SunGard’s New Derivatives Processing Utility: Panacea or Pipedream?

SunGard’s outsourced business model for handling post-trade functions in the listed derivatives and swaps market might sound like a dream come true for futures commission merchants and given that it has already nabbed its first mega client it’s off to a great start.

But whether the initiative will gain widespread industry buy-in remains to be seen. Custodian banks haven’t fared well with the same strategy for fund management firms, in large part due to client dissatisfaction and technology glitches. Outsourced processing attempts in the data management arena have also failed as have some offshoring operations projects.

Nevertheless, SunGard seems to think that it has found the magic bullet by reducing the operational costs of mundane and commoditized middle- and back-office work for FCMs whose bottom lines might not be as robust as they would like. Buy-side firms haven’t exactly been eager to jump on the swaps bandwagon, due to the extra costs involved with trading on new exchange-like platforms and meeting the new regulatory mandate to process their trades through a central clearinghouse.

So far  one FCM — Barclays Capital — has taken the plunge with Sungard’s new service. However, because it will not discuss the initiative beyond a press release issued by SunGard, there is only the technology giant’s  word on the perceived and actual merits to go by.

“SunGard will be handling most of the post-trade functions for listed derivatives and swap transactions, from the trade confirmation and allocation all the way to the clearance, with initial and variation margin calculations,” says Alun Green, SunGard’s head of post-trade strategy. SunGard will also determine how much of the required initial and variation margin must be distributed to each underlying fund.

Barclays has already been using SunGard’s Clearvision and GMI applications for middle-office and back-office processing on a licensed basis. Therefore, migrating to the SunGard service shouldn’t be technologically cumbersome. SunGard will simply be hosting the software in its own shop and ensuring business continuity.

Staff That Know

The far bigger change to Barclays’ relationship with SunGard is that an undisclosed number of Barclays staffers will transfer to SunGard — a decision aimed at reducing the concerns of Barclays client fund managers about service levels. “We are well-regarded in derivatives processing technology, but needed the [Barclays] staffers with the knowledge base to handle operations and exceptions processing,” explains Green.

The benefit to Barclays and any other FCM interested, according to Green: they can focus on more lucrative value-added services, such as trading and pre-trade analytics, needed to stay financially robust. Given that the number of FCMs handling swap trades has halved over the past few years, it stands to reason that there are high operating costs and relatively low margins. The latest firm to exit: State Street, which said it would shut down its US operation for handling cleared swap transactions and not move forward with launching a European one. The Boston-headquartered firm wants to focus on exchange-listed derivatives instead.

Will other FCMs buy into SunGard’s proposition, perhaps as a way to stay in the swaps business? It sounds like a convincing sell, but there could be several obstacles to closing the deal, according to swaps consultants and operations executives. For starters, an FCM will need to rely on SunGard’s technology. If the FCM doesn’t already use Sungard software, transitioning to a new platform might be an unattractive proposition. However, given that eight of the top ten FCMs and the majority of second and third-tier firms, according to Green, already use SunGard, technology might the least of SunGard’s hurdles.

Another potential obstacle: not every FCM may want to lose its middle- and back-office staff to a technology firm where they could ultimately be involved in work for competitors as well. Confidentiality is always a concern in shared systems, and SunGard will presumably have to prove the impermeability of its firewalls to prevent information leakage.

One more hurdle: FCMs will need to be convinced that SunGard has the operational wherewithal to catch any performance glitches and post-trade breaks. This may be the make-or-break issue in the success of the new processing service.  Granted, SunGard is a well-known player in the derivatives software space, but it’s a big step to performing the operations its software supports as an outsourced service provider.

Where Liability Resides

Last but not least: the bugaboo of all outsourcing operations, liability. “Hiring Barclays staff was a smart move, but it can only go so far and compliance directors should be concerned about where legal liability resides,” says a compliance manager at a New York-based FCM. SunGard has signed a service level agreement with Barclays, but the FCM retains legal liability — that is, the responsibility to make the fund manager whole — in the event of any operational glitches.

And how about what the fund management firms think? It is unlikely they will have any say in whether or not FCMs outsource their post-trade swaps operations. But like their FCMs, they will want reassurance they’ll continue to have the service they expect, and clarification about who will make them whole in case of any errors.

“There could be some hesitancy to remain with the same FCM based on the operating risks involved with such an expansive outsourcing model,” says a compliance manager at a fund management shop. Smaller fund managers might have little choice, as their options for choice of FCMs are more limited, but the larger ones may conclude that their concerns are strong enough to take their business elsewhere.

Of course, SunGard apparently believes that cost savings will trump all of these concerns. One operations manager at a US FCM, who was present at a SunGard presentation, estimates his firm could shave 20 percent off operating costs by offloading the middle and back-office work to SunGard. Green wouldn’t comment specifically on Barclays, but acknowledges that the figure is in the ballpark based on his firm’s analysis of multiple FCMs and fifteen common post-trade processing functions.

There is no question that there will be some fence-sitting to see how Barclays fares, before commitments are made. At the same time, SunGard is clearly offering FCMs a potential lifeline to keep their businesses lucrative. Count on finance and operations directors at other FCMs who acknowledge speaking to SunGard, to have some tough decisions to make.

“There is going to be a lot of talk around here about the pros and cons,” one operations director at a US FCM tells FinOps. “It’s a very bold move by SunGard, and it would be a bold move for us if we decide to join. At this point, there’s no way to tell which way we’ll go.”