In my previous blog I mentioned the growing external pressures for brokers when it comes to the reconciliation of exchange traded and over-the-counter derivatives. With EMIR requirements coming into effect, and Dodd Frank already impacting the industry, it’s never been so vital for brokers to improve their levels of operational control.

Even more demanding than regulatory bodies is the derivatives market itself. Despite the number of contracts declining in 2012, as reported in the recent FIA Annual Volume Survey, the number of transactions remains high and continues to grow across some markets. It is therefore essential for brokers to increase their focus on the operational control of their derivatives reconciliations. This ensures at all times that positions are correctly held and that the impact of discrepancies can be quickly ascertained limiting exposure to risk.

Critical then is the delivery of timely and position-level information to help brokers both reduce operational risk and improve compliance. In my view they should be looking to hone three aspects of their operations using the key steps I have outlined below.

1. Achieve transparency

To identify and resolve potential breaks in a timely manner, firms need an overall view of derivatives reconciliation results. This means consolidating all components including cash, positions and trades. Only with a consolidated approach to reconciliations can brokers easily identify discrepancies which need attention. In fact, if the different components of reconciliation are not consolidated in this way, manual intervention will be necessary to bring them together to achieve a holistic view of the reconciliation. This is bad news in terms of operational risk.

2. Meet control and internal audit requirements

In light of high-profile trading losses and increasing regulatory oversight, the need for senior management control in particular has clearly increased across the financial services industry. So, sell-side firms will need to strengthen their own internal audit capabilities and, where possible, replace manual spread sheets with applications that audit the actions and clearly define the duties of users.

Poor controls in the area of derivatives reconciliation could lead to inaccurate positions or the incorrect segregation of customer assets, which could attract regulatory fines. It’s also worth noting that the Dodd-Frank Act is putting a greater level of personal responsibility on the executives of firms. This alone gives firms a strong motivation to ensure accurate reporting. Ultimately, if firms are unable to meet internal audit requirements and introduce stricter controls, the result could be a severe dent in shareholder confidence.

3. Optimize business processes

Taking a long-term approach to optimizing processes will ensure sustainably high automated matching rates, and help identify recurrent sources of issues. Sell side firms can therefore be confident of continued efficiency across the entire reconciliation environment with tools capable of identifying patterns in their data, such as the frequency of breaks across different customer accounts. 

The demands of regulators and the market should never be underestimated. But a finely-tuned approach for optimal operational performance will meet both sets of challenges head-on, with benefits for compliance and risk management.