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An Oasis in the Desert: Collateral Management in a Funding Constrained World

By Radi Khasawneh, TABB Group
Originally published on TABB Forum

Market conditions and regulatory complexity have combined to make efficient management of collateral a critical component in a wider process of controlling trading and funding costs across the industry.

Market participants are caught in a pincer movement of regulatory-led market change that will make collateral management an increasingly crucial component of decision-making for trading desks and risk managers. This change has been driven by US and European regulations aimed at moving bilateral, over-the-counter (OTC) swaps onto exchange-like venues and through central clearing and a separate push by national regulators to impose renewed and more stringent capital calculations on the banks that act as the intermediaries for the buy side.

The net effect of all of this cannot be overstated. TABB Group estimates that shifting non-cleared OTC swaps to central counterparties will eventually require approximately $2 trillion in additional collateral deposits. And that is just one piece of the overall puzzle that means a more systematic attitude to the collateral workflow has to emerge. Alternative figures published last year by the DTCC put that OTC collateral figure at $4 trillion, showing how widely these estimates can vary. In any case, it is clear that the efficient use and management of collateral has become a key part of strategic thinking as the consequences of regulation are weighed.

To give an idea of the sheer scope of these figures, total collateral held against non-cleared OTC contracts at the end of 2013 was $3.2 trillion, according to figures published by ISDA. That figure includes the decline in non-cleared swaps as US and European mandatory clearing began to take hold; but 90% of those non-cleared swaps are subject to collateral agreements in any case.

Global clearinghouses have reacted to this by dramatically expanding the scope of their cleared products and enhancing the ability to net exposures across products and portfolios (as part of incorporating this new volume into existing flow). Nevertheless, the fragmented regulatory environment also has led to a proliferation of clearing entities across jurisdictions. Exhibit 1, below, shows the divergence in margin haircuts applied by global CCPs for the same securities. There is an obvious bias to home country securities (government bonds and equities) that can be posted, and the vast majority of collateral posted is in the form of either cash or sovereign bonds; but the extent of the differences shows that there is definitely scope for a change in approach to how collateral requirements are managed at global trading firms.

Exhibit 1: Margin Haircuts Applied to Securities by Global CCPs

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Source: TABB Group

Futures Commission Merchants (FCMs) have reacted to this by updating and enhancing their own technology platforms to allow clients to manage their own exposure through their platforms. In a survey of more than 50 US buy-side swap traders conducted last year, 33% of respondents said they selected their FCMs based on their technology platforms. Interviews with 16 FCMs conducted in the second quarter of 2014 showed that collateral management ranked highly as a strategic differentiator for firms (Exhibit 2, below); it also was the top area cited when asked to identify an area that would lead to the greatest increase in revenues for the business.

These positive trends are counteracted by a much more challenging funding environment overall. Sustained low interest rates have hit the performance of collateral reinvestment at firms (whether that is pure net interest income or passing through negative interest rates on cash balances), and the finalization and phased introduction of an Enhanced Supplementary Leverage Ratio (eSLR) in the US has had a seismic effect on bank attitudes toward balance sheet usage. The new calculation imposes a stricter, additional 2% capital buffer on bank holding companies and requires them to calculate notional, rather than netted, derivatives exposures in some cases. The leverage ratio denominator also takes into account off-balance sheet exposures that were previously not included. All of this adds up to a headache for firms designated as globally systemically important financial institutions (so-called G-SIFIs). In this year’s FCM interviews, nearly 90% of FCMs cited regulations – and specifically the SLR – as the key concern over the past 12 months.

Exhibit 2: Key Differentiators for FCMs, April 2014

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Source: TABB Group

What all of this means for the buy side is that higher collateral requirements will inevitably be accompanied by higher baseline costs, as fees are revamped to reflect the changing funding environment for banks. The Dodd-Frank Act in the US, the European Market Infrastructure Regulation and the Markets in Financial Instruments Directive (MIFID II) already have had a large effect on buy-side workflows (Exhibit 3, below). Rather than simply focusing on sourcing and tracking the correct form of collateral securities, firms are increasingly being offered the tools to optimize and analyze decision-making and valuation.

Exhibit 3: New Collateral Workflows

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Source: TABB Group

All of that being said, change has been slow in coming. There is a dependence on CCP models across the board, and 40% of US buy-side swap traders do not validate these valuations at all. FCMs have indicated that adoption of collateral analytics, although valued, has been slow.

TABB Group expects – and has argued for – the emergence of an expanded role for collateral-use decision makers at buy-side firms. There is a need for an ability to rapidly allocate collateral and optimize its use through efficiency in tracking, monitoring and managing collateral inventories across business lines. As these figures emerge, wholescale adoption of more sophisticated, global approaches at buy-side firms will have their champion. 

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Could Liquidity Itself Shape Fair and Efficient Market Structure?

By Doug Sanzone, Bayes Capital Markets
Originally published on TABB Forum

There has long been a question of whether regulatory relief should set market structure to ameliorate market deficiencies or whether competitive forces are sufficient to lead to efficient and productive markets. One of the competitive forces that can help today’s equity markets is liquidity itself. Can liquidity serve as the basis for effectively centralizing the fragmented market, and what is needed for fair and orderly interaction of all flow, regardless of source?

Much has been made of the deficiencies in market structure in the equities markets: fragmentation owing to too many venues; predation by HFTs; regulatory arbitrage and incrementalism; the decline in the number of equities listings with attendant volatility; the cost of trading; the inability to access the trade itself.

There has long been a question of whether regulatory relief should set market structure to ameliorate market deficiencies or whether competitive forces, conditioned by technology, are sufficient to lead to the efficiency and productivity markets have experienced in the past. The fact of the matter is that there has always been an appropriate balance between regulation and competition.

That said, one of the competitive forces that can help today’s equity markets, and which has not been sufficiently exploited, is liquidity itself. It is an economic fact that centralized markets, where all buyers and sellers can interact, are de facto efficient: supply meets demand and sets an efficient price.

That is not the case since the demise of centralized exchanges for equity trading – be they either dealer or auction driven. But suppose markets could be constructed in such a way that even though the structures don’t have the ideal efficiency of a centralized market, the underlying driver of markets, supply and demand – in other words, liquidity – was intermediated in as near efficient manner as possible. Here liquidity itself becomes the driver of market structure.

The question is: Can liquidity itself serve as the basis for effectively centralizing the market, if there are mechanisms to intermediate all the flow, rather than discriminating on the basis of selective types of flow?

This will require a bit of a rethink by market players if a truly effective level of supply and demand is to be achieved. And the rethink required is specific to liquidity: to suspend judgment on “types” of liquidity and see all liquidity as equal – quant, HFT, traditional, day trader, hedge fund. Flow is flow. More is better.

That said, there are legitimate historical reasons why certain types of flow developed in certain ways, and why players did not deem it appropriate to interact with other types of flow given the strategies they were seeking to execute. So what is to be done? What is needed for fair and orderly interaction of all flow, regardless of source, and which will allow all participants to interact on an equal footing are the following:

First, a neutral meeting point, an environment where diverse types of liquidity can interact in an anonymous, fair and orderly manner. This will require a compliance gateway to filter out any possible manipulative activity associated with orders with a very short-term trading horizon along with connectivity to the various important market centers using the latest technology available in order to access any liquidity outside the environment in a low-latency manner.

Second, algorithmic tools to interact with market. That genie is out of the bottle; algorithms will always be necessary to access liquidity in a low-impact fashion with minimal information leakage.

Third, a specialist/market maker to provide liquidity when needed whose motivation is to service order flow by providing liquidity when needed to maintain an orderly market to attract the next order, not to extract maximum trading P&L from each order by using the advantages of better market access and technologies to arbitrage the inefficiencies caused by Reg NMS, and the proliferation of multiple lit and dark trading venues. The execution of flow in this context is not simply agency (though that is the “first pass”) but actually replicates the traditional ability of order-driven market making when naturals do not meet. Here routing is simply not sufficient; but genuine market making providing liquidity as a service to the customer order completes an efficient marketplace.

Fourth, a neutral execution point that simultaneously satisfies all of the conditions above – once the aforementioned conditions are created, liquidity will naturally gravitate toward an environment that will allow orders to interact with each other in a fair and orderly price-time manner, leading to both superior price discovery and liquidity at those prices. This would create an environment that does not merely have access but aggregates the maximum possible liquidity available.

The effect, then, is as near a template as possible for an effective centralization in a fragmented market. A tall order? Not when judged against the criteria of continued market clunkiness and inefficiency.


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March 2015 Review -- Bloomberg Out in Front?

By Chris Barnes, Clarus
Originally published on Clarus Financial Technology blog

Bloomberg are #1 for SEF liquidity in Q1 2015 whilst Tradeweb saw the highest overall volumes. We saw record USD Swap volumes reported to the SDRs in March 2015, with our review highlighting increasing compression activity.  The great month for the industry was rounded-out with over 60% of volumes traded across a SEF.


$1.56trn in notional traded across SEFs during March 2015. This is the highest ever on-SEF monthly volume as measured through the SDRs. This makes a nice headline (is there such a thing as click-bait when talking about Swaps?), but it’s not 100% accurate when looking at all of the available data.

When we use SEFView to look at these same volumes, we see March was not quite a record month. This is because the SEFs report their volumes in-aggregate, without applying the block thresholds to individual trade amounts. SEFView therefore paints the truest picture of total volumes, and we see that March 2015 just fell short of breaking the December all-time record:

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Nevertheless, it’s fair to say that March 2015 was a pretty healthy month, and that the industry as a whole has had a strong Q1.


For those that missed it, March of course included an IMM Roll. To paint a fairer picture of volumes relative to previous months in 2015, we should therefore remove these largely portfolio-maintenance related volumes. Fortunately, that’s exactly the type of thing we like to do here at Clarus. In true Blue Peter fashion – here is one I prepared earlier, which finds that $39.9m of DV01 was traded as part of the March IMM roll. Doing some extra analysis now, I find that $33.9m of this risk was traded on-SEF.

Therefore, let’s look at the SEF volumes in DV01 terms from the SDR in March, showing a total of over $911m. When we correct for the $33.9m related to IMM rolls, this leaves us with a total of $878m in DV01 traded during March 2015. Therefore, even with this correction in place, March saw the largest amount of risk ever reported to SDRs – and was well above February’s $789m total:

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Unsurprisingly, volatility has begun to drop off slightly as we progress through 2015. Using SDRFix, we can see that about one-third of February’s heady move higher in Rates has been reversed in March:

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Whilst the absolute move in Rates has not been huge, it is worth having a look at the realised volatility throughout the month. As we can see, during March the monthly annualised volatility stabilised above 40%:

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This is way above some of the lows we saw back in 2014 of just 25%, so helps explain (and justify?) the elevated volumes we continue to see.

Of course, looking at these numbers as a time series can hide certain events during the month – such as the FOMC meeting on March 18th. This was a particularly volatile day as the intraday chart of 5 year prices shows (below), with a heady 16bp decrease in Rates following the dovish tone. This was undoubtedly the biggest driver of prices during the month, with this one event accounting for much of the monthly decrease in rates.

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Taking a bit of a step back, we take an even higher level view. CCPView allows us to capture the broadest spread of cleared markets by looking at everything that the CCPs reported throughout the month of March. We can see yet more month-on-month increases in volumes across most currencies:

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And we are pleased to see that industry efforts on Compression continue unabated. This means that whilst the volumes going through clearing houses are increasing, we are not seeing an explosion in “Open Interest”. SDRView Researcher shows that we saw the highest volumes of compression so far reported to the SDRs in March:

clarus 4 14g resized 600

And if we drill down on EUR, we see that over 3 times as many compression trades were identified during March than previous months:

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These Compression volumes have helped improve our favoured Clearing Efficiency metrics as well. This month LCHCME and JSCC have all managed to see a drop in Open Interest whilst still recording healthy new volumes – see table to the right.

Whether a result of maturing trades, FX moves or actual compression (very likely in the case of the top three) we see very healthy ratios this month, staying well below 100%.

To recap, what this means is that for every new unit of cleared trade, we are seeing less than 1 unit added to the residual stock-pile of trades. This is great news for customers as it means they are, overall, reducing line-item and maintenance charges associated with legacy portfolios whilst continuing to be able to move risk through OTC markets.

The large drop in LCH Open Interest relative to their healthy volumes is probably due to further weakness in the EUR (our data is USD denominated), plus further compression in their EUR portfolio. Whilst we will see some of this activity through the SDRs (such as the large compression volumes in EUR we looked at above), it is likely that there are far more conducted by non-US persons as well.

clarus 4 14i resized 600


With a record month in March topping off a record quarter for volumes, it’s been a great start to 2015 for the industry. However, as Amirlooked at, not all volumes are born equal. Therefore, let’s remember that Compression List trading is here to stay but that it can also artificially inflate the picture of “real” liquidity out there. Whilst these modes of trading remain highly useful, they are more akin to portfolio maintenance than true liquidity provision. Therefore, this month let’s look at SEF Market Share excluding Compression List Trading volumes. We also therefore exclude all FRA volumes as the vast majority of these are also transacted as portfolio maintenance.

Taking USD, EUR and GBP and looking at volumes in DV01 terms, we see the following for Q1 2015 in SEFView:

clarus 4 14j resized 600

With a little data manipulation, we can subtract the known Compression volumes from these totals. Amir explains how in his Compression blog. In brief, we know that for BBG the real (uncapped) compression volumes are double what is reported to the SDRs, and we apply this same ratio to TrueEx volumes. We then assume that TradeWeb’s are 1.75 times. This gives us the following adjusted table:

clarus 4 14l resized 600


  • Bloomberg have a huge 30% market share of vanilla trading across USD, EUR and GBP markets.

  • Tradeweb grab second place at 22%, despite over 31% of their volumes being compression related. As you can see from the above table, Tradeweb are actually in first place when Compression is included.

  • Ex-Compression, Trads are in third place at 15% – conversely, thanks to their lack of presence in portfolio maintenance trading!

  • The exclusion of portfolio-maintenance FRA matching systems sharply reduces ICAP’s market share from 23% to 14%.

  • And unsurprisingly TrueEx are down to a 0% market share.

Overall, during Q1 2015 we found that over 14% of SEF Volumes were related to Compression List trading. This was on an upwards trajectory throughout the quarter, increasing from 10% to nearly 17% in March. Much of this additional volume has been captured both through changes in the workflow process and by new platforms (TrueEx) challenging the incumbents with innovative solutions. It therefore sometimes pays to take stock and look at which venues have the truest liquidity in the old-school sense of the word!


Whilst it’s nice to fit into everyone’s reporting cycles with a monthly review, it’s worth noting that all of this data is available on-demand and as near-as-damn-it in real-time. So sometimes it’s worth bearing in mind that just because two trades happened within the same month doesn’t necessarily mean they have any relation to each other. I’m therefore quite intrigued by the rolling time-series of volumes that we can create from the data instead. These can make it easier to gauge trends and hence spot any changes as they emerge.

For volumes, a rolling 20-day total shows a fairly constant picture throughout the month, that was towards the top-end of the run rate for the first quarter of 2015:

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And going hand-in-hand with this we see a constant proportion of USD trades conducted on-SEF:

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Tradeweb take the plaudits for the highest overall volumes during Q1 2015, with Bloomberg taking the number one spot if we exclude Compression List Trading volumes. As Amir highlighted in his January blog, innovation seems to be the way to win volumes for SEF venues in 2015.

Volumes continue to push higher, whilst volatility in underlying markets has subsided a touch. Compression continues to be a focus which can distort the liquidity picture on a SEF, but results in more efficient central clearing houses. Fortunately, Clarus data allows us to paint a true picture of liquidity and having more efficient CCPs is certainly a positive evolution for market structure.

For the industry as a whole, the proportion of trades conducted on-SEF was running above 60% for the whole month. March was therefore a very positive month. It’s fair to say that greater volumes and a greater proportion of trades are going across SEFs than ever before – and may it long continue!

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Collateral for Clearing – A Race to the Bottom?

By Miles Reucroft, Thomas Murray
Originally published on TABB Forum

With mandatory clearing approaching, a global collateral shortfall ranging anywhere from $500 billion to as much as $8 trillion is widely anticipated. And since CCPs are competitive entities, there is a fear that they will lower their collateral standards in order to facilitate client clearing and win new business. But we will not know how great the collateral shortfall is, or how far the race to the bottom has been run, until clearing participants start to default.

A race to the bottom in collateral terminology refers to the potential for a downward spiral to occur in the acceptable quality of collateral to be posted at central counterparty clearinghouses (CCPs). Individual eligibility criteria at each CCP, which are operating as competitive, for-profit entities, added to an anticipated collateral shortfall in the market is resulting in very real fears of a race to the bottom taking place.

How bad any race to the bottom becomes, if it even becomes a reality at all, depends on how big the collateral shortfall is. While the exact number is an unknown, with estimates widely ranging from around $500 billion to $8 trillion, there is, by and large, a consensus that there will be a collateral shortfall; that there exists insufficient quality collateral to satisfy the post-crises regulatory environment.

In the event of a collateral shortfall, how will market participants be able to margin their positions at CCPs? CCPs will be taking initial and variation margin to offset the risk of a potential default in a trade, acting as the do as a buyer to every seller and a seller to every buyer. If one party cannot make good on its position, the CCP will step in and complete the transaction, utilizing that clearing participant’s margin and default fund to do so.

If market participants cannot obtain eligible criteria to post as margin in order to clear, then what can they do? Clearing will soon be unavoidable, standing as it does as one of the central tenets of the G20 response to the post-2008 financial crises that swept through global financial markets.

CCPs are competitive entities and there is a possibility – a fear, even – that they will lower their collateral standards in order to facilitate client clearing, helping them to win new business.

Market participants have a number of collateral demands placed on them currently, and knowing where their assets are and what they can be used for is crucial from a competitive view point. If assets are ineligible, then market participants can undergo a collateral transformation process – changing ineligible collateral into eligible collateral.

“Something has to give,” says John van Verre, global head of custody at HSBC Securities Services. “Either collateral transformation will have to become very, very efficient, or the acceptable standards of collateral will have to drop.”

With transparency and safety being two of the buzzwords about the shift to mandatory clearing, it is counterintuitive to allow the acceptable standards of collateral to drop. Regulatory interference in this area at the CCPs and how they should be capitalized are two outstanding questions to be resolved as mandatory clearing approaches. While there are capitalization rules in existence, the structure and adequacy of the default waterfall – how collateral posted as margin will be used and to what to degree – remains a topic for discussion.

“Collateral management is one of the biggest challenges facing our clients,” continues van Verre. “They need to know where their assets are and how they can be utilized. With central clearing they must appoint a clearing broker who accesses a CCP – keeping track of assets is not a straightforward, two-way relationship. They must also work out how to most effectively use this collateral and if needs be, what they can most efficiently transform, bearing in mind that their assets are not just to be assigned to CCPs.”

The demands on collateral are, seemingly, ever increasing. Exchange-traded derivatives have been collateralized since time immemorial, but the shift to clearing and margining over the counter derivatives is where the bulk of the demand will now come from. Aside from cleared OTC transactions, there are also non-cleared OTC transactions that will need collateral posting against them as well. The non-cleared world will be a more expensive place than the cleared one, too.

Portfolio margining and compression at CCPs is one way of reducing the demand for collateral at CCPs. Compression is, in effect, very similar to netting, so while it clears up the balance sheet, it may not result in much reduction for collateral requirements.

Another collateral demand being faced by the market comes from the FSAP (the Financial Sector Assessment Programme) from the IMF (International Monetary Fund). One of the FSAP recommendations is the central clearing of repo transactions. If all repo transactions are to be run through CCPs, then you would, in a lot of cases as regards collateral transformation, be collateralizing the collateral – the demand for collateral would rise even further, making the shortfall greater. Central clearing of repo transactions is already underway; LCH.Clearnet runs a repo clearing arm, for example. But if it were to be extended to mandatory status, the collateral demands would be vast.

With this in mind, where is the supply of collateral coming from? There is an estimated $60 trillion of government debt in issue. This, clearly, is enough to cover any shortfall, a few times over. But the debt being in issuance and the debt being readily available for use as collateral are not the same thing.

A lot of government bonds have been purchased by central banks as part of the quantitative easing process. As an example, it is estimated that the Bank of Japan, operating in an economy that is just coming out of a 2014 recession, will own 40 percent of Japanese Government Bonds by the end of 2016. All quantitative easing is achieving, in some cases at least, is the monetization of debt, since central banks are buying up government bonds from banks in exchange for cash. The central banks are unlikely to lend out these purchases to participants in CCPs.

As you can see from the below chart, which represents the percentage of the industrialized world that is operating at or even below 0 percent Policy Rates, there is not a lot of new government debt in issuance:

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How can market participants get hold of the government bonds from central banks? Well, they cannot. The vast majority of government bonds are held by parties that have no intention of lending them out. The collateral models that are operated by firms such as Euroclear and Clearstream will have to make the cost of lending them out very attractive. The knock-on effect of this is that the cost of borrowing would increase, making the cost of collateralizing OTC trades too expensive to make the trading activity viable.

The CCPs themselves are aware of this. A recently published paper from LCH.Clearnet, “Stress This House: A Framework for the Standardized Stress Testing of CCPs,” makes no mention of collateral. As soon as collateral is factored in, it makes the calculations impossibly complex and would have to rely upon the use of government debt. If equities are to be an acceptable form of collateral, then their inclusion in stress testing will weaken those CCPs that accept them.

So those central banks and pension funds that are holding government bonds are unlikely to be willing to put them up for use at CCPs, since there are no guarantees as to the safety of the clearing model.

While there are options available to market participants in regards of collateral transformation and compression, the most cost efficient way of posting collateral is to post what you have available at that time. As CCPs compete, it will be very tempting for them to start accepting lower-quality, more illiquid collateral – especially if the high-quality government debt is inaccessible.

If a CCP finds itself in a position where it has to liquidate a clearing participant’s collateral in order to make good a trade, then it will need highly liquid collateral in order to do so – government bonds fall under this category for countries such as the US and the UK. Until such a time of market stress, the requisite liquidity of the collateral remains unknown. We will not know how great the collateral shortfall is, or how far the race to the bottom has been run, until clearing participants start to default.

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Where’s the Arb? Regulatory Fragmentation Breeds Uncertainty, Opportunity

By Radi Khasawneh, TABB Group
Originally published on TABB Forum

Regional implementation of mandatory clearing and swaps trading reforms means differences in regulatory regimes could make all the difference in the race for alpha.

The much-delayed finalization and implementation of Europe’s Markets in Financial Instruments Directive and Regulation (MIFID II) means that it is now possible to make direct comparisons on the swap trading environment on both sides of the pond. In the absence of any defined cross-border recognition between the US and Europe (as has been planned), market participants are left in a preliminary limbo, forced to navigate an increasingly fragmented and uncertain environment.

TABB Group’s recent report, “European Swap Trading: Slow and Steady Wins the Race?” highlights the main areas of difference across these regimes. In essence, there is a view that, despite taking a much more complex and tortuous route, the optionality embedded in the European approach – with market participants able to choose among various venues and trading protocols – may in the end become an advantage.

European implementation will not be completed until January 2017 (see Exhibit 1, below), but the interim period has been marked by an increase in fragmentation – both in terms of trading flows and the infrastructure required in each region. For example, there are now 22 trade repositories for interest rate swaps globally. Six of those are in Europe alone (the figure includes regional entities set up by firms headquartered elsewhere).

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Source: TABB Group

This creates a unique data and consolidation challenge for market participants, and it has been highlighted as a key area of concern. In November last year, David Wright, secretary general of the International Organisation of Securities Commissions (IOSCO) complained about the impossibility of getting an aggregated risk picture from these different regimes and data systems. This high-level surveillance problem has led independent companies to step in and provide market participants with the ability to do this tracking themselves.

Meanwhile, trading flows have become increasingly fragmented and regionalized. Exhibit 2, below, shows the decline in uncleared Euro-denominated interest rate swap volumes in the US, and a more general downward trend in their use. ISDA data based on LCH.Clearnet interdealer volumes has shown a strong preference for European banks to trade such contracts bilaterally.

While this fragmentation continues, it is natural that market participants would look to compare regimes and retrench until compliance and surveillance issues are sorted and harmonized. That is all well and good; but the fact is, the market is undergoing a historically unprecedented shift out of over the counter (OTC) contracts and into centrally cleared ones – it will take a long time to sort through the mess.

Exhibit 2: Evolution of Cleared vs. Uncleared IRS Swap Markets by Currency

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Source: TABB Group, DTCC

There are many moving parts that will affect the overall picture; it ultimately will be more complicated than simply declaring winners. In the latest reminder of the ongoing regulatory disharmony, this week the UK Financial Conduct Authority warned that the net effect of European proposals to impose position limits and caps on commodity positions went far further than the US equivalent.

Each step will be scrutinized, but the uncertainty is the cause of the present fragmentation of swap markets. TABB Group will this month publish an in-depth analysis of post-crisis swap flows globally (please contact us for more information), but the current situation creates an opportunity for sophisticated buy-side firms to act in their own strategic interests.


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Compression List Trading on SEFs

By Amir Khwaja, Clarus
Originally published on Clarus Financial Technology blog

Compression List Trading volumes have continued on their upward trend this year and in this article I will look into the what the data shows both in terms of volumes and also SEF market share.


Lets start with an SDRView Res chart of monthly gross notionals in G4 currencies (5 Jan to 20 Mar).

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Which shows:

  • A rising trend, with each month higher than the last

  • February was $180 billion

  • March with a week left to report, is > $200 billion

  • Of which USD is 75%, JPY 20%, EUR 5% and GBP < 0.1%

Two caveats, firstly our identification of Compression packages from the SDR trades requires a number of assumptions, so is not 100% accurate and secondly block trade rules means that notionals are caped for these to below their actual size. This means the actual volumes for USD will be higher, but the trend holds true.

Update: For JPY, drill-down into the trades shows that these are single period with future dates executed at the same time, so rather than Swaps, look like FRAs perhaps executed as part of an FRA reset/match exercise but reported in-correctly as Swaps. (More on this later).

Looking at trade counts, we see:

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So a substantial number of trades, meaning a good number of compression lists are being traded, each with between 2 to 90 trades. See my earlier blog Swap Compression and Compaction on TrueEx and Tradeweb SEFs for the rational for these.

Interestingly if we now show volumes excluding Compression for the same period, we see:

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From which it is obvious that Compression Lists represent a growing share of On SEF trading activity.

  • In Jan this was 7% of USD On SEF Cleared Swaps

  • In Feb it was 10%

  • In Mar it is 12% (up to Mar 20).

It will be interesting to see the final percentage for March.


Lets now look at the same analysis for Off SEF, first for Cleared Swaps.

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Which shows that similar amounts of these compression lists are being traded Off SEF, perhaps not surprising as their is no mandatory reason for compressions to be On SEF. So we assume these are being transaction directly between clients and dealers or dealer to dealer or brokered Off SEF by IDBs.

Second if we just select Uncleared or Bi-lateral Swaps, we see:

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Also substantial volumes but the assumption these are actually compressions lists and not some other activity like backloading is a weak one, as the whole point of compression lists is for CCPs to net opposite cleared deals, a rational that does not exist for bi-lateral deals.

In general we can say that as much compression list activity is Off SEF as is On SEF, which is surprising as we would expect that the superior automation of On SEF should make it much more compelling than Off SEF.

Time will tell and we will keep an eye on the Off SEF activity.


A chart of weekly On SEF volumes shows very clearly the positive upward trend.

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With USD showing steady high volumes in each of the past 5 weeks, while JPY and EUR show more up and down volumes.

We know that these On SEF compression lists are traded on Tradeweb, TrueEx and BSEF.

So lets look at each of these in turn.


For BSEF, as we know that only BSEF reports to BSDR, so we can just use SDRView to look only at compression trade activity on BSDR.

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Which shows:

  • Only USD is traded on BSEF, with

  • $5.5b in Jan

  • $17b in Feb

  • $10b in Mar (up to 20 Mar)

The USD $10b in March can be compared to the $150b of USD (75% of $200b) we see from the first chart in this article. Meaning that $10b out of $150b or 7% of USD compression trading in March so far that we see on SDR is on BSEF.

However before sticking with the $10b, can we estimate how much larger the real number is if we did not have the capped rule for block trades? Luckily in this case we can exactly quantify this as BSEF separates out its compression trade activity in its daily SEF Reports.

Using SEFView we can drill-down to that daily data in March and sort the list to get Compression trades:

tw 3 25 hh resized 600

Summing these we get a gross notional of $21.4 billion. So our actual figure is twice the SDR figure. We will need to use this rule of thumb when we look at the next two SEFs.


Now both TrueEx and Tradeweb compression lists are reported to the DTCC SDR, so we have no obvious way to separate out which comes from which. However TrueEx does report its PCT volumes and using SEFView we can see the daily reported figures between 1-20 March.

tw 3 25 ii resized 600

And the same but by Currency.

tw 3 25 jj resized 600

Showing that:

  • In USD TrueEx has $102 billion

  • Interestingly CAD is $544 million

  • And CHF, EUR, NOK, SEK have small amounts

  • Nothing in JPY or GBP

Comparing the $102 billion in USD on trueEx with the $21 billion on BSEF, we can say that trueEx has almost five times the volume of BSEF in the period 1-20 March.


Tradeweb does not break out its compression volumes in its daily SEF reports, so we cannot use SEFView to get a figure for these.

This leaves us with SDRView and the problem of capped trades.

First lets start with EUR, JPY, GBP, where SDR has $11b, $38b and $240m respectively in the 1-20 March period. As there is nothing in BSEF in these currencies and just $34m in EUR on TrueEx, we can say that all of the volume in EUR, JPY & GBP is on Tradeweb.

Update: However looking at TW SEF volume by Currency we see that only $350m is reported in JPY. This confirms our earlier conjecture that the $38b of JPY is not compression activity.

Second lets look at USD. What information do we have?

  • $150 billion is reported to SDR

  • But we know this is under-stated due to capped notionals

  • $10billion of this is from BSEF

  • $21 billion is the actual (un-capped) BSEF figure

  • $102 billion is the actual (un-capped) TrueEx figure

  • We do not know what the capped TrueEx figure is

  • We not know the capped or actual Tradeweb figures

So we need to make an informed guess-estimate.

Lets assume the BSEF 1:2 ratio of capped to un-capped holds for TrueEx and Tradeweb, we would then estimate that TrueEx is $51b of the $150b in SDR. Which leaves $89 billion of the $150 in SDR as attributable to Tradeweb. Making the actual Tradeweb amount $178 billion.

Given that TW reported $422 billion in the period 1-20 March, this makes compression trading 42% of their volume, which strikes me as a little higher than the 30% we have observed in the past. If we instead used a 1.75 multiplier instead of 2 for TrueEx and Tradeweb, we would get Tradeweb volume as $143b and a 34% compression to trades volume ratio for Tradeweb.

So we can guess-estimate current market share in USD compression list trading as:

  • Tradeweb with 54% to 59%

  • TrueEx with 34% to 38%

  • BSEF with 7% to 8%


On SEF Compression list trading has increased month on month in 2015.

USD represents the majority of this activity.

Compression list trading is also an increasing percentage of USD On SEF Swap trading (increasing from 7% to 12%).

Off SEF Compression list trading is as large if not larger than On SEF.

Weekly volumes show a strong pick from Feb 16 onwards.

Bloomberg reported $21b in USD between 1-20 March, making its USD share 7% to 8%.

TrueEx has some CAD, CHF, EUR, NOK, SEK, but USD is the main, with $102b in USD between 1-20 March, a share of 34% to 38%.

Tradeweb has significant volume in USD, JPY, EUR & GBP, with $143b-$178b in USD between 1-20 March, a share of 54% to 59%. 

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Trade Surveillance in Swaps Trading

By Amir Khwaja, Clarus
Originally published on TABB Forum

The advent of Swap Execution Facilities and Swap Data Repositories means that it is now possible to implement effective trade surveillance in the OTC swaps market. US SDR public dissemination means that most trades are available within a few minutes of execution; and as the market is characterized by large trades in low frequency, this is a perfectly adequate time frame for real-time surveillance.

The advent of Swap Execution Facilities (SEFs) and Swap Data Repositories (SDRs) means that it is now possible to implement effective trade surveillance in the OTC swaps market, and to do so in an analogous manner to the futures market.

Swap Dealers or Major Swap Participants can and should compare their executed trades with the trades reported in the market, a role that usually falls to a surveillance manager in the compliance department.

In this article I will look at post-trade surveillance, both historical and real-time.

USD Swaps on March 9, 2015

Let’s start with the trades reported to US SDRs on March 9, focusing just on USD Fixed Float Swaps:

TW comm 3 25 a resized 600

Which shows that out of the 1,553 trades reported to DTCC and BSDR, 884, or 57%, were on-SEF cleared.

So is it as simple as starting with these and identifying which are our trades and comparing their prices and notionals with the rest?

Unfortunately, no – for a few reasons:

  • Unlike futures, there is no single instrument identifier (e.g., EDH15); rather, there are 40+ fields that we need to use to determine what specific type of trade it is.

  • Even when looking only at what SDRs term “Price Forming transactions,” we need to separate out package trades, such as Compressions, Curves and Butterflies.

  • Cancel and Correct transactions need to be accounted for.

We now enrich the SDR public dissemination data, using SDRView Res, with additional fields to address precisely these issues. In the drill-down we show the enriched fields below:

TW comm 3 25 b resized 600
  • SDR source, one of DTCC or BBG.

  • Subtype of the Swap, e.g., Spot for the standard trade or IMM or MAC or Fwd for others.

  • MAT as true or false to signify Made Available to Trade.

  • Package as Compression, Curve or Butterfly.

  • Package ID to link the trade legs of a package.

  • Tenor to identify 5Y trades rather than have to use the maturity date

  • Forward Term to identify IMM, MAC and Fwd Start term.

  • DV01 as a useful risk measure

All of which make our task much easier.

For example, if we know we have executed some vanilla 5Y Swaps on March 9, we can now extract just these from SDRView and compare the execution times, prices and notionals of our trades against the market at large:

TW comm 3 25 c resized 600

Swap Subtypes

What does the data enrichment do to our population of 1,553 trades? The table below shows precisely this:

tw comm 3 25 d resized 600
  • So only 423 out of the 884 trades that are on-SEF are standard spot starting vanilla trades in MAT tenors.

  • These are the ones we should first focus on, as it is likely we will find comparable trades to our own.

  • IMM and MAC, with 47 and 69, are also interesting, assuming we trade these.

  • Curves and Butterfly with 112 and 63 legs (56 and 21 packages) are also interesting for comparisons.

But after these types, a simple price comparison is not practical or possible.

For Forwards or Non-Standard trades, we are unlikely to find comparable terms to our own trades and consequently cannot do a meaningful price or size comparison. This means the only course of action is to calculate a fair price for these from the standard trades – which is a process we are currently working on, using the common NPV measure.

An interesting view is one of gross notional by Swap types and Packages for the same March 9 date:

tw comm 3 25 e resized 600

Historical and Real Time

Surveillance should be performed daily using all of today’s trades; historically looking for patterns of behavior; and in real-time with alerts for possible off market transactions.

US SDR public dissemination means that most trades are available within a few minutes of execution; and as the market is characterized by large trades in low frequency, this is a perfectly adequate time frame for real-time surveillance.


There are many uses of the SDR public dissemination data.

One of the most interesting is Trade Surveillance.

However, this is not easily done on the raw SDR data.

Clarus’s SDRView now provides enriched data. This serves to isolate packages and differentiate between types of Swaps, which makes trade surveillance practical and possible.

Swaps trading firms should now be able to improve their existing surveillance process – another benefit resulting from the markets’ investment in real-time trade reporting.

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The Need for Equivalence in European and U.S. Clearing Rules

By Miles Reucroft, Thomas Murray
Originally published on TABB Forum

Regulatory equivalence means that European banks clearing their trades via CCPs in equivalent jurisdictions can do so without the need for added compliance burdens. But ESMA has not yet judged the US standards to be equivalent to its own. As a result, the cost of clearing at US institutions for European banks could be cripplingly expensive.

The European regulator, ESMA (the European Securities and Markets Authority), has so far deemed the rules and their regulatory outcome around central clearing to be equivalent to its own standards in Japan, Singapore, Australia and Hong Kong, with the frameworks in Canada, Mexico and India expected to follow shortly. The big name missing from this list is the US.

Equivalence is important since it means that European banks clearing their trades via CCPs (central counterparty clearinghouses) in equivalent jurisdictions can do so without the need for added compliance burdens, since their domestic regulator (ESMA) recognizes the jurisdiction in which they are trading as being up to an equivalent standard as regards the regulatory framework. For example, a European bank clearing trades at a Japanese CCP can do so within a similarly robust safety framework as it does at an approved European CCP – according to ESMA’s view of the matter,at any rate.

European banks and market participants can also clear their trades at CCPs in those equivalent jurisdictions without being subjected to increased capital requirements on their balance sheets to margin the trades. Margin, both initial and variation, is posted at the CCPs to cover potential losses on positions.

Europe has linked its regulatory framework concerning central clearing to the new capital requirements laid out in CRD IV, meant to reflect Basel III in appropriate circumstances. To “de-risk” the system, these requirements greatly encourage banks to put their OTC trades through CCPs, since this is seen as the safest way to operate – central clearing of OTC contracts was one of the 2009 G20 responses to the global financial crisis, with a CCP acting as a buyer to every seller and a seller to every buyer. The implementation of globally harmonized regulatory frameworks around these systemically important infrastructures has not been smooth, with a battle having being fought over extraterritoriality, the manner in which one jurisdiction can impose its rules upon another. FATCA is an example of this emanating from Washington.

If banks are using Qualified CCPs (QCCPs), those approved by ESMA in Europe, then the banks can subject their trades to a 2 percent risk-weighted capital charge. If they are clearing through a CCP that is not recognised by ESMA, then this capital charge leaps up. This is to reflect the greater perceived risk exposure generated via clearing at a non-QCCP. The QCCP title is handed down by a CCP’s local regulator, so for the purposes of equivalence with Europe, the regulatory framework in which a CCP operates still needs to be approved by ESMA.

CME Group has publicly estimated that this could result in capital charges as much as 30 times in excess for banks not using QCCPs. It is, therefore, very important for US clearing houses to be recognized in Europe, since if they are not, the cost of clearing at US institutions for European banks could be cripplingly expensive and they will walk away.

The implementation of CRD IV in Europe already has been pushed back twice as a result of this delay in judgement on equivalence, most recently to June 15, 2015. ESMA and its US regulatory equivalent, the Commodity Futures Trading Commission (CFTC), have been discussing the best path to equivalence for two years now, with some hope of it being reached soon.

At the FIA conference in Boca Raton last week, Timothy Massad, chairman of the CFTC, said that his organization has agreed to a lot of the changes requested by Europe in order to find harmonisation – a partial compromise – although he added that they “would not be making significant changes.”

The major point of difference between the two regulators is around margin requirements at CCPs, with Europe having imposed a tougher margining framework than the US. It therefore carries over that they will need to hold increased capital on their balance sheets against trades conducted at non-QCCPs in order to mitigate the failure of that CCP, something deemed to be more likely by ESMA than at those CCPs it recognizes.

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Credit Default Swaps: Weapons of Mass Disclosure

By Michael Maiello, Capital Ideas
Originally published on TABB Forum

The multitrillion-dollar market for credit default swaps came under withering criticism during the 2007-10 financial crisis, and Warren Buffett famously deemed them “financial weapons of mass destruction.” But the CDS market may be improving transparency in the stock and bond markets, and more CDSs may lead to healthier and more robust markets.

The multitrillion-dollar (notional) market for credit default swaps (CDSs) came under withering criticism during the 2007-10 financial crisis. Warren Buffett famously deemed them “financial weapons of mass destruction,” and others compared them to taking out fire insurance on a neighbor’s home.

But the CDS market may be improving transparency in the stock and bond markets. Research suggests that hyper-informed CDS traders force company managers to disclose some of the negative news that only banks are privy to. 

CDS contracts are financial agreements that protect their buyers from default risk in exchange for a stream of payments known as the “CDS spread.” The owner of the CDS contract is compensated for negative credit events such as a downgrade or default, according to the terms of the contract. If CDS buyers and sellers believe that a negative credit event is likely, the spread that a buyer must pay to purchase the contract grows larger. 

The financial institutions that issue CDSs are often lenders to the underlying companies and, as such, have significant insight into the results of operations, balance-sheet quality, and the covenants attached to any outstanding debt. The CDS market is lightly regulated, and trades are generally conducted “over the counter,” in private negotiations between dealers. The securities have not been subject to the same insider-trading laws that govern stock purchases so, as in the commodities-futures markets, what would be considered insider trading in equities has been generally acceptable in CDS markets. The 2010 Dodd-Frank Act did make the CDS market subject to some insider-trading rules, but implementing those rules poses some serious challenges.

Because of the information advantage enjoyed by CDS-market participants, CDS prices generally lead stock and bond prices, so if a CDS spread widens it can signal future bad news for outstanding bonds and equities.

This can put pressure on corporate managers, who have strong incentives to delay revealing bad news. A company in danger of breaching a debt covenant would not have to reveal that to either stockholders or bondholders unless the covenant were actually breached, and it may delay mentioning the situation before mandatory reporting deadlines.

But the presence of a liquid CDS market makes delaying tactics more difficult to employ, argue Chicago Booth’s Regina Wittenberg-Moerman, Singapore Management University’s Jae B. Kim, University of Minnesota’s Pervin Shroff, and University of Toronto’s Dushyantkumar Vyas. Buyers and sellers of a company’s CDS contract are more apt to know how likely the company is to default, and will price that risk accordingly. CDS prices are also available to participants in the stock and bond markets.

The researchers find that companies with liquid CDS contracts are more likely to give earnings forecasts and issue press releases, both forms of disclosure where management has great latitude. They are 14 percent more likely to give earnings forecasts and 1 percent more likely to issue bad-news press releases. While the latter increase may sound modest, given the scarcity of such releases, that represents 15.8 percent of the total of such releases in a typical year.

“Our findings suggest that informed trading by lenders in the CDS market results in a positive externality for capital markets by eliciting enhanced voluntary disclosures, thus contributing to a richer information environment,” conclude the researchers.

Further, they cite previous work that details how “higher disclosure quality leads to more liquid equity trading due to reduced information asymmetry.” It may well be that more CDSs will lead to healthier and more robust capital markets in the future.

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The CAT Conundrum: A Cost-Benefit Analysis

By Shagun Bali and Alexander Tabb, TABB Group
Originally published on TABB Forum

The Consolidate Audit Trail is one of those unique initiatives that the capital markets community agrees is important. The details, however, are reason for concern. Who will pay for the CAT and how remains the No. 1 question. But implementation timelines, data challenges, and how to incorporate options market data all remain critical challenges.

This is the second in a three-part series about the Consolidated Audit Trail (CAT). The first note, “The Consolidated Audit Trail: Stitching Together the US Securities Markets,”examined the process to date, how the industry arrived at this point, and where the CAT needs to go to be successful.

The Consolidate Audit Trail is one of those unique initiatives that the capital markets community agrees is important. When completed, it will be the single largest repository of financial services data in the world. The CAT will house more than 30 petabytes of data, connect to approximately 2,000 separate data providers, and enable regulators to reconstruct market activity at any point in time.

According to TABB Group interviews with 100 financial institutions from the buy and sell sides, the majority of the industry agrees that the CAT is necessary; everyone recognizes the benefits. But what concerns market participants are the details.

When questioned about the importance of the CAT, more than three-quarters of respondents said they viewed the CAT as an important” orcritically important” element that contributes directly to the health and well-being of the US markets (see Exhibit 1, below).

Exhibit 1: Market Perceptions Regarding the Importance of the CAT 

However, the uncertainty in the process – which includes funding, implementation timelines, data challenges, and new participants from the options markets – has the community concerned. Cost and funding of the CAT is surely giving the community sleepless nights. First, the direct and indirect costs associated with the CAT are a concern for the broker-dealers, as they recognize that all funding avenues lead directly to their doorstep. In addition, they are deeply concerned over the fact that not only do they have to pay for the development and upkeep of the CAT, they also will need to cover the costs of FINRA’s Order Audit Trail System (OATS) and the SEC’s Electronic Blue Sheet (EBS) requests for at least five years after the CAT is started.

Yes, the CAT is necessary. But the big question among many on the sell side remains, “Can the industry afford it?” The broker-dealers need from the SROs a solution that will lighten their burden of investment and that will reassure them that the industry can indeed afford it.

In addition, elements related to data – gathering, storing, and data usage and governance – need heightened attention. To win the wholehearted support of the industry, the SROs need to put out clear strategies that address these challenges. The B/Ds understand the requirements, but ultimately are still uncomfortable with the idea of supplying this type of data with so many ambiguities left unanswered. The SROs need to address these issues head on and need to develop a solution that takes the concerns seriously – especially when it comes to data security and governance.

Furthermore, both TABB Group and the community recognize that the real wild card in the CAT process is the options market. Previously under-appreciated, adding options to the CAT mix greatly increases the complexity of the endeavor. A naiveté has been replaced with a clear understanding that incorporating the options markets into the CAT is no small feat and that whomever is tasked with this undertaking needs to understand all of the implications involved.

The same can be said of the need to solve the data storage and government questions, as well as the security and control issues associated with the program. Unfortunately, the CAT is a unique project, one whose size and scale are unmatched within the institutional capital markets. This means that the SROs do not have the luxury of learning from other people’s mistakes. They have to figure this all out in advance, with everyone looking over their shoulders and trying to influence the outcome.

Getting this right is critical for the success of the project. Market confidence is so fragile that authorities cannot afford to make mistakes in such harsh market conditions, when volumes are low and each participant is struggling with its bottom line numbers. Success is only possible if the SROs prioritize these key elements of the CAT and select a bidder that can deliver against all of the challenges. The entire onus and responsibility of the CAT’s success lies on the SROs’ ability to work out the problems and choose a solution that is in the best interest of the markets, and not their own.

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