The OTC derivatives clearing mandate is upon us.
We will be running a series of Prezis called the “Making lemonade from lemons” series. This series, like our similarly titled whitepaper, will be looking beyond compliance to the Dodd-Frank Act (DFA), and examining the opportunities for competitive advantage that the challenges of the DFA present.
The Prezi is best viewed in full screen mode (for normal sighted folk),
and may also be found on the Prezis and Case Studies tab on our Whitepapers and Case Studies page.
The Tabb Group – in a 2011 presentation to the Commodity Futures Trading Commission’s (CFTC) Technical Advisory Committee – estimates that the largest US OTC derivatives dealers will spend a total of $1.8B on Dodd Frank (DFA) related technology costs; with the top eight spending over $1.5B.
An August 2012 update to a 2010 S&P analyst report puts its annualized estimate of DFA-related technology and related expenses for the top eight US banks at $2.0/$2.5B.
Throw in the profound and fundamental changes the regulations have wrought on OTC derivatives market structure, business models, terms of competition and future earnings expectations – and that’s a lot of chucked lemons.
This new Acuity Derivatives client report From Regulatory Compliance to Technological Advantage (making lemonade…) seeks to show that given the fundamental nature of changes to the OTC derivatives industry and also the high technology costs involved; that the deployment of this technology spend should not be viewed solely in the context of sunk compliance costs, but in the context of investing for competitive technology advantage.
“The storm starts, when the drops start dropping
When the drops stop dropping then the storm starts stopping.”
― Dr. Seuss, Oh Say Can You Say?
“Pray don’t talk to me about the weather, Mr. Worthing. Whenever people talk to me about the weather, I always feel quite certain that they mean something else. And that makes me so nervous.”
– Oscar Wilde, The Importance of Being Earnest, Act 1
We will talk about weathermen and the predictions they make. And we will mean something entirely different. By weathermen, we will mean the models in a bank and the predictions they make or the hypotheses they form. And for the realism of Dr. Seuss’ drops dropping, we will substitute the realism of P&L.. More specifically, we will talk about P&L attribution (PLA) and the role it plays in helping us use the realism of P&L to test the hypotheses posed by our various risk models – which actually is its primary purpose in life.
I. Change in the mark-to-market value of its positions are materially determined by changes to a specified set of variables and parameters (i.e. risk factors) and the expected change is quantified by the sensitivities obtained to these risk factors from its models;
II. There is a specified % probability that the value of its positions will lose more than its VAR number over any given interval equal to the VAR holding period;
III. The cost of insuring its aggregate positions against the risk of counterparty Z defaulting is not expected to exceed the cumulative sum of the CVA fees charged to its trading desks for originating exposure to counterparty Z.