Coronavirus: Brokerage fee automation is a must in the current downturn
Investment banks are embroiled in an unforeseen cost crisis when trading over the counter (OTC) markets, driven by a surge in swaps, interest rates, oil and currency derivative volumes.
This month, some of the world’s largest interdealer brokers, who negotiate OTC trades between the big banks, have seen record trading volumes as sudden changes in interest rates, coupled with the plummeting oil price, trigger a whirlwind of global price volatility.
While current developments may be advantageous for interdealer brokers, sharp rises in volumes leave investment banks paying increasingly more in brokerage fees. Dealing with multiple brokers, all with different rate card structures, is challenging during normal conditions.
In the midst of this global pandemic, it must be nigh-on-impossible for any bank to get a true handle on how much brokerage they are being charged at the time of trading.
Take a typical sterling-dollar swaps contract. Last week saw the pound sink to its lowest level against the dollar since the mid-1980s. In this case, how does a bank quickly work out the time-to-maturity of the asset following such an extreme fall in value?
While the information needed to calculate brokerage fees on a trade such as this will be available to the trading desk, the data needed to justify passing along costs may not accompany it. After all, with prices everywhere right now, fees will vary significantly.
As a case point, a bank may receive a bill from their broker, reflecting numerous sterling-dollar swaps. But how can the bank reconcile at a transaction level, before accurately calculating fees including appropriate swap discounts?
Equally, it can be extremely complicated for the bank to accrue the appropriate charges against the appropriate book. Even if swaps volumes continue to climb, matching trades to clients is not the only challenge facing banks right now.
The trouble is, during this period of market turmoil, the exact amount that an interdealer broker charges a bank cannot be fully assessed until the bill comes in after the trades are completed. Banks can no longer afford to stick to old practices like waiting until the end of the month in order to calculate and pay trade expenses. With such extreme levels of price volatility, savings need to be identified daily.
For instance, a bank may well be trying to execute a trade for a spread designed to profit from an uptick in the value of, say, a manufacturers security, and a spread conversely aiming to profit when the value of the same security falls.
The challenge is that if the bank in question can’t easily identify the different elements of the trade, there is no way for it to know which broker rate to apply. It may well be that, by the time the trade gets into the back office, all the broker sees is one element of the trade. If the interdealer broker has not booked this trade correctly, a bank can end up paying more in fees.
As the market unpredictability continues to gather pace from one day to the next, banks will need to get a better grasp of this intricate level of detail. Brokerage is clearly under threat right now from the global turmoil. Now is the time for banks to start to automate, and crucially turn these activities into a detailed daily process.
After all, nobody would accept a bank taking 30 days to clear a cheque, so why should banks accept paying their brokerage bills on a monthly cycle? Right now, every penny that can be saved on a daily basis really does count.
Daniel Carpenter is head of regulation at Meritsoft (a Cognizant Company).