Can technology support OTC market growth?

A fresh wave of technological innovation has swept the OTC market in recent years, with tools like AI, machine learning and blockchain poised to potentially transform the market. But is tech alone enough to move the needle on market progress?

The OTC derivatives market is projected to reach more than $25 trillion in value by 2032, representing exciting growth potential. There are several factors behind this considerable growth trajectory, including the increased levels of macro volatility that make OTC’s an important hedge against risk in today’s economy, as well as enhanced regulatory oversight in the space, which is helping build trust.

One significant driver of growth potential is a new wave of technological innovation that has swept global markets in recent years; most notably, blockchain, artificial intelligence (AI) and machine learning.

Is the market ready for progress?

With many new opportunities, as well as some challenges, present in the OTC space, Parameta Solutions commissioned a survey to test the temperature of this growing market. The resulting report, ‘Navigating the evolving OTC landscape’, surveyed over 400 market respondents across a wide range of roles and businesses, spanning both the buy and sell-sides and covering key global markets.

In all, respondents pointed to 22 separate innovations in the market; with blockchain and DLT getting the most mentions. Despite challenges, such innovations will be essential to help improve transparency, especially in areas such as pricing.

The report reveals that the majority of respondents see the OTC markets as being an easier place to operate in than just three years ago. This has been aided in no small part by significant levels of technological innovation which have helped streamline bilateral negotiations and facilitated greater connectivity between counterparties.

This is reflected by the fact that half of respondents describe the levels of innovation as excellent. However, there is less confidence on the buy side; where, for example, few hedge funds agree with this sentiment and many are less than satisfied.

In general, respondents want to see greater automation of settlements and data processing as well as more unified information systems driven by real-time, reliable data and enhanced by AI and machine learning; as well as centralized systems for trade information.

Overcoming barriers

There are still barriers that need to be overcome for technology to deliver the innovation that’s needed. In particular, the extent to which there is general uptake of new technologies across markets and among both the buy and sell sides.

In the UK, there are high levels of openness to innovation, especially on the buy side. In Europe and the US, respondents were most satisfied with the levels of innovation from OTC market participants. However, in the Asia Pacific (APCA) region it’s a different picture. There, most respondents on the buy side in Hong Kong think levels of innovation are average and a considerable minority think innovation is poor. In Japan, many think innovation is average and only a minority think it’s excellent.

It’s possible that a combination of stricter regulations and fragmented market infrastructure has created an environment in which innovation is dis-incentivised and a lack of economic incentives are hindering technology investment. This creates an opportunity for operators in the more developed markets like the US and Europe to foster innovation through technology transfer and a drive to standardise products and processes. This would help level the playing field and lay the foundations for further global growth of the market.

AI challenges

While AI is widely hailed as a promising technology with potential applications to transform the market, many participants are likely to be cautious regarding its uptake. This is likely because the opaque nature of AI’s inner workings makes it difficult to trust its recommendations, especially for high-value transactions.

This may also raise concerns about regulatory compliance, with participants wary of potential penalties should anything go wrong. However, as the technology matures, more possibilities for it to impact the market may likely open up. In the meantime, more easy-to-adapt, off-the-shelf applications are making technology-driven execution platforms more accessible for market participants.

Bridging the gap

The study shows that the market is generally optimistic about, and willing to adopt, innovative, tech-enabled solutions. Despite regional and buy- and sell-side disparities, this appetite for innovation makes the OTC market well-placed to capitalize on increasing macro instability and seize the many opportunities to take the market forwards.

Essential to this growth potential will be a greater availability of reliable, high-quality data. Participants such as Parameta Solutions are at the forefront of this wave of growth, helping provide scarce, valuable data and insights that can support market performance and support better investing decisions.

Triennial OTC Derivatives Market Size, Growth by 2032 (businessresearchinsights.com)

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