New regulations in the North American and European markets are changing the requirements for firms middle- and back-office operations. These new requirements are difficult for firms to meet, especially with systems that have grown rickety after many years or even decades of use.
These factors, and the likelihood of more regulations ahead, are undoing the inertia that has enabled back- and middle-office systems to remain in place long past their expected lifespans. This new dynamic makes now an appropriate time for asset managers to re-evaluate their legacy post-trade systems, and perhaps begin to consider modernizing their capabilities.
This article describes the outdated middle- and back-office systems many firms still use, and highlights the regulatory changes that are stretching those systems to the breaking point. It also offers key things firms should consider as they begin to think about modernizing their middle- and back-office infrastructures.
The Legacy System Conundrum
Many asset managers today are running vintage middle- and back-office systems. Some of these products were developed before the people now using them were even born.
That seems like an ill-advised strategy, but its easy to understand why these old systems live on. They support critical business functions, and replacing them involves high costs and risks.
Those high stakes made it easier for asset managers to put off difficult rip n replace decisions. Instead, for many years – even decades – they got by with making lots of small changes to their systems. Over the years, all those changes made their systems so complicated that theyre nearly impossible to replicate with other, newer solutions. Thats the legacy systems conundrum – they hang around so long that they actually become harder to replace.
But with all technologies and systems, the ride eventually ends and you have to get off. That happens when the cost of maintaining a system gets so high, and its capabilities fall so far behind current requirements that it creates competitive disadvantages. That time has arrived for many legacy post-trade systems.
Regulatory Shift at Home: T+2
The new SEC rule requiring the standard settlement cycle for most broker-dealer securities transactions be cut from three days to two recently took effect. A parallel rule has taken effect in Canada.
At a high level, the T+2 rule is intended to do the following: reduce counterparty risk by speeding up settlements, free up capital faster for reinvestment, and lessen the increased margin and liquidity needs that can spike during time of high volatility. It also advances the overall goals of increasing the certainty, safety, and soundness of the capital markets.
For North American asset managers, T+2 has forced them to find ways to get all the systems theyve stitched together across their execution, confirmation, clearance and settlement processes to do everything 33% faster, and do it reliably. Thats no small feat with their legacy systems.
New Mandate in Europe: MiFID II
After the financial crisis of 2008, the European Commission set out to make its capital markets safer, sounder, and more transparent. Its tackling the job using a wide-ranging body of new regulations called MiFID II.
MiFID IIs main thrust is to increase transparency in the European capital markets. The main areas of these reforms include: market transparency, reporting and market oversight, investor protections, market structure, and market organization and governance. MiFID II is scheduled to take effect in January of 2018,
While MiFID II is a European regulation, U.S.-based asset managers will also be impacted. The extent of that impact depends on how much business they do in Europe and how they conduct it.
For U.S. firm that are active in Europe, there are several areas of MiFID II that merit careful consideration. One example is best execution requirements. Firms must take all sufficient steps to obtain best execution, and report their top five trading venues ranked by volume and quality of execution received. This opens the door for regulators questions, for example, about where and why firms steer their trades.
MiFID IIs scope is broad, covering much more than can even be summarized here. One thing is certain, however: it will cause major ripple effects in the global markets.
Key Considerations for Moving Ahead
Asset managers compete and differentiate themselves largely on their front-office capabilities, and not so much on their middle- and back-office operations. That said, firms cant let their post-trade performance limit their growth or create a drag on their competitiveness. And sooner or later, thats exactly what legacy systems will do.
To avoid that scenario, asset managers need to modernize their post-trade technology infrastructures. While doing that, its a good idea to avoid clunky integrations between disjointed systems. The smarter strategy is to unify and normalize as much of their entire post-trade processes as they can. There are flexible and scalable solutions now available that enable hedge funds and asset management firms to bring all of their post-trade activities onto a single, cohesive platform. Doing so helps them focus their energy on trading and investing, and stop feeling like theyre in the IT business.
Change comes with risk, but it also creates opportunities. The regulatory changes happening in the capital markets are presenting asset managers with opportunities to finally square away their lagging middle-and back office capabilities. Smart firms wont squander these opportunities.
Oren Blonstein is Managing Director, Product Management for TORA.
