Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Backoffice improvements after covid subsides
About a third of securities trading firms on both sides of the deal experienced operational stresses during the peak covid-19 volatility last year, according to a new DTCC white paper.
The paper, carried out by global back-office behemoth DTCC (Depository Trust & Clearing Corporation) and consultancy firm McKinsey & Company found some weak links in the trading chain under extreme market duress last year.
“At the height of the pandemic in the early months of 2020, trading volumes rose to unprecedented levels… even when compared to other historic events. Amid margin calls, dividend cancellations, coupon deferrals, valuation changes and associated administrative requirements, some 30-35 percent of firms – buy-side and sell-side equally – saw operational post-trade challenges in cash fixed income and cash equities,” the report says.
“After fixed income and equities, listed derivatives were the most-cited asset class, with 20-25 percent of firms saying they struggled to keep up with processing demands, particularly in clearing. In a number of instances, multiple OpsTech releases were required to scale services, as some clearing brokers saw extraordinary daily volumes.”
Almost 60 per cent of sell-side business also experienced settlements and payments issues as trading volumes surged with about 40 per cent also struggling with collateral and valuation services.
Based on a survey of 35 buy-side and sell-side institutions in the US and Europe, the DTCC paper says the latter group “was most impacted in the fixed income business, with 47 percent of firms reporting problems”.
“The buy-side, meanwhile, saw cash equities, money market instruments, and secondary loans come under the highest levels of pressure.”
Overall, buy-side post-trade processing continued relatively smoothly during the crisis, the DTCC survey found.
“… most significant [buy-side] challenges related to position exposures, for example where record volumes and high volatility put stress on collateral payments,” the paper says. “Buy-side survey participants attributed their relative outperformance to their simpler operational model when compared to the sell side, the need to coordinate with only few counterparties, and robust digital transformation programs, at least for the larger firms.”
Outsourced IT solutions also emerged well from the crisis, the study says, with over 90 per cent of respondents highly satisfied with third-party providers even as about half faced some “vendor disruption” at times last year.
But in spite of the operational outages during periods of historically extreme volumes in 2020, the industry as a whole held up well, the report says.
The automation of many back-office processes along with previous crisis management experience in the global financial crisis and other events left financial institutions in good shape to handle the COVID-19 fallout.
In particular, the industry shifted to virtually 100 per cent work-from-home (WFH) in a matter of days, the study says.
Michael Bodson, DTCC’s chief executive, said in a release: “During, and in the immediate aftermath of the COVID-19 pandemic, the industry remained resilient, with buy and sell-side firms working seamlessly to support unprecedented volumes and ensure uninterrupted trading for clients and underlying investors. However, opportunities remain for further optimizing post-trade processes across the capital markets.”
The survey found respondents would invest in several areas based on lessons from the COVID crisis, including:
- accelerated clearing and settlements coupled with improvements in capabilities around valuations and collateral;
- predictive analytics, for example to support fails prediction by client and/or product, and unleashing the power of advanced analytics and technologies like machine learning to enhance operations; and,
- transforming the ways of working and re-imagining the future of work by leveraging WFH learnings not only around operating remotely, but more broadly around process re-engineering and further automation.
In February this year, DTCC proposed a ‘pathway to settlement for the US equities market from the current two-day process. The plan came as some US retail share traders were shut out of the market during the GameStop kerfuffle that caused halts on the famed Robinhood platform as well as further afield in Australia (Stake) and NZ (Sharesies and Hatch).
Although not a household name in Australasia, DTCC wields enormous influence in the global financial plumbing system, processing securities deals valued at some US$2.15 quadrillion (a quadrillion is a thousand trillion) in 2019. The firm provides custody and asset servicing for securities issued from 170 countries and territories worth about US$63 trillion, according to a boilerplate blurb, while processing more than 14 billion messages each year through its global repository services.
– Investment News NZ
