A whitepaper on Work Flow Management on Multiple Platforms for OTC Trade Post Trade Processing

Vinod Jain - Business Specialist in the Derivatives Domain Consulting Group at Headstrong NY

In OTC trade life cycle management process, the economic trade details and trade status are exchanged with the counterparty, asset servicer, prime broker and now with OTC central clearing corporations multiple times. For each life cycle event processing specific changes, only relevant changes are communicated with the counter party. Firms are facing major challenges in building control procedures around work flow and communication process due to presence of multiple functional areas and processing platforms in the middle office and back office. This increases process duplication and the frequency of client communication and maintenance of the work flow status of each communication. There are four major functional areas in which the OTC trade details are communicated between the counter parties. These functional areas reappear for each trade life cycle event. Trade Affirmation and Confirmation Payment affirmation and confirmation. Collateral management process Dispute Resolution

1. Trade Affirmation and Confirmation

Trade affirmation and confirmation processing is the first area of client communication in post trade processing. The economic details are affirmed with the counterparty and the confirmation process stamps the trade as legal contract. The counter party is contacted using either electronic platforms or
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traditional manual paper processing method. Communication over electronic platform is preferred over manual processing but due to the nature of the OTC trades, unavailability of ISDA MCA and execution of trades with private MCAs, all trades cannot be confirmed on the electronic platform. Bothe Markitwire and DerivSERV differ in the affirmation and confirmation processing. The recent formation of MarkitSERV as a common platform is an effort to consolidate the confirmation processing and remove current discrepancies. Markitwire is seen as front end to middle office solution whereas DerivSERV is perceived as Middle office processing platform. Trade processing status and workflow on both the electronic platform differs. For example a trade can be captured in draft status without sending it to the counterparty on Markitwire while this functionality is not available on the DeriVSERV platform. The trade status assigned by the platform to a trade is unique. The non electronic method involves generating the paper document and sending it via fax or email to the counter party. There is no industry standard to identify when the paper document is to be sent or when the paper document should be received from the counter party. Firms have developed internal trade work flow status to identify the responses from the counter party. Impact on the Firms Maintenance of separate trade work flow processing state for manual and electronic confirmation Separate levels of integration with electronic platforms Multiple processing rules Duplication of static data

2. Payment Affirmation and Confirmation

Due to absence of a industry wide service provider for payment affirmation and confirmation for otc payment processing, the payment processing work flow status definitions are firm specific. In a trade affirmation and confirmation process economic attributes are exchanged for a single trade and the workflow processing statuses is designed for a single trade. In contrast in payment affirmation and confirmation the workflow processing statuses is for one payment instruction for multiple underlying trade information. If the counter party does not agree with the payment terms the whole set of underlying trades needs to be affirmed one by one. This would increase the time to complete the payment affirmation process. Further both counter parties have to reconcile between the actual amounts settled with the amount in pre advised sent. Payment affirmation is more manual as compared to trade affirmation, which is more electronic. The delivery of payment notification i.e. pre advises mostly is via email and fax. Due to absence of a derivatives payment affirmation platform, institutions have designed their own workflow to identify and process the responses of the counterparty.

** 6/30/2010, Headstrong, Inc. All rights reserved. CONFIDENTIAL AND PROPRIETARY INFORMATION. Use or disclosure of the data contained in this document is subject to the written permission of Headstrong, Inc. **

Impact on the Firms Maintenance of separate payment processing stage and workflow Strive to acheive multilateral netting across asset class Nostro reconciliation Multiple processing rules Duplication of static data

3. Margin Calls Collateral Management

The process of Collateral Management involves workflow in three separate stages.

a) Portfolio reconciliation - One of the key aspects of Collateral Management process is Portfolio reconciliation. The process needs agreement with the counterparties to identify what to reconcile, when to reconcile, how to reconcile and the acceptable tolerance level for exception processing. Due to multiple data formats, delivery mechanism fax, email, ftp etc to, trade representation in pdf, excel, csv etc formats the transformation and translation of the counter party data to match with firms format for reconciliation is cumbersome. Each of the processing stage in portfolio reconciliation entails another set of workflow within the firm to identify the processing stage. b) Margin Calls The communication of margin calls and collateral substitution with the collateral payment or settlement instructions is manual. Again here firms have designed internal workflow mechanism for process control. Currently there are very limited number of service providers like Acadiasoft which connects the buy side, sell side and the custodian for the margin call processing. c) Collateral Movement: Collateral transfer instructions are sent to Dealer and/or Third party depending on with whom the collaterals are kept and what kinds of collaterals are transferred. Similar to payment affirmation and confirmation, due to absence of a global collateral workflow platform, most of the communication with the counter party is via email, fax or over telephone. A buy side dealing with multiple dealers will need to identify another level of mapping of trade status to identify the settlement of collateral. Impact on Firms Collateral management is still manually processed With the Centralized Clearing of otc derivatives the collateral management function will become more complex
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Collateral management will increase the operational risk for smaller firms The new collateral management electronic message workflow from ISDA will redefine the work flow process

4. Breaks and Dispute Resolution

The ISDA Dispute Resolution puts strict timelines and process to resolve the valuation disputes. Mutual informal dispute resolution would be cheaper for the firms instead of formal legal process with the involvement of third party agents. The trade is investigated and based on the root cause analysis it would involve workflow around the operations processing team, client servicing team and top management to resolve the dispute. Having a common workflow in a dispute resolution across asset classes will reduce the operational risk in exception processing. Firms continue to invest in projects to reduce the cost of investigation and exception processing. A robust static data during client communication process will reduce the disputes. Impact on Firms To reduce the number of breaks the upstream systems will have to capture and process trades accurately Increase in the frequency of reconciliation cycles to immediately capture and highlights the breaks Define stringent process control on the root cause issue to avoid repetition Communication Protocol The communication process with the counter party and other entities involves multiple players - dealers, client, Fund Administrator, Prime Brokers and Custodians. A single trade is reflected in the books and system of all the entities. Every trade event requires a communication dialogue between the counterparties. The communication process in the post trade processing involves identifying a notification on the work queue to initiate an action. This is further segregated to identify what is the notification and then routing it to the concerned team for processing. Impact on firms Investment in process and technology to capture requests and responses on the trade processing platform A consolidated dash board to get the overall view Absence of industry benchmarks numbers for each of the work flow processing Conclusion All the trade processing function trade affirmation and confirmation, payment affirmation and confirmation, collateral management, dispute resolution involves work flow rules to control the business function. The workflow rules would define how a trade is processed. The changing dynamics in the OTC market and within the firm especially after the credit crisis makes any change or migration from

** 6/30/2010, Headstrong, Inc. All rights reserved. CONFIDENTIAL AND PROPRIETARY INFORMATION. Use or disclosure of the data contained in this document is subject to the written permission of Headstrong, Inc. **

an existing defined set of workflow rules to new workflow more complex. Integrating work flow rules across two systems is a pre requisite to systems data integration. The integration of Markitwire and DerivSERV to form MarkitSERV is a welcome step in simplifying the workflow process. Similarly the Trade Warehouse by DTCC for credit derivatives ensures a golden copy of the record for reconciliation. The trend towards centrally clearing credit derivatives would standardize the process in the long run. The dispute resolution protocol is a welcome step to identify a time length to settle the disputes. Firms continue to invest in process efficiency initiatives; they still continue to face challenges in common trade workflow processing within the firm and establishing a common set of protocols for trade processing. About the author - Vinod Jain is a Business Specialist in the Derivatives Domain Consulting Group at Headstrong. He specializes in business process, change management and IT consulting for middle office and back office derivatives processing. He has worked extensively with buy side and sell side firms in Europe and US. He has done consulting for Bank of America Merrill Lynch, Credit Suisse, New York Stock Exchange, Bank of New York Mellon etc. He analysis the industry trends and events through research and thought papers.

** 6/30/2010, Headstrong, Inc. All rights reserved. CONFIDENTIAL AND PROPRIETARY INFORMATION. Use or disclosure of the data contained in this document is subject to the written permission of Headstrong, Inc. **