In the second part of an interview with Bloomberg's global head of derivatives and structured products, Jose Ribas (pictured) talks about the cross-over between banking and technology, the issues around fragmentation, as well as the firm's differentiating factor and plans in the structured products market.
What is the differentiating factor of Bloomberg's offering?
There are many competitors and we think that is good for the market. However, it is important to differentiate yourself. We are unique in the sense that we not only have a very good risk management system, solid pricing libraries and can support the process with high quality data, but we also have a dedicated independent valuation team that has grown over the last five years and includes financial engineers with extensive expertise and a dedicated team that deals only with data. That combination of data, pricing libraries, risk systems and communication with clients has helped us improve the work flow and put Bloomberg in a very good position to be a leading player in this segment of the market. Data has also become a focus post-crisis as participants are no longer comfortable dealing with implied data and require historical data. Nowadays you don't look at the price on the last day before you sell the product, you want an accurate price of the derivative component on a daily basis because that tells you how much you own or owe, and because you might want to deploy some collateral to cover the counterparty risk of a trade. Data screening and cleaning has also become a very important element of what we offer.
How difficult is it to integrate this technology in legacy and existing systems?
It is all about having a seamless integration for our clients. Although it is challenging to integrate new technology, we made sure that it is used throughout our system. We have several APIs addressing different client needs. Some clients use Bloomberg's platform for the description of a transaction or contract that will be priced with in-house pricing libraries, or a client may prefer to use Bloomberg data within their proprietary pricing models and use our platform for life cycle management. Most issuers of structured products, particularly market makers, have to use their own approved in-house systems, libraries and models. However, these issuers may also deploy our service for independent pricing and enhanced transparency. For those players with proprietary tools Bloomberg acts as a communication solution which is integrated within their own in-house systems. For other players, including the buy-side and bigger banks, we offer a more comprehensive service around the understanding of pricing and valuation models, and how to use them as their main system.
What kind of tools have you actually developed to meet this demand?
We have been investing in pre-trade capabilities by improving and leveraging our document generation technology to meet new Dodd-Frank guidelines for pre-trade transparency and Priips requirements for product description, performance scenarios and risk factors. We made sure those products are integrated across our solution and can be moved from a pricing library into the system to process the full structure and link the parties in the transaction. In other words this allows you to upload a data structure into the communication tool which is then converted into an RFQ pre-trade request or a trade. At that stage you can then provide pricing on the structure or respond to requests for pricing.
The post-trade confirmation and risk management processes have also been a focus for us. Our life cycle engine, apart from providing all the risk scenarios, VaR, etc. also provides an extra layer where we can see upside or downside barriers at all times so that we can keep a continuous communication with clients. Other improvements address shortcomings that became apparent during the financial crisis such as counterparty risk, but also around underlying prices, and maturities or early redemptions. We can now monitor each product performance throughout the life of the product. This is now a requirement for those players that want to run an efficient-error free and profitable structured products business.
Why is automation getting so much attention?
Automation is getting more traction because there is a need to reduce the cost of doing business especially with the new regulatory environment. It is important that the market has the right tools to function properly and that counterparties feel there is a robust risk framework in which to operate.
An example of automation can be seen through single-issuer and multi-issuer trading platforms. But transactions are only the start of the deal lifecycle process. In order to truly lower the cost of doing business, automation needs to happen throughout the post-trade process. We believe risk and lifecycle management platforms are the kind of tools which will help the market to grow. As they become more widely available, they will provide a safer environment at a product development or origination stage and also when executing trades and tracking the performance of products. It doesn't really matter if these pre and post trade solutions are offered by third party providers or built in-house by market players. The key for the market to move forward is to have these tools and keep improving them.
Going back to the trading platforms, one of their main achievements is the ability to standardise naming conventions around plain vanilla structures for the sake of comparability. Automation is bringing standardisation to the market and enabling participants to understand and compare different products and how they work.
What areas can be improved?
Our scripting tools allow customers to design and back test products, and we are comfortable we are offering the right tools to address the needs of our clients. However, the market could do more around product representation, not just around the nomenclature of the products but also around APIs and how products are described and how different systems interact with each other.
Did traditional risk management techniques fall under a bad light after the crisis?
This is more to do with regulators setting higher requirements around best practice. Best practices and good risk management existed before the crisis, but the issue was that it was not applied across the board. The market had very good risk management techniques and processes, but there were issues around independent pricing, such as pricing structures based on historical volatility as opposed to implied volatilities from a liquid market, and this was being accepted when the market was strong (despite bringing distortion to the market). We don't think there were issues with the old risk management techniques, what has happened is that the good elements of the past have been improved today, and are used by a higher number of market players. In the past, the use of more complex techniques was limited to a few banks and buy-side players. Over the last few years there has been a significant shift, with issuers and other market participants improving their internal processes and investing in technology to improve their risk management.
What's your outlook for the structured products market?
We have seen the market reaching a level of maturity where the push for transparency and best practice has drawn a line under the past. These products are now becoming mainstream, and although the volumes are lower than before the crisis, we see that volumes continue to grow but more importantly demand and activity around structured products is also growing which speaks volumes about the value investors see in these products. Hence the demand for tools that can simplify the process of accessing and trading structured products. The market has learnt the lessons of the past and there is more emphasis in adding transparency around structured products.
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