LESS IS MORE.
Dr Sam Priyadarshi, Head of Portfolio Risk and Derivatives at Vanguard explains how his small team is leveraging technology to meet the increasing flow of business.
How has the derivative landscape changed?
The Dodd Frank regulation significantly changed the derivative landscape and asset managers and market participants had to adjust in terms of reporting, trading and clearing. One of the aims was to have a more robust infrastructure and to reduce counterparty risk. We adapted to the new regulations and have moved almost entirely to electronic execution for all futures, swaps, and Treasuries because there is enough liquidity in these markets. We clear almost everything – interest rate swaps, futures of course and our index credit default swaps. The only product we trade that is not cleared is single name CDS. We can take advantage of the efficiencies brought through straight through processing and the fact that there is very little human intervention and manual errors.
What about OTC trading?
The regulation is pushing towards more centralised clearing and margin on uncleared derivatives so we have opted to hedge with more standardised products. Bilateral transactions have become more difficult and inefficient. The problem is you can incur a credit valuation adjustment as well as have multiple line items in the portfolio. If you do a bespoke trade, you have to manually pick up a phone, agree terms, sign an ISDA (International Swap and Derivatives Association) agreement with the counterparties and then make sure there are no breakages. Now, if I go on a SEF, I can trade with any dealer or non-bank dealer. We are no longer facing counterparties, but the clearinghouse. Also, we can trade a whole list of swaps in a matter of minutes whereas before it could take half a day.
What impact do you think MiFID II has had?
EMIR and MiFID II followed on from Dodd Frank and we already had the operational framework in place for the reporting, central clearing and trading. There are new angles compared to the US but a lot of the changes we understood and already made especially on the reporting, central clearing and transparency obligations. Also, as a large global asset manager that manages around $5tn, it is our responsibility to be ahead of the regulations. This is why we were compliant and trading on SEFs before the deadline and also had an operational framework in place before MiFID II came into effect. Overall, we think regulations’ push towards greater transparency has led to improved price transparency and a more stable market. One of the main differences under MiFID II is the best execution requirement, which is not mandatory under Dodd Frank although there is a fiduciary responsibility to achieve it.
What changes did you make?
While the best execution requirement under MiFID II is unique to Europe, we are applying a global best execution standard across all our funds. This is because we are a client-owned global fund manager and regardless of jurisdiction, we want to comply with the most stringent best execution obligations. We distinguish between index and active funds and harness technology to capture the beta or alpha. The beta is highly automated but we will leverage machine learning, unstructured data and fundamental research to understand events, price movements and liquidity to produce alpha.
Speaking of technology, there has been a lot of hype about artificial intelligence – what do you think is the reality versus the hype? What technology are you employing?
There is definitely a lot of hype about AI but to date most of the progress has been on the machine learning and predictive analytics side. This is particularly the case in terms of unstructured data rather than structured data, which has a limited capacity.
Today, we can look at much richer data sets that include social media and, sentiment analysis to source assets and sectors that seek opportunities to add value and will generate alpha. We also use robotic process automation (RPA), which aims to automate anything that can be done in a routine manner. In other words it targets the low hanging fruit.
Where do you think that blockchain or the distributed ledger technology can be applied?
There is a groundswell of effort happening with asset managers looking at the DLT for settlement and transaction processing. However, there may also be some value in having certain derivative contracts on a platform, and I think the landscape will change significantly over the next three to five years.
I have read that you have five people handling a significant and growing order flow. How do you handle the flow with such a small team?
We still have five people and in the first quarter of 2018, we handled over $300bn in derivatives trading. We have a small high performing group of experienced traders who understand regulation and market infrastructure. Also, we are heavy users of algos to find the most liquid venues at the best price. The bulk of the creation and trading of orders is done electronically, which explains why we can do so many with so few people. There is very little manual entry or correction is needed throughout the lifecycle of the transaction.
What do you see as a challenge?
Some of the biggest challenges in the industry are the lack of liquidity margins on uncleared derivatives and credit management. We are also concerned about the lack of regulatory harmonisation. Trading is done on a 24-hour basis between APAC (Asia-Pacific), Europe and US and while we comply with all the regulations we think it would be more efficient and easier to transact if there was regulatory equivalency. We are compliant with global regulations as well as with each jurisdiction. However, if, for example, you have a block trade, you have to break it down jurisdiction by jurisdiction, which is not easy to do.
And the opportunities?
We have seen a lot of growth in our assets under management both in the US and globally and we think that is where our main opportunities lie. We want to continue building upon our low cost, high quality service and to take as many clients as jurisdictions will allow us to.
Dr Sam Priyadarshi is Head of Portfolio Risk and Derivatives at Vanguard and is chair of the Technology Steering Committee and a member of the Market Structure Committee. Prior to joining Vanguard in 2009, he worked at the Lincoln Financial Group for 12 years, where he was Vice President, Derivatives and was responsible for hedging insurance products and portfolios. He was a member of Lincoln’s Derivatives Committee, Insurance General Account Assets Committee, and Alternative Investments Screening Committee. Priyadarshi holds a Bachelor of Science in Mechanical Engineering from Birla Institute of Technology, Ranchi. He holds an MBA from the Indian Institute of Management, Calcutta, and has a Ph.D. in finance from Virginia Tech. He is an active participant in many industry panels and working groups related to derivatives and fixed income markets.