The Q4 Sell-Side Clearing Management Insight Report, produced in collaboration with report partner HelloZero, focuses on streamlining futures and options data processing. This quarter's analysis delves into EMIR 3.0, CCP default risk, DORA, manual clearing training, and the Basel III endgame impact.

A comprehensive examination of reconciliations explores changes and remaining challenges in reducing operational risk and enhancing efficiency and customer service since the 2021 study on sell-side listed derivatives market reconciliations.

Insights from the Sell-Side Clearing Industry

European regulators are conducting a review of the EMIR framework, aiming to strengthen European derivatives markets through central clearing of OTC instruments and reduce reliance on third-country clearing houses post-Brexit.

The UK and EU, after agreeing on equivalence to avoid regulatory disruptions, face a potential end to equivalence in 2025. While the risk has diminished, market participants are better prepared for a break, with 63% assuming it is disruptive but not disastrous, signaling improved readiness compared to previous years.

The increased volatility in various asset classes has heightened the risk of defaulting on trading positions, prompting clearing firms to focus on Central Counterparties (CCPs) and the potential of default fund contributions.

Concerns about clearing member default risk are widespread, with 43% conducting significant reviews of all CCPs and their default funds. Some are particularly focused on smaller CCPs, susceptible to volatility in a narrower range of products. Overall, 40% express no concern about default fund risk and are not conducting CCP reviews beyond normal procedures.

Exchanges have been increasingly aiming to establish a direct connection with end clients rather than relying on the traditional sell-side intermediary. This shift has been driven by a desire to enhance the visibility of who is trading on the exchange and to stimulate client demand for new products and services.

While 55% of the network acknowledges increased requests from exchanges for greater transparency and visibility, concerns about the competitive threat from exchanges exist among some, with almost half not entirely comfortable providing such information.

Post-Covid Reconciliation Priorities: Industry-Wide Improvements

The EU's Digital Operational Resilience Act (DORA), effective in early 2025, necessitates firms to map third-party relationships and conduct extensive due diligence on digital supply chains. Challenges in preparing for DORA include operational resource allocation, understanding threat analysis criteria, and obtaining information from vendors. Despite the compliance task's magnitude, a majority, 67% of the network believes they are on track for DORA readiness, with varying levels of preparation.

Banks, alongside preparing for DORA, are anticipating the impact of the Basel III endgame regulation. Global systemically important banks (G-SIBs) express concerns about potential increases in regulatory capital requirements, with counterparty risk requirements identified as having the most significant cost implications for clearing services. While 44% foresee cost implications, 25%currently see no significant impact on the cost of clearing services from the Basel III endgame.

Since March 2020, post the surge of Covid-19, clearing firms prioritized reconciliation system improvements. The 2021 Acuiti and HelloZero study highlighted industry-wide efforts, with a "good enough" attitude, and reliance on manual processes, and spreadsheets, especially among tier 1 banks.

In the last two years, 39% of firms, including 44% of tier 1 banks, fully automated reconciliation processes, focusing on day-to-day efficiency, cost reduction, and resource allocation to higher-value tasks. Significant investments in reconciliation software, driven by the goal of increasing efficiency and capacity, have been made by over two-thirds of respondents.

Larger firms have shifted investment focus from headcount to automation. Currently, 2% predominantly use manual processes, 59% partially automate, and 39% use fully automated reconciliation for derivatives trades, showcasing widespread integration of automated processes.

The adoption of artificial intelligence (AI) for reconciliation processes is in its early stages, with 58% of respondents in the investigation stage, 13% in early implementation, and only 8% having fully implemented AI. This indicates a cautious approach to leveraging AI to reduce dependencies, wage pressures, and operational vulnerabilities in reconciliation systems.

Sell-side firms in the derivatives industry have made significant strides in improving reconciliation software efficiency since the 2021 Acuiti report. The use of spreadsheets has decreased, automation has increased, and reliance on key staff members has diminished.

While not fully automated across the market, the continual investment in reconciliations is having a positive impact on satisfaction levels, with over half of the respondents expressing satisfaction with their processes. However, intentions to invest in reconciliation software are declining, with just under a fifth planning to invest and over half not considering it, indicating a potential risk despite the progress made since 2020.

The network has expressed optimism about the next three months' business prospects in derivatives clearing, with a sentiment score of 73, marking an increase from the previous quarter's score of 68. Among respondents, 18% are very optimistic, 55% are quite optimistic, although 27% remain neutral about the outlook.

Sell-side firms in derivatives have improved reconciliation software efficiency, reducing reliance on spreadsheets and increasing automation. While progress is evident, achieving a fully automated environment remains ongoing, emphasizing continuous investment.

High satisfaction levels suggest positive strides, but declining intentions to invest pose risks, including capacity issues in volatile markets. Maintaining a competitive edge requires ongoing investment, recognizing reconciliations as crucial for success. Despite challenges, the overall optimism about business prospects for the next three months indicates a positive outlook for the industry.