In the year since the first live Financial Products Mark-up Language (FpML) messages were sent over SWIFTNet, SWIFT's Derivatives solution has progressed apace. All eight pilot firms (four investment managers and four custodians) are now live, and the use of SWIFT to exchange trade notifications in standard electronic formats is enabling these firms to eliminate faxes and significantly reduce their costs and risks.
The successful launch of the Derivatives solution marked the culmination of a two-year process during which SWIFT, in collaboration with customers and its partner the International Swaps and Derivatives Association (ISDA) (which spearheads FpML), resolved a number of challenges to meet a real market need for automation of a historically very manual, high-risk activity.
In spite of the global financial crisis and its impact on derivatives volumes, this need for automation remains, says Cherie Graham, Senior Vice President, Investor Services & Markets at Brown Brothers Harriman (BBH), one of the users of SWIFT's Derivatives solution. "We have seen a drop-off in volumes, but not to the degree that this solution is any less valid," she says. "Large asset management firms that use derivatives still need to automate, as a manual approach is still not sustainable, even with lower volumes. In fact, viewed through the added lens of risk management, there is an extra edge to the business case."
Adds Neil Wright, Global Product Manager for Derivatives at Customer State Street: "The demand for the SWIFT Derivatives solution remains strong. Though no one can predict the regulatory framework we will end up with, there will certainly be a continued call for transparency, and some of the functionality SWIFT is delivering is helping to meet the increased need for transparency." In a recent Vision Paper, which features the SWIFT Derivatives solution, State Street emphasises its ongoing commitment to automate derivatives processing. "Derivatives continue to be a very important part of all our clients' portfolios," says Wright. "The Vision Paper was designed to inform our customer base about the direction we are taking and the investments we are making."
The benefits the users of the Derivatives solution are achieving include cost reduction and scalability, says Graham. "The primary benefit we have achieved is improved operational risk management," she adds. "Manually keying in instructions is fraught with risk of errors, where incorrect information could go into an accounting system and be used to strike a NAV [net asset value] for a fund."
Customers of the SWIFT solution can use the industry-accepted standard for derivatives, and at the same time leverage all the benefits of SWIFTNet, while maximising their return on investment in their existing SWIFT infrastructures. As State Street's Wright says: "FpML is the de facto standard for automated processing of derivatives, and it is a natural progression for it to be used by investment managers to advise notifications to custodians. As and when more information can be transmitted in the FpML format, the ability to send it via the secure SWIFT network becomes more of a benefit. We will continue to see the coverage of FpML evolve, and the benefit of sending it over SWIFT is clear."
Indeed, Graham at BBH reckons the combination of SWIFT and FpML has been crucial to secure buy side involvement in the solution. "Prior to this, FpML had been primarily adopted by the sell side, but less so on the buy side," she says. "Dealers used it as a matter of course, but asset managers were not familiar with FpML. Because FpML is XML-based, adoption requires a bigger investment from a buy side perspective. The community needed a clear business case to invest. SWIFT was a game-changer in that regard: by adopting FpML and putting a stake in the ground, SWIFT gave the format the credibility required to convince investment managers to build towards it as a future standard."
SWIFT and ISDA first forged an agreement to work together in June 2006, so the process of taking the Derivatives solution into live operation was clearly not a rapid one. "The length of time it took to get the SWIFT Derivatives solution live was related to the lack of standard business processes in this area," says Graham. "When SWIFT pulled the user group together, it was quickly discovered that there were few standard business processes for derivatives, and it was not possible to apply technology in such an environment. Much of the work the group undertook - facilitated by SWIFT - was standardising business processes such as the trade notification procedure for swaps. This was time very well spent to ensure we were not automating non-standard processes."
These users of the Derivatives solution agree that there is more work to do if the industry is to reap the full benefits of FpML messaging over SWIFTNet. "There remain gaps in terms of the number of investment managers using FpML," says Wright, "and we know from our investment management outsourcing business in which we act as a middle office and generate these instructions that there are also custodians not yet ready to receive them. However, we are certainly already seeing benefits on both sides." More uptake is needed - and the catalyst for that should be "that everyone should be pushing in the same direction", he says. "The challenge is that everybody's at a different stage, and given all the other work going on, it's understandable that firms have different priorities."
Graham adds that the solution needs to be extended to cover more instruments. "A challenge for asset managers is that many of the derivatives platforms are being rolled out in instrument silos, for example covering some CSDs but not all, which means they need intelligence in their systems to cope with the fact that some instruments are matched in one place and some in another. Investment managers would prefer one infrastructure for all derivatives types," she says. SWIFT's approach is the right one, she adds, "to focus on the high volume instruments first" and then extend the solution further.