When the leading clearing body acquires the next leading clearing entity-especially when they both boast a global reach-it’s hard not to notice.
Earlier this fall, officials from the Depository Trust & Clearing Corp. announced that it had completed its 100 percent acquisition and ownership of Omgeo, the provider of post-trade services known for its international buyside clients. Previously, DTCC and Thomson Reuters had jointly owned Omgeo. Financial details for the deal were not released to the public or the press.
The numbers behind both of these post-trade firms are staggering. Last year, DTCC’s subsidiaries processed securities transactions valued at around $1.6 quadrillion. It provides custody and asset servicing for securities issues from 131 countries and territories valued at $37.2 trillion. DTCC’s global trade repositories record more than $500 trillion in gross notional value of transactions made worldwide.
Omgeo, for its part, boasts 6,500 clients and 80 technology partners in 52 countries. In 2013, Omgeo systems processed more than 723 million transactions.
Why would these two large and wide-reaching firms agree to an acquisition of this scale? To take a hint from the title of a James Bond film, the world is never enough. In a truly global and interconnected economy, both established and emerging markets need post-trade and clearing services to compete and manage risk.
Traders Magazine spoke with notably chipper Omgeo president and chairwoman Marianne Brown in London and DTCC president and CEO Michael Bodson in Jersey City, N.J., to find out what’s behind the clearing merger in an era of both Big Data and Too Big to Fail.
WHY DID DTCC BUY OMGEO?
According to Bodson, the acquisition of Omgeo was a no-brainer, especially after the dust settled following the credit crisis of 2008. After that tumultuous year, Bodson says, his and other financial services firms looked at post-trade infrastructure on a global basis. “There is a new appreciation for what happens in the post-trade space, but also for the first time, there’s been a serious rethink about the competitive advantage that firms get from owning the whole vertical stack on the post-trade side of the equation,” he said.
Bodson and his team looked at where DTCC could add efficiencies and value to firms that realized once and for all they were in an interconnected market. Omgeo’s global reach was a clear plus. “I think the industry saw an asset in Omgeo both in the post-trade matchings functionality as well as in the dealers’ database and some of the other services Omgeo offered,” he said. “We felt that having that under a more industry-governed structure, a user-governed structure like DTCC has, would better align those capabilities and the interests of the industry.”
Brown and her team at Omgeo say the acquisition by DTCC came at the right time. The Omgeo board of managers recently conducted a study of market sentiment and she says she can sum up the findings in a single word: utilization. Firms took a look at their back offices and noticed they were performing the same functions again and again, firm by firm, she recalled. “The feeling was that there’s got to be a better widget, a better way, and how do we leverage trusted industry partners to enable that sense of utilization?” she said of the Omgeo study.
It turns out that 2008’s jarring and game-changing impact was still being felt throughout the clearing industry well after the collapse of Lehman Brothers and shotgun mergers on investment banks in September of that year. Spooked by those events, investment firms took a hard look at their operations and where they could add innovations and greater efficiency, Brown said.
“We all said the words, ‘This is structural, not cyclical,’ and everybody went full steam ahead with mitigating expense where they could and driving costs out of the business,” she said. “But there’s a finite ability to execute on that until you change the core of the model and how it all works.”
Once the fat was trimmed and head counts reduced, firms started looking at operations and procedures that never really warranted much attention before the crash. “Everybody was full steam ahead until they had an epiphany that, ‘Oh, this is very much structural and therefore we need to take a new structural view of how this all gets done. We need to really lead the market to be much more creative on things that had seemed to be mundane,'” she said.
“All of a sudden, the back office got sexy,” said Brown.
THE BUYSIDE TAKES ON CLEARING
As the buyside gains more power over the sellside, it is asking for an increased role in post-trade clearing. Bodson confirms there is a renewed interest in these once mundane and arcane procedures among buyside participants.
“Obviously, the buyside has relied heavily on the sellside to be the intermediary between themselves and the clearing organizations. What you’re seeing is, a lot of the larger firms are looking at what it means to become a member of a clearinghouse,” Bodson said. He pointed out that smaller buyside firms such as hedge funds are not allowed to be members of clearing services, but they are asking if this should be an option. According to Bodson, buyside firms are asking, “Do I want to have exposure to some of these firms, or is it better to have our exposure to a clearinghouse? With the collateral requirements, what does it mean in terms of movement securities and cash in terms of intra-date collateral calls?”
While Bodson calls this renewed focus an “evolving space,” he does see buyside firms asking about the risks of taking a direct membership model with a clearing organization as opposed to simply relying on the sellside.
One of the challenges for clearing firms like Omgeo and DTCC working directly with the buyside is the variety of sizes, focuses and demands. According to Brown, “the buyside is so broad, and there’s such a varying degree of participants between family offices, pension funds, and then the larger firms are saying, ‘Game on.’ By and large, the more substantial buyside firms understand the relationships and where they have opportunities to mitigate risk and engage more directly in the process.”
Brown points to Europe, where she works in Omgeo’s London office. Buysiders in Europe must report directly to the global trade repository or make sure their transactions are reported. “There are different ways to do that, but many of the brokers are concerned that the buyside is assuming that the brokers are going to fulfill that role for them, and by regulation they have to enable that themselves,” she said. “It’s a myriad of perspectives.”
WHAT DOES THE BUYSIDE WANT?
In reaching out to the buyside, some of the same questions pop up time and again. In Europe, Brown says, the aforementioned reporting to regulators crops up repeatedly. In the U.S., the main issue is the danger of relying on only one prime broker.
“After Lehman Brothers failed, the very important topic for the hedge fund forums was using multiple primes. Lehman was a very significant player in the prime broker marketplace, so when it collapsed, all the hedge funds said, ‘Wait a minute, maybe we shouldn’t have one prime,'” Brown said. Although there were advantages to using one prime broker-especially one with the breadth and depth of service of Lehman Brothers-the dramatic collapse of a leader in the space unsettled once-satisfied hedge funds and buyside firms.
T+2-JUDGMENT DAY
Another issue, especially in Europe, is the T+2 settlement cycle, where a trade will be settled two days after the deal is made. Regulators and market participants in the U.S. markets have been talking about T+1-settling a trade one day after the deal ends among traders-since before 9/11. Unfortunately, the devastating terror attacks put the notion of T+1 and true STP or straight-through processing on the back burner, as firms rebuilt their trading floors and considered how to protect themselves in the event of another attack.
But according to Brown, European regulators are making T+2 a reality on that continent next year, and this places a burden on firms in the U.S., which is currently at T+3. “It’s getting pretty urgent, and that’s going to happen in 2014,” said Brown. “So the topics on the buyside are generally driven by what’s going on in their particular markets, what’s going on in their segment, and that’s the global driver of the moment.”
When will the U.S. reach the T+1 trading settlement target even though it is nt near reaching T+2? Don’t hold your breath. Given the glacial pace of financial regulation and the fact that investment firms and exchanges are still dealing with implementing the Dodd-Frank Act and the forthcoming Basel III, Bodson doubts it will happen any time soon.
“We’ve obviously been very engaged with the U.S. industry in terms of moving from T+2 to T+1,” Bodson said. He cited a case study by the Boston Consulting Group, and officials at the DTCC are “re-vetting” some of the numbers. “I think T+2 is achievable here in the U.S. It requires changes to systems both for the sellside and buyside, but is not as dramatic a change as T+1,” he said. The concept of T+1 “pushes a lot of the processing, especially on the buyside, to T+0 in terms of allocation process and affirmation of trades,” he added.
“The systems changes and the process changes to go from T+2 to T+1 are fairly significant,” Bodson said.
This move will require an investment in IT and open collaboration on standards, and many industry observers see the benefits to risk mitigation and greater market efficiencies in this project that has been gestating for more than a decade. Bodson wondered aloud whether T+1 will happen in six or 10 years. “What’s a reasonable cycle?” he asked.
“What we’d really like to say is, ‘Let’s plant the flag in the sand and say we want to get it done within X years,’ so that as firms do their natural refresh of their technology-usually once in a five or a 10-year cycle-they know what they’re building to,” he said.
Setting this date and tying it to future IT refreshes-even in an age of stagnant IT budget increases-is a good idea, Bodson suggested. “Then it’s not a massive change overnight, but is rather the industry driving itself to achieve that standard,” he said.
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