INVESTMENT BOOK OF RECORD: improving decision support and transparency in an increasingly complex environment

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    INVESTMENT BOOK OF RECORD: improving decision support and transparency in an increasingly complex environment

    Rapid technology innovations during the past few years are disrupting business models within the financial services industry that have largely remained untouched for decades, challenging operational processes and rendering traditional architecture options suboptimal. With increased regulation stemming from the global financial crisis and competition from new financial services providers, leveraging innovation in the quest for alpha is now a necessity for buy-side firms. In this article, Joshua Satten and Sidhartha Adholekar outline why the Investment Book of Record (IBOR) is critical to empower operational and investment process functions. They also address why an IBOR is equally beneficial to funds, fund administrators, investment banks
    and custodians.

    Despite the transformative changes in global capital markets, two ideals have remained true: firms trade with the intent of positive financial returns; and firms perform operational processes supporting these investments with the intent of mitigating risk wherever possible. Still, constraints around timely and consistent investment information have long been an issue. Specifically, many hedge funds and asset managers employing traditional, vanilla equity and fixed-income strategies have seen their trading and investment details constrained to back-office end-of-day views generated from their Accounting Book of Record (ABOR). This latent settlement-focused information is founded on Custody Book of Record (CBOR) data maintained externally by a combination of custodial banks, administrators and/or outsource providers. It reflects the expected and actual settlement of cash and securities to different managed legal accounts and the reconciliation of related breaks or failures. However, the collection of this data and the resulting three-way or four-way reconciliation presents an unnecessary challenge.

    A front-office Trading Book of Record (TBOR) informed by the use or combination of an Order Management System (OMS) and Investment Management System (IMS) provides firms with another view. An OMS is typically more specific to what’s being traded and its execution, while an IMS is used to facilitate the capturing and matching of intricate trade details in support of more complex confirmation, pricing, analytics and other processes. These position views are also incomplete and limited to trade-based position data and related updates. They must be enriched with security master, product, confirmation and settlement information. Most importantly, they need to support various risk lenses, including but not limited to product, counterparty, strategy, date, asset class, compliance and collateralization.

    Consolidation using sophisticated extract, transform and load (ETL) processes or simple (though complexly orchestrated) overnight batch processes can take end-of-day TBOR positions, apply additional security enrichment, transactions, corporate action events and prepare the TBOR for the start of the next day. Other middle- and back-office processes are triggered by this end-of-day information to enable risk management, performance reporting, compliance and other functions. The dependent data points and processes between trading and operations include prices, existing positional and transactional holdings, unsettled or unconfirmed trades and securities as well as other market data.

    The technology solution requirements in support of these front-, middle- and back-office processes have largely been proprietary and led to the creation of bespoke technology solutions over time that lack central data storage in a corresponding data warehouse. IT teams are continuing to separately support the front, middle and back offices resulting in a more complicated shared service structure replicating key value chain links, such as pricing, analytics, security master and accounting. For firms that work across an array of legacy systems, weaving them together to get a consolidated view of positions and associated valuations in a timely manner is a highly complex process.

    Figure 1. A general view of trading operations noting essential groups and their functions.

    A UNIFIED DATA VIEW

    When pricing and asset data is contextually latent, trading and operations teams lose efficiency and deal with slow information hand offs. Batch reports among operations, accounting, risk management, third-party administrators and custodians only serve to provide segregated, disjointed snapshots of information, while contending for accuracy across multiple ends of days, funds, regulatory bodies and investors. Consider a global fund administrator that performs portfolio administration services for its clients in multiple geographies and the portfolio of assets for its clients’ funds span multiple geographical markets. To strike a net asset value (NAV) in one time zone, the fund administrator’s existing process might involve running the end-of-day valuation process for the client’s geography by using the current day’s market data for assets within the same market but with models or older accounting-based valuations for assets traded in markets that may not have closed yet. Further, information that is stored in reports and files generated by other regional end-of-day valuation processes from multiple systems may have to be linked, which can be time consuming. As this NAV drives fund subscriptions and redemptions, it is critical that the valuation information is as close to real-time as possible.

    As a result, in a global marketplace, where firms are beholden to different geographic, operational and accounting nuances, the concept of an end of day poses exponential complexity. The batched nature of existing accounting, position and valuation systems in addition to inefficiently arranged system communication flows, increased offshoring and outsourcing and geographic nuance increases the likelihood of making investment decisions on stale position data. For firms that have multiple OMSs for different asset classes, this problem gets invariably more risky as there isn’t a single, accurate or robust view of positions and valuations.

    The impact of these limitations can result in underinvestment or overinvestment, a lack of optimization of cash and collateral, inaccurate forecasting, insufficiently hedged positions, deficient risk management, costly operational errors and even regulatory punishment. Conversely, well-constructed and well-maintained data allows for the reutilization of existing data for further insight and analysis that enable investment and trading decisions.

    Firms that can generate a dynamic singular view of their data, including holdings, valuations, breaks and exposures, are in a position to get ahead of the competition. Investment decisions made on accurate and transparent views of positions in the context of market liquidity should yield improved forecasting capabilities around cash and securities and agility in assessing the impact of and responding to market events. For client service providers, such a unified view also enables improved and timelier client service.

    Perhaps the best example of this intersection of technology, operations, investment support and data governance is the IBOR.

    IBOR TO THE RESCUE

    An IBOR represents a master data warehouse of both persisted and dynamic views of positions and transactions, which are inclusive of those data sources typically feeding the TBOR and the ABOR across asset classes and geographies. It can be leveraged regularly by front-, middle- and back-office related functions.

    Think of an IBOR as a financial entity’s heart. When functioning properly, it provides mutually accurate, real-time and historical information from trading desks and operations to accounting and governing bodies. It houses the data from which risk and performance are derived, from where investor relations and accounting are driven and from which the security master and pricing processes are both predicated by and beholden to. It’s the golden source of information utilized for regulatory reporting and profit and loss. It’s the system through which many core operational processes are performed, controlled, requested and subsequently, audited and executed. A carefully balanced consideration of sustainability and usability alongside a mindset of consistent evolution must be employed.

    From an operational perspective, this central pooling of information in the IBOR enables the generation and processing of triggers flowing across middle- and back-office operations teams that are responsible for supporting trade life cycle and other business events, corporate actions and reconciliations. Ownership for additional operational functions, like the setup and maintenance of business event definitions for the IBOR and management of related exceptions, also needs to be assigned for relevant steps in the information flow.

    Furthermore, the underlying transactions and events captured inherent to the support of core investment information must be exhaustively stored for valued usage where there is any potential bearing financially or legally. Optimization would include bringing together data across this historical disconnection into one centralized store for simultaneous access and usage across processes where different stakeholder groups would have differently defined views of the same book of record and its underlying pool of information. It is implicitly required to install upon this view of positions an application and tool framework inclusive of exhaustively comprehensive amendment, enrichment and control functionalities. Such a time-series view of positions also allows firms to leverage business intelligence, reporting and analytics to uncover patterns and explain changes in positions as well as offer insight into the data used for investment decision making. In addition to retroactively viewing position information and gleaning insights, this all-encompassing view also enables the ability to use IBOR information to forecast cash balances and security positions.

    As such, the advent of a modern functional IBOR could very well underscore a need for a renewed approach to the construction of target operating and architectural models. It also calls for a renewed focus on accountability for data quality and the streamlining of day-to-day functions to optimally align them with sound information management and governance processes.

    Figure 2. IBOR in context: the business functions it enables and the financial entities it empowers.

    WHY AN IBOR IS BENEFICIAL FOR MULTIPLE FINANCIAL ENTITIES

    Hedge funds trade and have investors. Asset managers and mutual funds trade and have investors, shareholders and clients. Custodial banks, administrators and investment banks provide an array of services, including outsourced operations, accounting support, trade execution and clearing, risk and analytics. The fact that different firms have different needs for different services in no way affects their information and reporting needs. It simply reflects an infinite number of proprietary balances of cost, scale and expertise that can be put into place by way of keeping services in-house, outsourced or in a hybrid model. As a further consideration, outsourced services can be retained as a secondary operational stop-check, not a replacement, resulting in a need for nightly book-of-record reconciliations.

    As an example of the increased need for a properly situated IBOR implementation, consider the mandated advent of central clearing, where new information relationships have quickly arisen across trade support and information management. If a large global asset manager or pension fund engaged in standard fixed-income and equity strategies with a need for bond and interest rate hedges as well as a need to execute vanilla credit default swaps and interest rate swaps, the manager or fund, depending on the geography, must view prices of comparable products from two or more clearinghouses, across a number of Swap Execution Facilities (SEFs) or Designated Contract Markets (DCMs) from any number of brokers, which would then require one or more (two for the purposes of safety and liquidity) Futures Clearing Merchants (FCMs). Architecturally, investment data would be shared between vendor platforms typically supporting valuation, collateral, clearing and matching, reconciliations and regulatory support. Operationally, for a multi-fund manager closing its book daily in multiple geographies and perhaps using a combination of custodial and administrative services, this can be increasingly difficult to manage in spreadsheets and reports.

    For a fund administrator to strike a NAV, an IBOR-based approach will make available the transaction and position data needed to calculate the NAV on a near real-time basis and also provide more transparency into the quality and lineage of the information used for the calculation. However, this will require rules around which type of positions should feed the NAV calculation for markets not yet closed.

    For OTCs and alternatives, the quality of the IBOR data will also improve the inputs for the models used to perform valuations, thereby improving the margin calculations as well as transparency.

    GAIN PERSPECTIVE WITH AN IBOR

    Although the specific needs of different types of financial entities may vary, there are a few guiding principles that firms can follow when considering an IBOR solution:

    1. Alignment with long-term business objectives—Any business process change or technology solution must align with the objectives of the business and improve its competitiveness.
    2. Type of products traded and strategies employed—The level of complexity of trading vanilla securities compared to trading exotic securities varies exponentially and the level of transparency and agility in responding to market changes will be an input to this decision.
    3. Complexity of existing operational processes—The type of operational processes and the nature, age and maintainability of the technology solutions used to support these processes is also an important factor in assessing the value provided by the IBOR.
    4. Regulatory requirements—This is most important for firms that operate in multiple geographies and have regulatory and tax reporting requirements under multiple jurisdictions.

    Further, depending on firm-specific needs, successful IBOR implementation should be inclusive of how firms prioritize the following questions and measure their responses:

    • Has the quality, contextual value and speed of data improved? Are better investment decisions supported or made through more effective management of existing holdings? Has response time to regulatory, investor and client inquiries improved?
    • Is pricing, PNL, risk, regulatory, operational, accounting and investor information sourced and delivered consistently on time and accurately in line with all documentation, SLA and audit requirements, when needed and on demand, with minimal risk of penalty or failure?
    • Are collateral and margin management practices in relation to calculation, optimization, portfolio margining, rehypothecation, securities lending with Futures Clearing Merchants (FCM), Prime Brokerages (PBs) and Central Clearinghouses (CCPs) enhanced?
    • How is the development of the future technology architecture, including planned integrations, products launches, fund launches and new regulatory requirements, envisioned in the short term as well as in relation to new technologies and market changes, like blockchain, cloud computing, cleared OTC and electronically-traded bonds, over the long term?
    • Despite up-front investment, is the firm projected to proportionately cut operational and technical support costs without sacrificing quality over the coming years?
    • Are more projects focused on enhancements or upgrades and fixes? Cost savings or quality enhancement?

    CONCLUSION

    To emerge as leaders, firms across the capital markets need to leverage innovation to improve their investment decision capabilities and their operating models. The fabric that weaves this front-to-back innovation together is the quality of investment data. Having a unified, consistent view of this data across asset classes, strategies and geographies is a key enabler to long-term success.

    In a follow-up paper, the costs, benefits and value of the proper implementation and application of an IBOR as related to key processes, including position management, pricing, reconciliations and regulatory reporting will be explored in greater detail. The paper will also touch on the advent of innovative new concepts for the IBOR of the future, such as distributed ledger (blockchain) capabilities and web-based applications (e.g., HTML5).

    The Authors
    Joshua Q. I. Satten

    Joshua Q. I. Satten
    is a Director of Business Consulting, in San Francisco. As a member of Sapient Global Markets’ West Coast Leadership team, Joshua leads business development and market strategy. He has over 15 years of experience leading operations management, strategic innovation and enterprise business architecture for major buy-side, sell-side and third-party outsourced and administration entities. He specializes in change management and growth of full life cycle trading operations across listed and OTC products combining strong management, leadership and strategic planning skills focused on globally balanced, sustainable growth across a wide range of specialty areas. Joshua is an active industry participant and speaker, and has worked with and chaired working groups within ISDA, ISITC, SIFMA, AMF and others.

    Sidhartha Adholekar

    Sidhartha Adholekar
    Based in Chicago, Sidhartha is a Senior Leader and Financial Services Consultant at Sapient Global Markets. He has over 12 years of technology consulting and broad industry experience spanning OTC derivatives collateral and margin management, asset management, fund administration and retirement solutions, serving large global financial institutions. With a diverse skillset that includes cross-functional team leadership, program and project management, change management and strategy development focused on achieving top-line and bottom-line focused goals, Sidhartha leads regional strategy development and drives business development and operationalization of the strategy.

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