir) and the Dodd-Frank Act that are forcing changes in the way derivatives are traded, cleared and reported to clients and regulators.

To a large extent, legacy systems do not make any provisions for the likes of these regulations or requirements. A recent poll by SimCorp shows that 82% of North America capital markets firms said that they needed to create work-rounds in their middle- and back-office operations because their systems could not support new regulatory requirements for derivatives transactions under the Dodd-Frank Act.

It is these outdated systems that feed into the TBOR model for calculating investment positions. But where TBOR was once acceptable practice, regulation has created demands in the front, middle and back office that outweigh the capabilities of these systems – making the entire model unsound. Now, information about where transactions can be traded and cleared and how much and what type of collateral needs to be posted against the transaction all play a role in what assets and where investment managers invest in.

And regulation is not the only driver of this development. With firms under continued pressure to find ways to remain competitive and retain their client base, portfolio managers have begun to search for new sources of alpha through multi-asset class strategies and/or investments in high growth markets, while traders are seeking to make basis point savings through best execution.

IBOR, unlike TBOR, integrates front, middle and back office and is updated intraday with any event that impacts the investment position, no matter the origin. This means that the data needed to make informed decisions is in one place. It includes information on executed trades and corporate actions, as well as resets, simulations, open trades, benchmarks, collateral needs and cash.

IBOR serves to address all of the issues that are so concerning to regulators and investors: it minimises the risk of ill-informed decision making; provides an overview of risk exposures and enables more efficient use of assets. Operating an IBOR requires operational resources to keep updated but the benefits can provide tangible results.

A study by Citi and forward look called The missing link: operations improvements enhance portfolio performance, suggests that the operational efficiency of deploying an IBOR can contribute to realised investment performance in the range of 50 to 200 basis points.

Not all investment managers require a separate IBOR: some already operate on integrated systems strategies that provide one book of record. However, roughly one in four investment managers run their businesses on old systems that have lacked ongoing investment.

Establishing an IBOR is a significant undertaking but, increasingly, a necessary one. As new market and regulatory requirements continue to manifest themselves, so will the need for systems that can support them, and provide firms with the true information about their investment positions they need to compete.

John Mayr is marketing and partner development at SimCorp

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