I have no idea whether this estimate is still valid, but back in the days when I was working with O’Connor & Associates, the head of technology (and O’Connor had a well run technology operation) said the cost of documenting software (as in having the developers write up what they did in sufficient detail so a third party could maintain the it) was an additional 20%. It was very difficult to get traders to pay for it, ironically not so much for the hard dollar costs, but the fact that IT was resource constrained. The idea that the coders would spend a lot of time on leaving a paper trail, rather than getting to a business center’s urgent need, was a hard sell.
But Lehman illustrates what happens when you do what most places do, and skip documentation. Now of course, modern IT on the Street was supposed to be using more off the shelf software and doing less custom development, but you would never know that reading this Financial Times story:
Unwinding derivatives is a complex task at the best of times. In the case of Lehman, one of the biggest dealers in some of the most complex derivatives markets, this has been even more so. Lehman’s global derivatives book included contracts with a notional face value of $39,000bn and deals with 8,000 different counterparties when it went bust. The derivatives business was actually split into multiple strands, backed up by between 20 and 30 different systems.
Once it went bankrupt, the staff who supported these systems “evaporated”….
“The more time goes by, the less insight remains in terms of the people who staffed those systems,” said Mr O’Hanlon. He likens the amount learnt about derivatives from the Lehman job to lessons from wars. “The medical industry has advanced itself whenever there is a war, when it has to undertake hundreds and thousands of procedures in a compressed period of time.”
The main conclusion so far – and there are many fascinating details in the Lehman unwind – is that the technology costs for derivatives have been underestimated. In addition, the answers that every regulator now wants and every investor should demand, in terms of levels of exposures and risks that banks hold, cannot be easily gleaned from the current multiple systems used to value and track positions.
“Many previously hidden costs of running a derivatives business, including technology support of multiple disjointed systems, can no longer be discounted,” says Luc Faucheux, a managing director at Lehman Brothers Holding Inc in New York.