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"A bolder approach – and one more likely to succeed – is to identify the optimum model to succeed in a Basel III, Dodd-Frank and EMIR world, and build towards it, accepting interim solutions only where absolutely necessary." ROLLO BURGESS, PA BANKING EXPERT

Helping the long tail to wag: profiting from low-volume derivatives clients

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As the changes to derivatives regulation evolve, large broker dealers are fighting to capture prime OTC clients with high-volume demand and low counterparty risk. The queue of firms lining up to support smaller clients is much shorter. In fact, many firms are ratcheting up the price of services to smaller clients in an attempt to make servicing them less unprofitable, or even to drive them away.

Yet this long tail of small users represents a real opportunity for broker dealers. In driving low-volume clients away, firms are turning their backs on a segment where they can quickly capture market share. The question is: how can broker dealers service smaller-volume market participants in a way that is profitable?

To make money from the long tail of smaller OTC clients, firms must live the dream of efficiency, standardisation and sound risk management.  

Developing efficient processes   

Only firms with finely tuned processes and low operating costs will be able to make a profit on the narrow derivatives margins in the long tail. The good news is that the volume of business associated with standardised OTC products is set to grow as regulation pushes in this direction. This will open up opportunities for firms to reduce costs through automation. With streamlined, scalable processes in place, most of the growth associated with standardised products can flow to the bottom line of firms willing to serve small-volume clients.
Standardising services

Firms should avoid offering low-volume clients the same bundled service they offer larger, more profitable clients. The needs of these two client segments may be similar, but providing the supporting service infrastructure to low-volume clients is likely to make them unprofitable. Instead, firms need to segment their clients and define value propositions that meet the needs of low-volume clients profitably. Some firms are already considering gold, silver and bronze categories of client with progressively automated interfaces to each segment.
Establishing sound risk management

Establishing sound risk management for high numbers of low-volume clients will be a challenge. Clearly, a lot of operational risk controls can be built into workflows, automating most of the risk monitoring that takes place in the course of normal business. The time and risks associated with on-boarding and exiting clients will remain a problem. Some firms are setting up specialist client on-boarding/exiting operations, which they hope will provide a white-label service to other organisations. Whether firms manage risk internally or by using external third parties, they will have to bring down the cost of due diligence and client risk management if they are to succeed in serving the long tail efficiently.
PA’s brings together deep expertise in deriatives, derived from our work with exchanges, clearing houses and regulators, with extensive experience of process optimisation, client segmentation and client on-boarding.

To find out how we can help your business achieve exceptional results from servicing low-volume derivatives clients, contact us now.

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