June 2019

The risks of using legacy systems to reconcile derivatives

Anyone who works with derivatives will be familiar with Microsoft Excel, often much to their frustration. Excel is a powerful tool, but using it to reconcile derivative trades on an institutional level poses significant risks. Some of these are obvious. Others, less so.

The problem with Excel

Markets are fast. Legacy IT reconciliation systems are slow to adapt.

Twentieth Century software simply isn’t designed to handle the pace of today’s derivatives markets. Everything is greater now – the speed, volume and complexity of trades have all increased since the first IT systems were built to handle them. Traditional reconciliation systems simply can’t keep up – because they weren’t built for the complexity of derivatives.

Most firms use spreadsheets to process derivatives transactions, and they’re certainly a step up from legacy systems in terms of speed and flexibility. But spreadsheets are no panacea.

Excel was built for consumers, not financial institutions. It’s a one-size-fits-all solution for people with a wide range of needs, but it can’t deal with the complexity of professional derivatives trading. It has no audit functionality and it has no change control ability. Relying on Excel for trade reconciliation and collateral management exposes organisations to a new set of risks.

Most firms dealing with derivatives know this and have already started to take action. The modus operandi is shifting from legacy reconciliation systems (often co-existing with Excel) to specialist platforms.

Cut your losses

From conversations with firms across capital markets, we know the biggest fear amongst decision-makers is loss of P&L. When markets are traded by humans, mistakes happen, but using a platform designed with derivatives in mind helps to minimize their size and frequency.

It also helps to reduce operational costs. CEO of ISDA, Scott O’Malia, says “the legacy systems we have today are killing us from a cost standpoint.” Whilst this is alarming, we believe an even greater risk is non-compliance.

This goes beyond the prospect of fines from the regulator. Far more destructive is reputational damage that could lead to clients abandoning a firm for a counterparty that has their house in order. In the long run, damage to the brand is more costly than an FCA fine.

Another risk that gets scant attention relates to due diligence. Increasingly, prospective investors and partners are looking for reassurance that their counterparties have robust systems in place for handling derivatives. By failing to demonstrate their operational capabilities, firms risk losing out on investment and business.

It’s also worth considering the cost of retrofitting legacy systems to deal with derivatives. Upgrading proprietary technology is expensive, time-consuming and high-risk. More often than not, it sucks resources from an organisation and requires specialist project management. Once implemented, developers must then be kept up to speed with changes in the products being traded and the wider market context. After going through this arduous process, many firms are left asking if they are a derivatives house or a technology company.

It’s hard to do both well. So for the majority of firms, it makes sense to migrate to a specialist platform that’s engineered for their specific needs, rather than struggling with outdated systems or making do with Excel.

Help is at hand

Many firms lack the robust infrastructure required to support derivatives trading in a manner that minimises compliance, operational and financial risks. They rely on manual processes to handle high volumes of complex transactions.

It isn’t that they’re not smart, diligent or forward-thinking. Often, they’re open-minded but lack a holistic view of the end-to-end operational workflow required. There can be an admirable (albeit short-sighted) desire to focus on trading rather than technological applications. And there’s a widespread lack of awareness of how far middle office technology has travelled and how cost-effective it’s become.

Here at Duco, we have witnessed first hand the challenges firms face working with Excel and retrofitted legacy systems. Detailed client feedback has been instrumental in shaping our product into something that makes a meaningful difference for firms that are serious about trading derivatives.

It’s not all or nothing. Our cloud-based reconciliation software integrates with proprietary systems, complementing existing platforms and enabling firms to work with very complex data. Clients can set up reconciliations in a fraction of the time taken using traditional systems, and we guarantee that reporting data is accurate and complete, providing a clear audit trail and reducing the risk of regulatory fines.

In recent years, headwinds have changed the way derivatives trading firms do business. Increasing competition, cost pressures and regulatory scrutiny have changed the rules of engagement. Thankfully, technology has evolved to help firms handle these challenges in an affordable and efficient way.

With this in mind, is it time you took a step back and thought about your middle office infrastructure? If so, we’d love to chat with you and demonstrate how we can help.