5 steps: automate settlements and netting

August 30, 2019

 

See where Jens is speaking on the ETOT programme here

 

Automation is as instantly alluring as the latest pop star on the Disney cutting board - however what many people may overlook is that its temperament is also akin to the aforementioned stereotype.

 

In other words, get it wrong and the promise of efficiency and productivity can collapse into an embarrassing mess. But get it right, and, well, let's just go grab that picture of Ariana Grande...

 

Fidectus are a bold new outfit with a lot of industry pedigree behind them looking to revolutionise the settlement process in energy trading -- and they're going to tell you all about it at ETOT next month.

 

Before that however, we got the chance to pick the brains of their CEO Jens Bartenschlager & EVP of Sales of Marketing, Chris Sass, on a number of topics surrounding the industry as well as their journey.

 

 

 

Why do you think there is so much buzz around electronic settlement for OTC energy trading?

 

(Chris Sass) The excitement stems from the fact that settlement and invoicing remain the last
vestige of a manual or semi-automated process in the OTC trade lifecycle. Energy traders rely on manual operations for invoicing, reconciliation and netting. Some argue their organizations have automated settlement as they use OCR or rudimentary RPA (robot process automation).

 

The truth is, the settlement processing is still reliant on teams of humans which makes it error-prone, adds operational costs while operating at the speed of humans. Moving to an electronic settlement platform gives traders new powers unimaginable with the legacy settlement process.

 

Once only a concern for back-office or operations eSM is becoming an opportunity to create value for other parts of the organization. Automating the post-trade workflow enables improved cash flow controls while providing additional tools for managing (credit) risk and delivering significant operational savings.

 

"The truth is, the settlement processing is still reliant on teams of humans which makes it error-prone, adds operational costs while operating at the speed of humans."

EFET has enabled the industry to close the technology gaps in the OTC trade lifecycle by releasing the eSM 1.0 standard. Industry participants can now leverage a standards-based approach to automate settlement while avoiding one-off solutions. Fidectus supports and built its business on a standards-based solution.

 

To answer your initial question, I believe the buzz is created by people seeing an opportunity to make an immediate impact and improve their organization’s bottom-line.

 

We have asked a few industry insiders about their need for eSM and they said they already have a solution. How can this be?

 

(Jens Bartenschlager) Let me explain two perspectives from a trader’s point of view. The first is an approximation towards automation, which has been implemented at several OTC energy traders.

 

Chris already mentioned OCR and RPA as examples. What we see is traders create documents in legacy systems digitally but typically encounter a media discontinuity when sending outgoing documents to counterparties. At the same time, traders collect incoming documents and leverage optical character recognition to overcome media discontinuities getting the process back to the digital world. Fully manual processes such as reconciliation remain completely untouched and have yet to benefit from automation. Still, today’s workflow is an improvement compared to the past. The initial efforts did reduce errors and cost by around 30%. There is still significant benefit being left on the table as the process only appears automated. If you take a closer look, you will see it still is a costly, slow and error-prone process increasing operational risk. In such a 1-to-many situation, it was simply not possible unlocking the real business-value. Until now!

 

The second perspective is around electronic confirmation matching (eCM). The standard and its solution were born in 2003 as an EFET initiative. First designed as a peer-to-peer solution (EFET box) by EFETnet, it became a centralised hub-and-spoke architecture now operated by a privately held company. eCM appears to be like eSM. A closer look reveals eCM addresses another business problem: eCM helps confirm deals electronically, rather than relying on a broker's written acknowledgment of a trade being completed. Leveraging eCM brings operational improvement thru automation resulting in less errors and cost efficiency. eSM in contrast is going far beyond operational improvement. It will help reshape physical and financial settlements. It will allow you to free up trading limits earlier by managing cash flows and by reducing credit risk. You will make conscious business decisions about your desired time-to-cash cycles. In a nutshell: You will be able to optimise your working capital through settlements.


To answer your question. We have not yet met any European OTC energy trader who has
implemented the full eSM potential. However, what we experience is a massively increasing

interest in doing so. Unlocking the full potential typically requires buy-in not only from Back-Office but also from Accounting and Risk.

 

"eSM in contrast is going far beyond operational improvement. It will help reshape physical and financial settlements. It will allow you to free up trading limits earlier by managing cash flows and by reducing credit risk."

 

 

Your materials show your solution uses Blockchain. Is this another Blockchain company trying to disrupt the entire trading process?

 

(Jens Bartenschlager) That’s a good question. Let me start a few years back: In 2015, we came up with the vision to automate settlements via a Blockchain solution. We developed several pilots utilizing smart contracts in different frameworks as e.g. Ethereum or Tobalaba. The more
iterations we went through, we understood that the Blockchain itself did not fit the equation. We did not see it working yet on a high-performance enterprise level, being easily scalable with reasonable development, maintenance and predictable transaction cost. Moreover, it did not easily unlock the full business potential. We still needed to solve the specific problem of
settlements in European OTC energy trading. Even though that technology enables business as I said in my ETOT interview 2017, we adapted our vision to utilize technology in a way that it
benefits solving the business problem. That’s why we adjusted our pathway and started using
Blockchain for the purpose it was originally made for: a tamper-proof audit trail. To get back to
your question: It has always been our objective to seamlessly integrate a solution into existing
legacy systems rather than disrupting the entire trading lifecycle. We believe that our approach will be more likely to succeed than trying to get the entire OTC trade lifecycle on a Blockchain at once. However, we are prepared to take that step as soon as the industry is ready to do so, and our clients are asking us for it.

 

How did you come to found Fidectus?

 

(Jens Bartenschlager) That is a long story. I will try to keep it short. It is November 2015. I am
sitting in the open space of an energy trading company in Düsseldorf. It is getting dark. I am tired of the operational madness. My phone is ringing. A colleague is calling. He says, „I am almost there“. I am looking forward to meeting him at dinner. We speak about digitisation in energy trading. We brainstorm business problems and ideas. Suddenly it is there. We are so excited. We will solve the settlement problem and close the last process gaps in the OTC energy trade lifecyle.

 

So, what did we do then? I will tell you now. We found that lack of automation translates to being error prone, high operational costs and increased exposure/risk. We agreed to improve the industries situation by proposing “A Blockchain for OTC settlements” at ETOT 2016. The industry feedback was overwhelming and promising at once. The initiative became our passion. As we continued speaking at numerous industry events, the work continued. Whereas my industry contact started driving the official EFET eSM Project Work Group in 2017, I worked with several industry players to validate the underlying hypothesis and expectations towards a solution. I then invited major industry players to PWC`s experience centre in Zürich in April 2018. The objective was to jointly develop a way forward for a standards-based solution. They all invested time and effort to elaborate and agree on the problem statement, a joint vision and a minimum viable product. I took pictures to document the results.

 

Subsequently, my former employer – a global audit firm – intended to invest in the business case. We spent time and money to iterate and successfully pass a Proof-of-Concept phase. When we came to decide about making this real, we discussed days and nights with our lawyers. In September 2018, the decision to proceed was negative due to independence and regulatory reasons. Therefore, I formed a small team and continued the work independently.

 

We founded Fidectus in March 2019 and arranged an IP transfer. In the meantime, EFET had published the first release of the new eSM Standard v1.0. The eSM standard is now opening a window of opportunity for OTC energy trading. I believe in competition and interoperability as a guarantee towards our clients for continuous innovation and generation of benefits. Today, my beliefs and the pictures I took in April 2018 are the foundation and purpose of what we do at Fidectus.

 

What are some of the business advantages of implementing electronic settlement(eSM)?

 

(Chris Sass) Electronic settlement is a business process for enabling reduced operational cost,
automating a semiautomated or manual operation and providing efficiency while reducing errors.

 

Traders get more than simple operational savings; the true magnitude of value comes when one starts taking advantage of the platform for improved cash-flow management and risk reduction.

 

Implementing eSM provides traders a competitive advantage by aligning settlement timing and cycles with reduced risk exposure. Automation offers near real-time visibility of all positions and tools to take advantage of the information.

 

Reconciliation gains are only part of the solution's actual value. Automating settlement provides a single source of truth, allowing for significant benefits to the netting process. Today bilateral netting is a well-established tool in the trader's toolbelt. The associated complexity and operational cost of the current methods limit the actual value traders receive. It is now possible to leverage multilateral netting to gain additional control, not practical with the legacy manual process.

 

In addition to the immediate value, progressive traders have their eyes on the future. For
example, a few traders already have their eyes on future capabilities such as leveraging the
Fidectus platform for margining.

 

Today, traders are saying the value created by the Fidectus eSM solution is a no-brainer. The
calculus is simple, operational savings, improved cash-flow, and reduced risk exposure add up to the right business decision. In the end, savvy traders understand eSM needs to be built on an extensible platform to unlock the full potential today and into the future.

"Be mindful of vendors who claim expertise in this emerging space simply because they participate in other phases of the OTC deal lifecycle."

What is the recommended path forward for energy traders wanting to automate settlement and netting?

 

(Chris Sass) Step 1: Get an initial overview by Fidectus’ presentation of the present state of the
market, defining the problem statement as it is currently understood to ensure any proposed
solution aligns with real business requirements. Initial presentations tend to be more about the
market and business drivers than a product pitch.

 

Identify internal stakeholders who benefit from eSM. Operational savings often start the
conversation, but risk management and improved control of cash-flow almost always outweigh
the operations savings. OTC settlement tends to take place deep in the back-office, so it is
essential to bring the potential solution to light for all who may benefit. Successful organizations tend to engage potential stakeholders such as the CFO, Accounting and Risk Management early.

 

Step 2: Dive into the technology: Apply care when reviewing possible technical solutions. Be
mindful of vendors who claim expertise in this emerging space simply because they participate in other phases of the OTC deal lifecycle. Best practice favours a best of breed solution purpose-built for today's emerging requirements with an eye to future capabilities. Any proposed solution must carefully follow EFET standards while providing added innovation and extensibility. Ask the vendor for deep dive into architecture, roadmap, vision, and pricing for the first five years to ensure both financial and technical goals align with company and industry direction.

 

Step 3: Business case: Create and socialize a business case for eSM. Internal stakeholders should understand all the potential benefits of eSM. Typically, organizations lean on Fidectus to provide solution expertise and market data as stakeholders build their internal business case.

 

Step 4: Lab Trial: Joining a trial is an excellent first implementation step. Some will choose to go straight to the Fidectus production platform, but they risk missing the opportunity to gain real-world experience and vet their processes. We recommend a PoC with your most important counterparties. For the first phase of testing, all counterparties can upload documents enabling testing even as your integrator builds the standards-based schemas required to participate in eSM.

 

Step 5: Full production: Leverage Fidectus APIs to fully automate the eSM process. Interventions only needed for dispute resolution or corner cases lowering operational risk and creating staffing flexibility.

 

What are you looking to get out of your involvement with ETOT 2019?

 

(Chris Sass) I am looking forward to providing a market update of the current state of electronic settlement for European energy traders. ETOT 2019 is an opportunity for Fidectus to share today's best practices and hear what is on our customer's minds.

 

(Jens Bartenschlager) I am looking forward to meeting the delegates at the summit and discussing the business opportunities they have utilizing eSM. Representing Fidectus, this year’s ETOT settlement platinum sponsor, will give me the unique opportunity to show our product, listen to the community and to get one step further into making my passion real.

 

See the solution for yourself at ETOT

 

 

Has Fidectus solved a vital problem in the eSM space? Find out for yourself at ETOT this October!

 

Register here

 

See where Jens is speaking on the ETOT programme here

 

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