Derivatives Software Systems

One of the complex software systems in capital markets world is derivatives software system. Though derivative products itself are not new to markets, there are many complex derivative products have been introduced in decade or so. Due to complexity and custom nature of OTC derivatives, total software solutions are not fully matured. Having said that, I can’t miss to mention that the systems dealing with listed derivatives are quite matured. But systems to support OTC products need to catch up a lot. Though there are few well built pricing and risk libraries, systems to serve end-to-end derivatives processing are yet to fulfill their promise.

As part of the series of posts I would like to cover different aspects of this subject, I will start off with this initial post discussing key requirements of derivatives business and different types of financial institutions and their specific needs. In future posts I will cover organizations structures, various market players and their roles, products currently available in market and other insights.

First, let us look at some of the key features that derivatives system should deliver.

  • Valuing (Pricing) Derivatives
  • Provide Portfolio Analysis Tools like P&L Calculations, VaR (Value-at-Risk), CVA (Credit Value Adjustments) etc
  • Mark-to-market positions and portfolios with multi-class products
  • Calculate various risk factors to assess Market Risk, Credit Risk
  • Calculate Business risk including VaR (types of VaR)
  • Provide tools for Scenario Analysis, Stress Testing
  • Support for multi-class asset portfolios
  • Ability to change or configure certain attributes of products
  • Easy integration with back-office system like accounting, finance and other software systems
  • Ability to setup Straight-through processing (trade workflows)
  • Easy integration with Market data systems (external market data providers)
  • Support for industry regulatory and compliance requirements
  • Technologically Flexible, Scalable and Robust system

Now let’s look at different types of users of derivative systems.

  • * Derivatives Traders
  • * Portfolio Managers
  • * Risk Managers
  • * Analysts
  • * Corporate Treasurers
  • * Accountants

It is time look at various types of financial institutions that deal with derivatives. In a nutshell any institution small or big that manages money will have to manage the risk using some derivatives. Smaller institutions rely on their dealers or service providers for derivatives valuation, accounting and other functions, while big firms use proprietary or vendor systems. Here is the list of types of firms that mostly use some kind of derivatives systems.

  • * Banks
  • * Asset Management Firms
  • * Asset Management Departments of Insurance firms
  • * Hedge Funds
  • * Corporate Treasuries of large businesses

There are many software systems serving derivatives field with specific features addressing needs of specific business functions. For example systems just doing derivatives accounting, valuation, risk analytics etc. Now let’s look at functions of various business groups dealing with derivatives.

Corporate Treasuries

* Valuation of Derivatives – Compare dealer/counterparty prices

* Assess Counterparty Exposures and VaR (Value-at-Risk)

* Assess Credit Risk (Counterparty Risk)

* Perform Scenario Analysis and Stress Testing

* Compliance with Accounting and other regulatory requirements

 Asset Management Firms/Divisions

* Pricing/Valuation of Derivatives

* Portfolio Analysis – P&L Calculations

* Portfolio Analytics – VaR etc

* Scenario Analysis and Stress Testing

* Risk Analytics – Calculation of various risk factors position level and portfolio level

* Trading Limits and Risk Control

* Collateral Management

* Accounting and regulatory compliance 

Hedge Funds

* Pricing/Valuation of Derivatives

* Portfolio Analysis – P&L Calculations

* Portfolio Analytics – VaR etc

* Scenario Analysis and Stress Testing

* Risk Analytics – Calculation of various risk factors position level and portfolio level

* Trading Limits and Risk Control

* Collateral Management

* Support for various Trading and Hedging Strategies

* Support for building and customizing financial models 

Broker/Dealers

Broker/dealers would need a system that provides everything above and much more. Most of the broker-dealers have different desks dealing with different class of products and usually prefer proprietary models. This creates the need for them to either build their own system or use advanced vendor product. Let me try to list some of the common desks and/or departments serving the derivatives business.

* Equity Derivatives Desk / Listed Products Desk

* Fixed Income Desk (Listed and OTC Products)

* Credit Derivatives Desk

* FX Desk

* Risk Management Group

* Collateral Management Group

* Margining Group

* Pricing and Evaluation Group

* Operations Group

* Prime Brokerage (Serving Hedge Funds and other asset mgmt firms)

These are just some names you may come across, but actual organization structure may vary from one organization to the other.

Some of the top Wall Street broker/dealers are:

* Goldman Sachs

* JPMorgan Chase

* Citi

* Bank of America

* RBS

* Barclays

* HSBC and other

I hope this gives some brief idea about derivative software system. I will explore this subject further in future posts.

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