GLOBAL - Asset servicing giant Northern Trust says pension funds could face higher than necessary costs unless they put pressure on asset managers to adopt standardised language when trading in over-the-counter (OTC) derivatives.

Revel Wood, EMEA product manager for derivatives processing at Northern Trust, told IPE asset servicing firms are keen to reduce the cost of handling OTCs as well as the operational risk of processing and administering derivatives for pension funds and investment managers who use derivatives in their portfolios.

However, there is currently no single system or method for handling OTC trades - in part because derivatives contracts can be unique - even though steps have been made in recent months by asset servicing houses, as well as systems like the T-Zero and Markit OTC services, to introduce some forms of standardized messaging or financial product markup language (FpML) where there are at least some common terms to a contract.

As a result, companies like Northern Trust are increasingly introducing price differentials between what it sees as ‘standardised' contracts or communications between organisations - which follow some form of recognized XML document like one Northern Trust has created - and ‘non-standardised' or inefficient manually-settled contracts.

While the trades are usually handled between the asset servicing firm and asset manager or investment bank, asset managers are still some way behind in their use of what standardised process do exist, and it is ultimately costing the pension funds extra, rather than asset houses, said Wood.

"In the custody relationship, the pension fund is the asset servicing client, and the external asset manager is appointed as agent of the client, and this makes it difficult for the asset servicer to apply pressure on the asset manager other than through the underlying client to use market standard message formats like FpML," said Wood.

"But we are trying to introduce incentivised pricing points driven by the level of rework and risk taken on as a result of non-standardised trade formats. If market standard formats are adopted, it makes a significant difference to the level of automation that can be achieved and also cuts down on trade amendments. Ultimately, the underlying client bears these costs, so there is an incentive for them to put pressure on their asset managers to change how they process and message to the asset servicing industry.

"If more of the asset management industry adopt FpML or participate in initiatives like the SWIFT FpML user group, it would make a significant difference to processing and pricing," he added.

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