Knowing the lifetime cost of a derivatives trade
A partnership between Cassini Systems and IHS Markit is enabling investment firms to build a deeper understanding of their derivatives trading costs into pre-trade portfolio and execution decisions. Best Execution asked Marco Knaap, Head of Business Development, at Cassini Systems and Brett Schechterman, Managing Director and Global Head of Business for thinkFolio, IHS Markit how it works?
How did the partnership come about?
Brett Schechterman (BS): We were approached by a number of customers with respect to the rising importance of pre-trade margin and collateral analysis in the context of modelling, execution and regulatory considerations. We had already been in discussions with Cassini for some time and this was a perfect opportunity to develop an integration between our two applications, leveraging input from our customers.
Marco Knaap (MK): There is an increased realisation in firms that if you want to optimise the carry cost of a trade, you actually have to start in the front office. Typically, these processes happen at the back and middle office, from a margin and collateral perspective. The trick is, how can you model all those post-trade carry costs in a pre-trade process? Those were specific questions we got from thinkFolio users. We were already in conversations so we brainstormed how we could best service our clients.
What were clients asking for in terms of best execution and managing margin?
MK: The cost of derivatives trading has significantly increased as a result of regulation. Therefore, firms are now under increased pressure to manage and reduce those costs.
Historically, buyside firms do not have the infrastructure in place to manage best execution, margin and collateral. Front office users, portfolio managers and execution desks, traditionally focus on getting the lowest execution price without understanding the impact of the cost of the trade on best execution.
Not only do firms need to know the cost of the trade at pre-trade, they also need to allocate these costs back to the original consumer of the margin, at post-trade.
At Cassini, we have seen a cost impact from 1-20 basis points of the notional of a given institutional fund. This increase in transaction costs has a direct impact on manager performance and ultimately the institutional client, and therefore its crucial to empower the front office with the tools and models required to achieve best execution.
BS: Our customers desired to see the results of lifetime cost analysis directly within thinkFolio to facilitate the decision-making process. Our product team partnered with Cassini to design and implement interoperable workflows that help our users shape derivatives trades based upon the best execution algorithms offered by Cassini. This provides our clients with full transparency to allow them to execute in the most cost-efficient manner possible.
Do you see a changing importance in the use of derivatives as interest rates limit long-only investment returns?
BS: In general, the more levers that institutional clients provide to their investment managers to effectively manage risk and seek alpha, the more advantageous it should be for those clients. Many of the best performing and most sophisticated shops have access to a broad investment toolkit, and they require robust technology platforms that allow them to dynamically implement the most efficient ways of achieving a given exposure to generate a target return or to apply a given hedging strategy. With the liquidity backdrop in fixed income cash instruments, derivatives can offer an effective way of achieving a given exposure, with considerable flexibility.
How do the Cassini margin analytics work?
MK: First thing is to map the client’s trading infrastructure, such as clearing and bilateral trading relationships, products traded, etc. The next step would be to access, in real-time, the full portfolio to determine all potential margin offsets. This then allows the front office to submit ‘what-if’ trades for modelling and optimisation purposes. Our analytics will calculate the margin impact on both trade and portfolio level, analyse drivers in margin movements, and then reduce the margin through optimisation. For cleared trades, we connect directly to CCP models and data, and for bilateral trades we apply ISDA SIMM or GRID.
Initial margin (IM) is just the first step. When you know the margin, you need to figure out how to satisfy it; with either cash or non-cash collateral. We optimise collateral and calculate its funding cost, which together with CCP fees, FCM add-on fees (plus any other fee), determines the life-time cost of the trade. At Cassini, we run this life-time cost analysis through all potential routes to market and deliver the cheapest route.
How does the partnership add value and meet regulatory requirements?
BS: Derivatives asset coverage has always been a core strength of thinkFolio. We provide tools to efficiently access or create derivatives instruments on the fly and that allow our clients to model orders across broad sets of portfolios and strategies at scale. Although we are a multi-asset platform with proprietary analytics and with access to leading derivatives content from our partners at IHS Markit, there will always be cases where partnerships will make more sense.
While considering how to solve challenges and streamline workflows for our clients, Cassini’s focus and demonstrated expertise in this space was a natural fit. Through offering interoperable access to Cassini’s engine, we’re providing portfolio modelling, best execution and, as Marc will highlight, significant regulatory benefits for our mutual clients.
MK: The partnership helps firms become compliant with UMR, EMIR, Dodd-Frank and MiFID II for their OTC bilateral and cleared trading activities. We also move a step further than helping firms become compliant, and allow them to make better informed trading decisions to minimise the cost, as a result of these regulations.
How do users access the solution?
MK: The beauty of this partnership is that Cassini’s analytics are fully integrated within the thinkFolio platform. It is very quick to activate this functionality, as all the data required by the client is already thinkFolio and configured within Cassini. With one click of a button, a thinkFolio user can see pre-trade lifetime cost analysis within the existing thinkFolio workflow UI.
BS: It is accessible via thinkFolio version 19.4 and we’ve made additional improvements in our most recent release, version 20.2. So, it’s simple. As long as clients are leveraging 19.4 or beyond, it’s a simple matter of extending their thinkFolio contract to leverage Cassini’s services.
What’s next for the partnership?
BS: Engagement. To highlight the combined value proposition to our audience and to onboard as many thinkFolio clients as possible. Once we have more clients onboard with the solution, we’ll perpetually seek feedback as to how we can partner with Cassini to enhance or optimise the functionality further.
MK: Depending on client feedback, we will add additional Cassini functionality to thinkFolio. For instance, many of our clients have recently added margin forecasting functionality for both IM and VM. These new features, in addition to intraday monitoring of margin and collateral requirements, enables firms to track margin movements and manage cash buffers way more tightly. This allows our clients to free up cash and collateral and use this for investment purposes, i.e. limit the collateral drag.
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