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MARKET NOTE

Listed Derivatives
Tom Lehrkinder, Senior Analyst
March 2018

The Evolving Middle Office: A Seal of Approval


In the middle
The second decade of the 2000s is almost over, and it feels Key Points
as if technology is in overdrive. End users are more and • The middle-office technology supporting the futures
more demanding as they strive for efficiency and innovation. industry is finally evolving after years of
Disruption from Blockchain and Distributed Ledger underdevelopment and a lack of innovation.
Technology (DLT) is on the horizon – it is no longer “if,” but
“when.” The futures markets have always been a leader in • FIS Stream Clearvision and ION’s SEALS have been
terms of cutting-edge technology for front-office trading. the middle-office technology leaders for many years.
Unfortunately, the middle and back offices have been in an
innovation funk for many years. • ION SEALS has been a change agent by treating the
middle office with the same attention and urgency as
front-office trading technology.
More recently, buy-side clients have been demanding their
Futures Commission Merchants (FCMs) provide new and
• Technology is at the forefront of conforming to
improved tools to allow their trades to be processed and regulation, and it is important to have a trusted
reconciled on a near-real-time basis. The middle office is technology partner to help navigate the changing
the heartbeat of this function, and the systems that support tides.
it drive straight-through processing (STP). Reliability and
system availability should be a given. • The middle office is an integral part of the futures
market structure that helps ensure confidence in
The futures middle-office space is dominated by two the entire process.
players: FIS (Stream Clearvision) and ION (SEALS/Prysm).
TABB Group reached out to C-level operations and • It’s OK to break from the old guard when choosing
business executives to discuss the state of the middle office the best middle-office technology to meet your
and investigate the technology improvements to date. We needs.
spoke at length to a variety of professionals from a cross
section of firms, including global and regional FCMs at
banks, independent FCMs/broker-dealers, and self-clearing One firm broke completely from the fold and is using ATEO
organizations. – Lisa.

The middleware system from FIS is called Stream


Who is the middle office?
Clearvision (Clearvision). When it is mentioned, however, it
The futures business has always been incredibly tight knit. is sometimes accompanied by a frustrated frown. The
This camaraderie stems from the open out-cry trading pits platform has been in production for a very long time and is
where very often the fiercest rivals would help each other built on dated technology. As a result, reliability and
out of some potentially catastrophic situations. This functionality leave a lot to be desired. But it works, and it is
mentality spilled over to middle-office operations, where the current dominant player.
clerks developed relationships with clerks at other firms who
could be called upon to help during sticky situations. The next version of Clearvision has been promised for years
but seems to have been caught up in the continual
The processing and settlement platforms have gone development cycles, mandatory regulatory changes, and
through some ownership changes, but they have remained potentially red tape related to software companies caught
historically tight knit, with FIS (GMI > SunGard > FIS), which up in acquisition mode instead of development mode.
currently enjoys most of the market share, and ION (Rolfe
& Nolan > ION) as its main competitor. As expected, when The ION middle-office solution is called SEALS. ION also
we asked which middle-office solution firms use, FIS and supports a system called Prysm that was originally
ION captured 93% of the market share, with one firm noting developed by ex-GMI programmers (Wag the Dog – WTD)
that it uses both providers based on regional preferences.
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The Evolving Middle Office: A Seal of Approval | March 2018

who were frustrated with the pace of change and direction Why Change?
of Clearvision. These separate yet related platforms have A consistent theme for why clients look to change their
attributes preferred by their user groups, and both SEALS middle office is to become “more real time.” Notice: I did not
and Prysm sit on updated architecture and are scheduled to say real time, as that is still not a practical situation, since
merge under the banner of the real-time trade processing too many variables remain in the middle-office process.
platform ION XTP. New arrivals such as Cinnober and That said, the market, driven by regulation, risk
Broadridge, while potentially interesting competitors, have management, and efficiency, is moving toward real-time
not yet earned the trading-pit-type trust that the futures reporting, and the middle office will be an important link in
market requires. the chain. When we discussed managing risk throughout
the day, the professionals we spoke with lamented that they
What does the middle office do? use internally built and maintained tools to assist with
The futures middle office acts as the filtering and matching reconciliations. This needs to change.
mechanism that ensures the orderly flow of information to
and from clients, brokers, FCMs, exchanges, and clearing “It is expensive to perform intraday rec’s every day. We
houses. Without the middle-office function, the clearing and started to do it, but it took up too many resources. We
settlement at the futures clearinghouses would never occur. can do it if we have to.”
The handshake connections between the middle office and -Regional FCM
both front and back is critical to the ultimate success of the
back office and allows for proper statement generation,
Non-front office applications rarely generate attention
accurate financial and regulatory reporting, and correct
unless there is a catastrophic event – the prevailing attitude
margin calculations.
often is, if it ain’t broke, don’t fix it. Even though many of the
users we spoke with are not enamored with Clearvision, the
The reliance on the middle office and the systems
thought of changing a middle-office platform is typically
supporting it has increased over the years, but unfortunately
pushed way down the priority list. This is supported by the
the way the middle office (people and systems) is viewed
fact that 54% of the firms we spoke with have had the same
has not completely evolved in kind. Ninety percent of the
middle-office solution for more than 10 years (see Exhibit
executives we spoke with feel that the middle office is still
2). Unfortunately, and especially over the past 10-15 years,
viewed as a cost center and not as a part of the “front office”
human nature often comes into play, and managers of the
business (see Exhibit 1). This stigma historically may have
middle office typically prefer to build workarounds or stick
stifled the push for aggressive development and
with sub-standard services instead of making a solid
investment, as well as the ability to change providers in this
business case that would result in a request to switch to new
area; but with the focus on regulation and risk management,
systems and solutions. Complacency is the mother of
the winds are changing.
inaction.
Exhibit 1: How Is the Middle Office Viewed? Exhibit 2: How Long Have You Had Your Middle-Office
Solution?

10.0%
FIS - greater than 10
31%
years
54%

ION - greater than 10


23%
years
Cost center

Value Added
FIS - less than 10 years 15%

46%

90.0%
ION - less than 10 years 31%

Source: TABB Group Survey Q1 2018 Source: TABB Group Survey Q1 2018

2018 The TABB Group, LLC. All Rights Reserved. May not be reproduced by any means without express permission. | 2
The Evolving Middle Office: A Seal of Approval | March 2018

Exhibit 4: Middle-Office Head Count Changes


“Moving to SEALS was easy and a no- brainer. We like
the functionality and reliability.” How has your middle office support headcount changed over the last 5 years?
-Independent FCM
IT Support IT Development Operations
This is not to say there has not been any movement
between providers over the years. Of the FCMs that we
spoke with, 7 decided to go in a different middle-office
direction and changed providers - 5 chose ION, and 2 chose
FIS (see Exhibit 3). Middle-office users who changed to ION
How will your middle office headcount change with new middle office technology?
may have been looking for a thin front end and connectivity
to more than 70 exchanges built on the state-of-the-art IT Support IT Development Operations
Microsoft .NET software.

Of the Clearvision converts, many of the firms migrated


away from internally built and supported systems and
adopted the FIS solution. The package of GMI back-end Source: TABB Group Survey Q1 2018

and Clearvision middleware had been the industry standard


for many years and was the easy decision at the time. This lack of development has frustrated managers, as
Unfortunately, during those years, many of the users grew support costs have not mirrored the downward spiral of
frustrated with the lack of advancement in functionality, commissions and interest income. Those FCMs that have
usability, and reliability. embraced the new technology stack have been or will be
able to adjust middle-office head count going forward. The
Exhibit 3: Which Middle-Office Solution Did You Change to? dilemma that many FCMs face is that the middle-office
software supported by the dominant vendor has not
changed significantly in many years. Can they afford to
continue to wait?

FIS 2
28.6%
Hosting
One of the reasons why IT Support head count will trend
downward is because the FCMs have started to migrate the
hosting of their middle office away from an in-house solution
to allowing the software vendors to take on that
ION 5 responsibility. Eighty-five percent of the FCMs we spoke
71.4%
with shared that they have either completely off-loaded that
hosting responsibility or at least are managing it jointly with
an eye toward a total shift in the very near future. Firms such
as ION and FIS support a Software-as-a-Service (SaaS)
Source: TABB Group Survey Q1 2018 model and are more than happy to manage the entire
process – if the firm is willing to relinquish the oversight (see
Shape of the middle office Exhibit 5).
The past five years have seen futures volumes continuing
to grow, with the number of FCMs processing the business
in decline. With fewer FCMs, it only makes sense that the
remaining group will need to do more. In a normal business
environment, technology would be expected to pick up the
slack. According to our group of participants, straight-
through processing is approaching 90% for most of the
trades even though the middle-office technology provided
by the dominant player has remained stagnant. FCMs have
been forced to look to alternative providers and develop in-
house solutions to improve efficiencies. As a result, the
head count for IT Development, IT Support, and Operations
supporting the middle office has only been affected
marginally over the past five years (see Exhibit 4).
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The Evolving Middle Office: A Seal of Approval | March 2018

Exhibit 5: How Do You Host Your Middle-Office Platform? FIS Clearvision connects to GMI and is currently only able
to provide a near-real-time view via a “Prelim” run that is, in
Hybrid 15.0%
most cases, manually launched by the user. While
Clearvision also provides real-time reconciliation and
exception processing, it is unable to provide a real-time
middle-to-back view, as GMI operates in a batch
environment.
External 69.2%

While real-time capabilities seem logical, cutting-edge, and


a must-have, not all users’ operations are able to process
intraday reconciliations with CCPs and carrying brokers in
Internal 15.0%
real or near-real-time (see Exhibit 6).

FCMs receive files from central counterparty


Source: TABB Group Survey Q1 2018 clearinghouses (CCPs) and carrying brokers on a regular
basis throughout the day but do not apply reconciliation
Reconciliation logic to each instance.
While volatility in the markets has been subdued for the past
few years, a recent spike has brought attention to the ability Exhibit 6: Do You Reconcile Real-Time Clearing Flows
of FCMs to reconcile their business intraday. Without a Against CCP and Carry Brokers?
good intraday reconciliation process supported by state-of- 100%
the-art technology, the FCM and the overall market are at Use combination of middle
and back office systems
risk of clients being under or incorrectly margined. This
would carry over to FCMs running the risk of not having
accurate data and information to ensure the calculations Carry Not real time Near real time
used to arrive at their segregated requirements are correct. Broker 83.0% 17%

Despite these concerns, the firms we spoke with, to a


person, admitted that while they could reconcile all their
business intraday, they do not as a regular course of
business. CCP
Not real time Near real time
83.0% 17%

When digging deeper, they shared that the functionality of


the middle office is an important link to the reconciliation
chain. The need for data to be “cleaner” before it hits the
back-office systems fits into the real-time requirements the
Source: TABB Group Survey Q1 2018
industry is trending toward. Currently, many of the firms we
spoke with could not provide a comprehensive
reconciliation without using functionality from the back office The FCMs often delay the reconciliation because clients do
as well as homegrown systems and processes. This not provide timely and accurate business recaps throughout
deficiency is an opportunity for the software firms to address the day. In fact, some asset managers are notoriously late
and solve. or make a high percentage of changes to allocation files,
which causes the FCM to fight end-of-day (EOD) deadlines.
These same clients are often the first to complain the next
Real Time
morning that their margin calls or positions are not what they
In today’s world dominated by curbing costs and improving expected. One way to address this market convention is to
efficiencies, systems that still operate in a batch provide a middle-office tool directly to the clients and allow
environment are becoming extinct. In the world of the them to make corrections and updates before the data goes
futures middle office, the ION SEALS platform offers real- from the FCM to the CCP, shortening the reconciliation
time matching, exception processing, and seamless process dramatically. Many FCMs have taken this route and
connectivity to ION’s back-office system, XTP, which is the allow their clients direct access to the ION middle office
back-office system that is updated in real time. The middle platform which has helped improve the efficient flow of
and back office, in terms of urgency, are treated like front- information especially near the EOD.
office trading platforms.

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The Evolving Middle Office: A Seal of Approval | March 2018

CONTROL hypothesis is that updating or correcting commission and


fees very early in the trade life cycle would help ensure more
accurate data, not only for T+1 reporting but also to stave
Carte Blanche off larger undetected errors. The responses varied but
Having a robust middleware capable of improving exception clearly leaned toward the notion that static data updates
processing and alerts before the trades get to the back should be restricted to the back office. The reasons shared
office is becoming increasingly invaluable. Unfortunately, included: middle-office personnel may not have the training
surprisingly few firms utilize these capabilities. or mind-set to completely understand what changing one
fee amount may cause downstream; we need to limit the
The concept of execution-only trades or give-ins has access to the commission and fee information due to
historically been a stumbling block as the industry strives to separation of duties; and all static data should be
improve controls. To manage counterparty risk, clearing maintained and monitored in the back office to ensure
brokers, for years, have attempted to control the amount of change control and approvals.
business any one client could transact and clear daily. To
facilitate this, brokers have installed contract and dollar- In my opinion these reasons seem a bit dated, but I do
based limits on front-office trading platforms with some understand the need for strict controls. Since the FCMs
success, but unfortunately the logic does not always questioned did not have any large commission
translate to the middle-office systems due to give-in market adjustments/errors following the time-tested process, I have
structure. We asked our group of industry professionals if to admit it must still work and is consistent with the idea that
they performed automated checks before taking in give-in the middle office is a processing cost center.
trades and 61.5% use a carte blanche process where they
take all the trades in for clearing and deal with the credit Regulation
check later. Only 7.7% used the middle office to perform an
The futures business is arguably the most highly regulated
automated credit check, and the remainder used some sort
on Wall Street. The global nature adds yet another level of
of combination of middle- and front-office technology (see
complexity that must be considered. MiFID II was one of the
Exhibit 7).
most anxiously awaited regulations in recent memory. Since
much of the focus is data driven, the software providers
Given that 61.5% of firms we spoke with accept all incoming
were looked to for guidance, expertise, and compliance.
trades without automated checks, this does not reflect well
According to the clients we interviewed, ION was an active
on the industry’s ability to manage risk, efficiently process
partner, working with end users as well as the industry as
transactions, or manage balance sheets effectively.
they struggled with the opaque nature of the rules.
Ultimately, due to the SEALS clearing workflow including
Exhibit 7: Do You Perform Automated Checks Before
enriched information coming from the trade execution
Accepting ‘Give-In’ Trades?
platforms, MiFID II reporting became much easier.
Yes
Generally, ION received a passing grade from the
7.7% executives we spoke with in terms of preparation for MiFID
II, as it was up to date with the changing rules and actively
Combination
managed the impending deadlines.
30.8%
Users of FIS Clearvision we spoke with did not have the
same experience. Their feelings stemmed from the fact that
while the MiFID II rules were very fluid and ripe for
interpretation, FIS took a more deliberate approach to
Carte Blance determine where the reporting data would originate. FIS
61.5%
ultimately decided that MiFID II reporting should be done
out of the front office systems where key date fields were
available. This strategy drove many users to search for in-
Source: TABB Group Survey Q1 2018 house solutions or to employ outside consultants to assist
with compliance and reporting.
Commissions and Fees “FIS/SunGard did nothing for Clearvision in anticipation
In addition to trade reconciliations, we asked if of MiFID II.”
commissions, trade-related fees, as well as execution fees -Regional FCM
should be updated in the middle-office applications. The

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The Evolving Middle Office: A Seal of Approval | March 2018

When we asked the users to share a few things their current modularize their processes to ensure a best-in-breed
middle-office technology provider could do to improve solution is being deployed.
regulatory compliance, the leading answer was to work to
establish common industry protocols. This of course is With serious competition and alternatives will come
nirvana, with more than 70 futures trading venues around opportunities for software providers to pick up market share
the world supported by dozens of clearinghouses that like and instill their marks on the industry. The use of add-ons
to put their unique stamps on their data. Having a and internally developed systems to make up for
technology partner that is willing to anticipate change deficiencies exposed by the old way of doing things will
instead of coding after the fact will prove invaluable going become a thing of the past. The ION SEALS platform is one
forward. Also, having a solution that uses the source system of the first to successfully push the middle-office technology
– in this case, clearinghouse data – as the golden data envelope and challenge the status quo.
source gets the user one step closer to compliance and
eliminates the need for additional data manipulation, which Strides continue to be made to improve the futures middle
introduces regulatory risk (see Exhibit 8). office in terms of process and technology. Choosing the
best technology partner will help shape the level of control
Exhibit 8: Please Share a Few Areas Where Your Current and efficiency an FCM will achieve.
Technology Providers Can Improve Regulatory
Compliance?

Common industry
protocols
60.0%

Work better with


user community
30.0%
They need to know
the answers and not
search for them
10%
Source: TABB Group Survey Q1 2018

Conclusion
The role of the middle office is changing. It is no longer
simply an extension of the back office at the FCM, but
instead it is an important link between the middle offices at
clients and, ultimately, clearinghouses. The industry
expects cutting-edge technology from firms such as ION
and FIS to help evolve the role from mundane matching and
checking to exception-based processing aided by built-in
artificial intelligence. FIS is being aggressively pressed by
ION and a few newer entrants, as FCMs are not satisfied
with dated technology and are becoming more willing to

About TABB Group


TABB Group is the international research and consulting firm focused exclusively on capital markets, founded on the interview-
based research methodology developed by Larry Tabb. Since 2003, TABB Group has been helping business leaders gain a
truer understanding of financial markets issues to develop actionable roadmaps and approaches to future growth. By accurately
assessing their customer base, competition, and key market opportunities, TABB Group works with senior industry leaders to
make critical decisions about their businesses. For more information, visit www.tabbgroup.com.

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