DerivAlert Commentary

Bond Market Liquidity? Look to the Buy Side

Posted on Thu, Apr 28, 2016 @ 10:00 AM

By Anthony J. Perrotta, Jr., TABB Group
Originally published on TABB Forum

In the corporate bond market, the buy side traditionally has relied exclusively on dealers to facilitate risk transfer. As we move further away from the financial crisis and toward the regulatory regime left in its wake, however, banks are being forced to alter business models, and that dependency is being questioned. As a result, liquidity is at risk. The solution lies not with the banks or trading platforms, but with asset owners. Once they harness and leverage this power, markets can begin to move forward.

Let’s set the record straight: There are some in the New York Fed and other regulatory agencies who suggest US corporate bond market liquidity is fine; I am skeptical. The datasets they are using to arrive at this conclusion are incomplete and misleading. TABB Group research demonstrates that bid/ask spreads are widening (i.e., risk transfer costs are growing), immediacy is contracting, and trading sizes are shrinking.

Of course, regulators may have a different definition of market liquidity. If systemic risk is mitigated in favor of a market that trades by appointment, that is prone to extreme volatility and asset value gyrations produced by single trades, and that is fueled predominantly by new issues, then maybe everything is sanguine.

Perhaps I am getting as long in the tooth as the liquidity conundrum story, but I am of the belief that the US corporate bond market is broken. If it’s not fixed, the wheels will eventually come off the track. We may not be looking at a systemic crisis similar to the one we faced in 2008 (when there was a leverage and counterparty problem), but there is a risk that a lot of “blood” (in the form of negative returns) will have to be shed to get back to equilibrium.

Trading platforms are busily designing innovative protocols, expanding established models, and deploying technology to improve efficiency in an attempt to serve as the release valve for the pressure building up in the system. That pressure is the cumulative result of the decline of immediacy provided by dealers, growing liquidity premiums, and lengthening timelines to move assets from one investor to another.

At the moment, investors have two primary options for risk transfer. First, they can call a dealer and request a bid or offer. Nowadays, however, they likely will get a partial fill and will be asked to leave an order for the balance. Data we recently published suggests a dramatic rise in riskless-principal (or “brokered”) trading since 2006 (see Exhibit 1, below). Second, they can break up their trades into smaller lot sizes, request a bid or offer over an electronic network, and place even more pressure on the system (most dealers agree that the trades they execute electronically are not profitable). Interestingly, both of these options start with the same premise: investors requesting liquidity.


Source: TABB Group

The efficiency of the RFQ network allows one to “scale” the probability of consummating transactions, but it misses out on one major premise: the positive effect of direct externalities brought about when each participant in the system incrementally confers value to each of the other participants in the system, in what is commonly referred to as a network effect.

Recently, innovation has expanded search, discovery, and execution options available to fixed income market participants. All-to-all is an emerging, multi-dimensional class of trading protocols and liquidity pools in fixed income, but too often the market defaults to the notion of it meaning an anonymous, lit pricing, central order book protocol. If we begin to think of all-to-all as trading protocols that allow participants to proactively contribute to the liquidity equation in a fashion that provides incremental benefits to everyone in the system, then the equation shifts. There is an incentive to be a member of the network.

Exhibit 2: All-to-all trading? Respondents who believe it’s possible for corporate bonds.


Source: TABB Group

The market needs to readjust to the premise that asset owners drive liquidity, since dealers have less capital to commit to secondary market-making, and the amount they do have is getting smaller relative to the overall size of the market. Once the market gets comfortable with the idea of buy-side liquidity provision, greater benefits will be derived as participants become more proactive in the equation.

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Tags: bonds, liquidity

OTC Derivatives Under MiFID II – Transparency Only Through Collaboration

Posted on Wed, Apr 20, 2016 @ 09:01 AM

By Ralph Achkar, Colt
Originally published on TABB Forum

One of the major – and possibly one of the most transformative – parts of the MiFID II regulation is the introduction of controls around the over-the-counter market, specifically how certain asset classes should be traded. Organized Trading Facilities (OTFs) are to be established to capture trades that would otherwise be executed OTC and are designed to increase pre- and post-trade transparency. But the practicalities of implementing and working with such new trading models may prove more difficult and more costly than expected.

While the idea of increased transparency is laudable, the practicalities of implementing and working with such new trading models may prove more difficult and more costly than expected. For example, previously, when an OTC trade took place, very little in the way of reporting was needed and post-trade activities were already understood. Now, ironically, things are less clear, as reporting requirements are being reviewed and more consideration is needed for the post-trading arrangements. Where will such trades get reported, by when, and by whom exactly? What post-trade models will be adopted? Are such trades getting cleared, and where?

The nature of the directive means it has caused significant uncertainty around how it will practically affect the market; only once the regulations are finalized will the initial impact become clear. However, if the creation of MTFs for equities under MiFID I is anything to go by, the full implications will not be understood until well after these regulations come into force and market participants react to them.

Indeed we can use MiFID I as a lens through which to look at the potential future of the markets after the creation of OTFs. MTFs were almost a small-scale test of what is to come with MiFID II. In the wake of MiFID I, MTFs such as Turquoise, ChiX, BATS and others were set up with the aim of lowering transaction costs and increasing liquidity in equity markets. However successful they were at this, it was not the only effect they had on participants or the market.

The increase in the number of venues placed a greater emphasis on the technology needed, highlighted the importance of latency on the network and in systems, and the latency race began. Trading times as well as execution size plummeted, variations in pricing across venues were exploited and, as speeds increased, the amount of time these pricing anomalies existed for decreased. The impact on clearing requirements, relationships and clearing houses was also profound.

Arguably this race for faster trading speeds and the change in the post-trade space would have happened sooner or later – but MiFID I’s introduction of MTFs increased the pace of this change. It’s not a huge leap to suggest that MiFID II’s introduction of OTFs will have effects on the same scale.

The emergence of the synthetic CDO 2.0?

While it’s difficult to speculate what these effects will be, it’s not hard to see the risk of potentially stifling of innovation (and thus revenues) in structured products.

Structured products have sometimes been seen by regulators as “weapons of mass destruction,” and as such have been the focus of their ire since 2008. However, the majority are used responsibly and allow participants to express complex views of the market that vanilla products do not have the capability to match.

OTC contracts have been successful in part because they are arranged in private and tailored to the business needs or market views of clients. By bringing these products onto exchange, and making them more transparent structurally, there could be the risk that other parties benefit from someone else’s foresight. This will erode any real incentive to create innovative structures. Another concern would be how to ensure that parties buying such complex structures on exchange really understand the risks involved, akin to the commoditization of the dreaded synthetic CDO. If the past teaches us anything it’s that new regulations often spawn new things to regulate.

Will OTFs be the new MTFs?

The introduction of MTFs under MiFID I was arguably the lasting legacy of that regulation. It democratized equity markets, trading costs decreased, and technological advances prompted a rapid increase in trading speeds and reduction in overall latency. Under MiFID II, OTFs could do exactly the same thing for non-equity markets. The question is where these OTFs will come from and if their evolution will eventually follow the same path of competition, co-opetition and eventually consolidation?

The MTFs sparked something of a turf war with established exchange; it could be argued that some MTFs were set up expressly to reduce trading costs. Eventually the dust settled with, for example, the LSE buying Turquoise, BATS and ChiX merging, NASDAQ OMX Europe closing and eventually a more open, liquid landscape forming.

There is the potential for the same thing to happen with OTFs. Will participants look for access to multiple OTFs from the start or will they wait to see what the end state is? These questions will have an impact on how far and how fast the OTC market changes.

It’s good to keep talking

It’s clear that moving OTC contracts onto exchange is not without its challenges, and these challenges are exacerbated by the need for complete transparency. This need for transparency involves technological solutions and what these solutions are is another thing to add to the growing list of uncertainties.

Reporting systems will need to be created, both pre- and post-trade. Market access will have to be secured – what’s the best way of connecting to multiple destinations and multiple data feeds, what hosting needs will arise, what other service providers are needed? Will the infrastructure needs be differentiated between cleared and non-cleared transactions?

The exact form of these technology requirements will be shaped by the eventual market structure and the market’s reaction to such a change. In order to be in a position to move efficiently and rapidly when the OTC market starts changing, all participants need to work together to create a new market landscape – both operationally and technologically. It’s only through an open dialogue between service providers and participants that the market will be able to move forwards.




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Tags: Transparency, regulation, MTFs, OTFs, OTC Derivatives, MiFID II

SEC Looking to Fit Final Piece of Swaps Data Puzzle

Posted on Wed, Apr 13, 2016 @ 03:01 PM

By Colby Jenkins, TABB Group
Originally published on TABB Forum

The first batch of Swap Data Repository reports, under the CFTC’s purview, was released to the public more than two years ago. For market participants eager to gain a similar look into security-based swaps, including single-name CDSs, under the SEC’s regime, it likely will be a year from now before we can add a new data repository to the U.S. list. But the SEC’s patient approach to rulemaking should pay off.

Publicly available, real-time disseminated trade data for the traditionally opaque over-the-counter fixed income markets is very much a new species within the capital markets animal kingdom. When Dodd-Frank was signed into law, the vast majority of OTC fixed income products were placed under the regulatory purview of the Commodity Futures Trading Commission (CFTC). The Securities and Exchange Commission (SEC) was given authority over a smaller subset of products – most important, single-name credit default swaps (SN-CDS). This responsibility was the lurking giant of Dodd-Frank Title VII (see Exhibit 1, below).

Exhibit 1: SEC/CFTC Swap Jurisdictions


Source: TABB Group, CFTC, SEC

The aggregation and public dissemination of OTC derivatives trade data was one of the most significant and ambitious goals of the 2010 G-20 agreement, and 2016 is shaping up to be one of the most significant years of progress for U.S. regulatory regimes. Central to the progress is a major step forward taken recently by the CFTC toward refining the workflow of its own Swaps Data Repository (SDR) framework by requesting industry comment on how best to improve the process.The first batch of Swap Data Repository (SDR) reports (under CFTC purview) was released to the public more than two years ago. It was a fascinating first glimpse into an otherwise opaque OTC derivatives market. For market participants eager to gain a similar look into the last bastion of Dodd-Frank Title VII opacity – security-based swaps under the U.S. SEC’s regime (again, the most important of which are single-name CDSs) – the wait just got longer.

On the SEC side of the equation, however, progress has been less aggressive. On March 18, the SEC extended the registration deadline for entities looking to register as a Security-Based SDR, or SB-SDR – the SEC equivalent of the CFTC’s established SDR framework – until June 30, 2016. Looking still further out, the eventual rollout of implementation dates for reporting and public trade data dissemination will likely follow a staggered +6 and +9 months from the point at which the SB-SDR is “operationally ready.” The definitions of “operationally ready,” however, are murky, to say the least, and a handful of core definitions and outstanding cross-border agreement issues are yet to have rules finalized. With an optimistic outlook, it will likely be year from now before we can add a new data repository to the U.S. list.

In the global context, we are still in great shape comparatively. There are four U.S. SDRs currently in operation under the CFTC that are pending provisional registration: The DTCC (Interest Rate, Credit, Equity, FX and other Commodity asset classes), Bloomberg’s SDR (BSDR) (Interest Rate, Equity, Credit, FX, and other Commodity asset classes), Ice Trade Vault (Commodity asset classes and Credit), and CME SDR ( Interest Rate, Credit, FX and other Commodities). Meanwhile, the number of trade repositories in Europe (6) greatly outnumbers the resources available in other regions (see Exhibit 2, below) across all asset classes.

Exhibit 2: Trade Repositories Across Global Regulatory Regimes

content colby2 resized 600

Source: TABB Group, FSB

The quick rate at which the trade repository framework in Europe developed certainly has come at a cost, however. Significant discrepancies between reporting standards from one TR to another in Europe, coupled with the inefficient double-sided reporting practices, have been detrimental to oversight progress within the European regime.

The SEC’s wait-and-see approach is evident in the framework for SB-SDRs laid out in the final published rules – taking many of the standards of the CFTC’s rules with deviations where the SEC has felt it could improve upon existing rules within the CFTC approach. The SEC has been wise to be patient.

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Tags: U.S., CDS, regulation, CFTC, FSB. Dodd-Frank, SEC

Central Clearing: Customer Protections

Posted on Tue, Apr 12, 2016 @ 10:08 AM

By Ivana Ruffini, Financial Markets Group at the Chicago Federal Reserve

Since 1936, the segregation of customer assets from intermediaries’ house funds has been a key mechanism for customer protections in intermediated derivatives markets in the U.S. Following the 2008 crisis, regulators began implementation of the central clearing mandate for standardized swaps and the new customer margin segregation framework for centrally cleared swaps (legally segregated operationally commingled - LSOC). 

Central clearing concentrates risk in central counterparties (CCPs) and financial inter­mediaries, such as clearing members (CMs) and futures commission merchants (FCMs). In the U.S., exposure to FCM risk is some­what mitigated by the regulation of market intermedi­aries and the implementation of two customer protection frameworks - the traditional futures segregation (for futures) and LSOC (for cleared swaps). Both rely on rules that govern segregation of customer assets held by intermediaries and CCPs.

U.S. futures segregation model shields customer segregated funds at depository institutions (DIs) from the “banker’s right of setoff.” Customer seg­regated funds are meant to repay customer claims and cannot be applied against debts owed to DIs by an insolvent intermediary or a CCP. In the case of FCM insolvency customers are repaid in full if:

  • The aggregate amount in customer segregated accounts equals or exceeds what customers are owed.

  • There is an aggregate excess in customer segregated accounts - the surplus margin that does not belong to customers is returned to the estate of the FCM.

However, if there is an aggregate shortage in customer segregated accounts, customers’ claims would be prorated with all of them incurring the same percentage loss. It is important to highlight that an aggregate shortage (under-segregation) in these types of accounts is a violation of CFTC rules, but could occur due to fraudulent activity or operational prob­lems.

LSOC precludes CCPs from using the initial margin assets of non-defaulting customers to offset losses of de­faulting customers of a failed FCM. An FCM is required to transmit account-level margin and position information to the CCP which is validated daily. If there is a default, LSOC protects customer segregated accounts as reported by FCMs. Also, any excess customer margin would either be transferred together with the customer positions to another FCM or returned to the swaps clearing customer.

However, LSOC is limited by Section 766(h) of U.S. Bankruptcy Code, which provides that non-defaulters in an account class that has incurred a loss will share in any shortfall, pro-rata thus exposing customers to potential losses should their FCM fail, and under-segregation occurs because of inaccurate FCM records.

CCPs do not protect customers of a defaulting FCM, and protections offered under the U.S. futures customer segregation and LSOC are limited because under the U.S. Bankruptcy Code even individually segregated customer funds are treated as if they were held commingled in a single account. 

Ivana Ruffini is a Senior Policy Specialist in the Financial Markets Group at the Chicago Federal Reserve.

The views expressed herein are those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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Tags: U.S., CCPs, LSOC, regulation, FCMs, Customer Protections

March 2016 Swaps Review: Compression Trades Tell the Story

Posted on Mon, Apr 11, 2016 @ 08:53 AM

By Amir Khwaja, Clarus Financial Technology
Originally published on TABB Forum

Swaps compression activity was exceptional in March, helping drive a jump in on-SEF trades and propelling Tradeweb ahead of Bloomberg in the race for SEF market share.

Let’s take a look at Interest Rate Swap volumes in March 2016.

First the highlights:

  • On-SEF USD IRS volume in March 2016 was > $1.25 trillion.

  • For price forming trades, DV01 was 10% lower than Feb. 2016.

  • Butterfly trade volumes were up and Outright volumes were down.

  • USD SEF Compression volumes were exceptional, at > $240 billion.

  • On-SEF vs. Off-SEF for price forming trades was 64% to 36% in March.

  • USD Swap Rates were up, reversing the Jan. and Feb. downwards trend.

  • SEF Market Share shows Tradeweb first, taking over from Bloomberg.

  • Tradeweb gains are due to its larger share in Compression and Roll activity.

  • CME-LCH Switch volumes were the lowest since Oct 2015.

  • Global Cleared Volumes show LCH SwapClear increasing its share of USD Swaps.

  • And LCH SwapClear significantly increasing AUD OIS Swap volumes.

Onto the charts, data and details.


Let’s start by looking at gross-notional volume of On-SEF USD IRS Fixed vs. Float and only trades that are price-forming – so Outrights, SpreadOvers, Curve and Butterflys:

aa resized 600 


  • March 2016 gross notional is > $1.25 trillion.

  • (Recall, capped trade rules mean this is understated, as the full size of block trades is not disclosed.)

  • A little lower than February 2016, by 2%.

  • Compared to March 2015, gross notional is down 4%.

And splitting by package type and showing DV01 (adjusted for curves and flys):

bb resized 600


  • In DV01 terms, March 2016 was 10% lower than February 2016.

  • Overall > $500 million of DV01 was traded in the month.

  • (Recall, capped trade rules mean this is understated.)

  • Butterfly DV01 was higher in March 2016 than any of the other months shown.

  • Outright DV01 was lower in March 2016 than any of the other months shown.

And gross notional of non-price forming trades – Compression and Rolls:

cc resized 600


  • Exceptionally high Compression activity of > $240 billion.

  • Higher than the > $220 billion in Feb. 2016.

  • Far higher than January 2016 and the corresponding months in 2015.

  • And higher than the > $204 billion in March 2015.

  • IMM Roll activity is significant, as we would expect in an IMM month.

  • With > $63 billion in March 2016, compared to > $51 billion in March 2015.

  • Evidencing larger positions in IMM or MAC Swaps being rolled.


Comparing On-SEF vs. Off-SEF for price-forming trades as percentages:

dd resized 600

  • Showing that On-SEF vs. Off-SEF for March 2016 was 64% to 36%, the highest On-SEF percentage in the months shown and noticeably higher than the 57% to 43% ratio in March 2015.

USD IRS Prices

Let’s now take a look at what happened to USD Swap prices in the month:

e resized 600

Showing that:

  • Rates were up with the curve steepening.

  • Reversing the downward moves we saw in January and February.

  • Short rates up 1bps, medium up 6 bps, and long rates up 8 to 9 bps.

  • Reflecting the general improvement in global markets.

  • EUR, GBP, JPY Swaps.

Let’s also take a look at On-SEF volumes of IRS in the other three major currencies:

f resized 600

  • Showing similar volumes in March to those in February.

  • The overall gross notional in these three currencies of > $237 billion in March is just 19% of the USD volume of $1.25 trillion.

And then looking at SEF Compression activity:

g resized 600

  • Showing that compression in EUR at > $38 billion was significantly higher in March than other months shown.

SEF Market Share

Let’s now turn to SEF Market Share in IRS including Vanilla, Basis and OIS Swaps.

We will start by looking at DV01 (in USD millions) by month for USD, EUR, and GBP and by each SEF, including SEF Compression trades, and use a chart to compare the relative share in March 2016 with the prior two months.

h resized 600

Showing that:

  • Overall, March volume is higher than February.

  • Which the prior SDR charts show is down to Compression and Roll volume.

  • Tradeweb has the highest volume in March, overtaking Bloomberg.

  • Due to its larger share of Compression and Roll activity.

  • Bloomberg is second with similar volume to Feb.

  • ICAP-IGDL is slightly down from prior months.

  • Tradition is slightly higher than Feb and significantly higher than Jan.

  • Tullet is up from Feb.

  • BGC is down from Feb and similar to Jan.

  • Dealerweb is similar to Feb.

  • TrueEx down from Feb and similar to Jan.

CME-LCH Basis Spreads and Volumes

We can also isolate CME Cleared Swap volume at the major D2D SEFs (on the assumption that this is all CME-LCH Switch trade activity). Let’s look at this for the past 3 months:

i resized 600


  • Overall volume in March was $35 billion gross notional.

  • Significantly down from the > $50 billion in prior months.

  • And the lowest month since Oct 2015.

  • Tradition mostly held on to its volume.

  • IGDL was significantly down.

CME-LCH Basis Spreads remain at similar levels to the end of Feb., with 30Y at 2.65 bps. The lack of volatility in the month either was the cause or effect of the lower CCP Switch volumes.

Global Cleared Volumes

Now let’s look at Global Cleared Swap Volumes for EUR, GBP, JPY & USD Swaps:

j resized 600


  • Overall Global Cleared Volumes similar in March to Feb.

  • LCH SwapClear volume at $18.3 trillion is similar to the prior month.

  • CME at $2.66 trillion looks higher than prior month (more on this below).

  • JSCC at $607 billion is down from Feb but above Jan.

  • Eurex is up a bit, but at $14.5b in the month. still tiny compared to the rest.

Let’s drill-down to the daily numbers in March for CME:

k resized 600

Showing that:

  • 23 March has $1.25 trillion!

  • Clearly this cannot be new trade volume.

  • And as we have observed in the past, this is TriOptima compression showing up as volume.

  • We can verify this, as the Outstanding Notional does not jump by $1.25 trillion over this period.

  • As an estimate, let’s assume that $1.2 trillion of the $1.25 trillion is compression.

  • Manually adjusting the CME March volume of $2.66 trillion results in a new figure of $1.46 trillion.

  • Which is similar to CME’s Jan 2016 volume.

A comparison of USD Swap volume at LCH SwapClear and CME gives 84% to 16% for all volume in March.

Client Clearing volume for USD Swaps shows LCH SwapClear at 77% and CME at 23%, which is higher than the 69% to 31% in Jan. and Feb.

And before we end, let’s look at the volumes of AUD, HKD, SGD Swaps (including Vanilla, OIS, Basis, Zero Coupon):

l resized 600


  • LCH SwapClear has the largest volume.

  • And is significantly up, increasing 47% from Feb. (which was up 75% from Jan.).

  • Driven largely by increasing AUD OIS volumes.

  • ASX figures for March are not yet available to us.

  • ASX volumes for Feb. were up 64% from Jan., so also on the up.

  • CME and SGX just register on the chart.

  • HKEX not visible.

That’s it for today. A lot of charts – 12 to be precise. Thanks for staying to the end.

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Tags: Compression, SEFs, Clearing, Tradeweb

Counter(party) Intuitive

Posted on Wed, Apr 06, 2016 @ 09:45 AM

By Steven Strange, Fidessa
Originally published on TABB Forum

Pressures from all sides are driving buy-side firms around the world to pay ever-closer attention to counterparty exposure. Asset managers are looking critically at their existing processes for monitoring and controlling counterparty risk and often finding them to be inadequate. How has the counterparty landscape changed for the buy side, and what can be done to ease the burden?

No longer enough

Once upon a time, a good credit rating was sufficient to establish a counterparty’s fitness as a trading partner. Counterparties were managed via simple “do not trade” lists delivered to traders at the start of the day, and traders honored these by hand, or by using basic software and home-grown tools.

Times, of course, have changed drastically. Regulators now expect firms to aggregate their counterparty exposure across asset classes and include a myriad of additional holdings where the counterparty is in any way affiliated. “Do not trade” lists are monitored far more closely and updated swiftly as conditions change.

Clients are more demanding, too, as everyone attempts to mitigate risk in an ever-nervous market. Having become used to the accuracy and speed of automated reporting, they are no longer satisfied with manually generated reports based on post-trade transactional data. Institutional clients are also more likely to have counterparty risk guidelines in place, which must be navigated individually – a task that quickly becomes complex when multiple clients are involved.

Current systems don’t measure up

Most OMSs and internal systems simply aren't up to the job. Aggregating risk is much more difficult now, when a given counterparty could be any (or all) of: an issuer for a security within the fund; an indirect issuer for a security within an index or ETF; or a counterparty to another trade in a different system. Or a counterparty could cause a knock-on effect if it were to fail and impact affiliated entities.

Calculating total exposures is even more complicated. Outstanding options orders might use mark-to-market or delta-adjusted values, where interest rate swaps use notional. Working out the total exposure from outstanding orders in each asset class, considering both hedging and netting arrangements, and then rolling them up into a single value, is either beyond the capability of most systems, or too time-consuming to be feasible on a pre-trade basis.

Compliance and risk managers are at the coalface of this new battle to conquer counterparty complexity. “Do not trade” lists have broadened to become “do not trade with broker X for asset Y, but asset Z is ok.” Some firms take this a step further, setting different limits by broker for FX spot, FWDs and swaps. Lists must be updated many times a day as market conditions and trading activity change exposures in real time. Restrictions can even be hierarchical, where higher-order restrictions supersede more granular restrictions on brokers or assets, even when those lower-order restrictions haven’t been breached.

A patchwork solution

At some firms, daily limits are still supplied manually in the morning. Throughout the day, each trade must be manually calculated and deducted from the limit. Elsewhere, the end-of-day operations team extract trading data from multiple trading systems into a different database, run a series of queries to test adherence to trading mandates, and then send the results to the risk team to be managed.

This broadening and deepening of complex manual systems is clearly unsustainable. Fragmented processes and systems across regions, asset classes and acquired firms add even more layers, all of which is an anathema to achieving the control that firms – and regulators – want, and clients demand.

It’s an additional source of frustration for risk and compliance managers that a fundamental requirement for controlling and monitoring trading activity – i.e., the trading data itself – is located only within the trading system. The middle office often doesn’t have adequate access to trading data and receives notice of violations only after the fact, with no supporting data, from systems over which they have no control.

Better alternatives exist

There are some levers that forward-thinking asset managers have begun to pull that protect the firm and its clients, and ease burdens for the back office.

First, decision-making authority has been transitioned from trading operations to a compliance or risk management group.  This independent perspective gives senior management an independent and holistic view of counterparty exposure and removes that burden from traders.

Second, a single point of implementation and monitoring is chosen and supported by removing manual processes in favour of automation. The cost benefits of doing this are backed up by significant improvements to recall and auditability. Additional benefits include the ability to implement controls proactively, and to respond quickly to changing conditions.

Obviously, the solution requires technology. In assessing the available options, firms should closely look at the counterparty assessment capabilities of a system, which should provide the flexibility to add and alter rules, lists and calculations during business hours. Risk calculations should be sophisticated and aggregate overall counterparty exposure using all the different metrics based on asset class, and include related holdings issued by the counterparty.

Any system will need to integrate seamlessly with the order management systems in use in the front office, and provide transactional data to the middle office for monitoring and control.  It must account in real time for the impacts of trade amendments on exposures as well.

In this way, breaches of counterparty risk limits can be prevented before they occur, and burdens are lifted from trading, risk, compliance and administrative staff. Forward-thinking asset managers are becoming “counterparty intuitive” to everybody’s benefit. And this means that they not only run better operations, but also position themselves to win more business and maintain their competitive edge.

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Tags: ETFs, regulation, IRS, Swaps, counterparties, OMSs, FWDs

The Race to the MAR Deadline Is On: Can Buy-Side Firms Cross the Finish Line on Time?

Posted on Tue, Apr 05, 2016 @ 10:32 AM

By Stefan Hendrickx, Ancoa
Originally published on TABB Forum

Not subject to MiFID II delays, the new Market Abuse Regulation aiming to increase the transparency, safety and resilience of European financial markets is due to come into effect on July 3. While compliance preparations by the sell side are well underway, however, many buy-side firms, including proprietary trading firms, asset managers and hedge funds, are unaware of or are procrastinating over the fact that they might fall under MAR’s remit.

Unlike the F1 World Championship, which sees expert teams of technologists and drivers compete for the title in more than 20 Grand Prix races, the Market Abuse Regulation (MAR) race will conclude on July 3, 2016, with regulators across Europe requiring participants to cross the finish line in one fell swoop. While compliance preparations by the sell side are well underway, the buy side is off to a slow start in determining when and how to join the MAR race.

Our recent conversations with buy-side firms, including proprietary trading firms, asset managers and hedge funds, have shown that a substantial number of firms are unaware of or procrastinating over the fact that they might fall under the remit of the forthcoming Market Abuse Regulation (MAR). Not subject to MiFID II delays, the new legislation aiming to increase the transparency, safety and resilience of European financial markets is due to come into effect on July 3.

As evidenced by the FCA’s Market Abuse Thematic Review for Asset Managers last year, the establishment of appropriate systems and procedures by firms in order to detect potential market abuse will likely become high priority for national regulators. It is worth noting that firms based outside of the E.U. will also be affected by MAR if they are trading financial instruments on E.U. markets.

The question is: How should smaller buy-side firms determine if they are going to be MAR-affected or not?

New criteria: surveillance technology and automation are key

Under MAR, firms will be required to consider whether an automated system for market surveillance is necessary and, if so, its level of automation. In its Technical Standards, ESMA laid out a set of criteria that firms are advised to take into account when considering levels of market surveillance, including: the number of executions and orders that need to be monitored; the type of financial instruments traded; the frequency and volume of order and executions; and the size, complexity and/or nature of their business.

Firms should take note that ESMA has deemed, for the large majority of cases, an automated surveillance system to be the only method capable of analyzing every execution and order, individually and comparatively, and which has the ability to produce alerts for further analysis. Regardless of what type of surveillance system is eventually decided upon, firms will have to be prepared to justify to regulators how generated alerts are managed by their chosen system and why such a level of automation is appropriate for their business.  

Intent on change: capturing both intent and market abuse

One major development in the market abuse legislation for all firms is a transformation of the existing STR (Suspicious Transaction Reports) regime into a new Suspicious Transaction and Order Reports (STOR) requirement. STOR mandates that suspicious ‘orders’ are to be reported to regulators (i.e., intent), as well as the “transactions” that are required today – even if the orders do not proceed to execution. Because regulators will be reviewing the cancellation or modification of orders, analysis of suspicious orders and executions which did not result in a submission of a STOR form would also need to be retained and accessed by a firm.

This is expected to affect buy-side firms in the following ways:

  • Dependence on third-party market surveillance: Buy-side firms will no longer be able to rely on their broker to perform market surveillance on their behalf. Brokers, on the other hand, will be required to continue market surveillance practices and flag a STOR with the regulator directly, without notifying the buy-side firm. Doing so would be a breach.

  • Storage of orders: The biggest challenge for the buy-side may be the actual storing of the analyses of suspicious orders and executions. Currently, many firms only keep an audit trail of executions, whereas orders are not often kept in any sort of systematic structure.

  • Capable analysis software: ESMA guidelines prescribe that surveillance systems should include “software capable of deferred automated reading, replaying and analysis of order book data on an ex post basis.” This is considered of particular relevance if the activity and dynamics of a trading session need to be analysed, for example, by using a slow motion replaying tool.

Crucial capability

Buy-side firms need to consider their current capabilities in order to meet MAR requirements. Yet concerns remain over cost of implementing appropriate surveillance systems and the amount of resource taken up from sifting through numerous alerts.

Systems with a built-in contextual approach can help reduce the number of false-positive alerts, thereby saving on valuable resource. Surveillance tools can facilitate an immutable audit trail of structured and unstructured data (such as instant messaging and other forms of communication), and certain tools can furthermore normalize and consolidate data from across systems, ensuring improved visibility across the firm, thus enabling better analytics at large.

Other areas that can also help minimize time spent on managing alerts are the inclusion of a back-testing environment for alerts, as well as a flexible approach to handling different segments of the business according to perceived risk and other characteristics. Moreover, some vendors offering market surveillance systems charge a flat fee, as opposed to the approach of charging per asset class, instrument or market, which can add up substantially over time.

The finish line in sight

In just more than three months from now, buy-side firms will need to be in a position to self-assess whether an automated level of market surveillance would be regarded necessary by the regulator. Establishing a data trail of orders as well as executions is an important first step. In this instance, automated surveillance systems can help solve regulatory obligations.

Not only can regulatory compliance be achieved through the use of market surveillance tools, overall business opportunities can be explored because of the increased level of business intelligence. In the race to the MAR finish line on July 3, 2016, there is really no downside for prop-shops, asset managers and hedge funds to having the right market surveillance tools in place. High performance through technology and automation brings competitive advantages and improves business success.

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Tags: ESMA, regulation, Buyside, MiFID II, E.U., MAR

Blockchain: Disruption or Distraction?

Posted on Mon, Apr 04, 2016 @ 10:24 AM

By Jeffrey Billingham, Markit
Originally published on TABB Forum

If every bank, exchange, infrastructure provider, and clearing house put their internal working groups in one room, all would agree to one point: Blockchain technology is not a silver bullet for financial markets. But beyond defining what the technology is not, few seem to agree on what the technology actually is. Markit examines the challenge in developing a long-term framework for blockchain in financial services.

The financial industry began 2016 with a host of blockchain promises. While many of these promises show encouraging momentum, a clear implementation strategy remains elusive. If every bank, exchange, infrastructure provider, and clearing house put their internal working groups in one room, all would agree to one point: blockchain technology is not a silver bullet for financial markets. However, beyond defining what the technology is not, few seem to agree on what the technology actually is.

The financial industry has invested more than $1 billion in the past 14 months to support blockchain consortia, pilot programs, companies, and other efforts to create consensus about implementing blockchain. This activity indicates a high level of excitement, but is atypical of how innovative technology enters a market. We would expect the industry to eschew consensus and exhibit bolder, unilateral moves in pursuit of competitive advantage. Moreover, if incumbent institutions were slow to move, we would expect blockchain startups to build new banks.

For now, neither is happening in earnest. A cynic would say the focus on partnerships only shows that players are hedging their bets. The eternal optimist would say that players need to partner to be successful. 

Nevertheless, there is merit to the collaborative approach. A blockchain isn’t simply software to install, but rather the foundation of a robust peer-to-peer network. We at Markit certainly appreciate the time and efforts necessary to build a successful network. And, to be fair, at least one startup has obtained a banking license.

However, the question persists: Why a blockchain? How did we go from a conversation about a digital currency to talk of a revolution in the creation and transfer of financial products and agreements?

Though unfashionable to admit, it started with some key perceptions about the Bitcoin protocol. Specifically:

  1. Bitcoin transactions settle within minutes – minimal settlement latency.

  2. Payers and receivers of bitcoin use a distributed ledger – no central data store.

While the financial industry struggled to come to terms with the post-crisis financial framework and its associated systemic costs, the Bitcoin protocol provided tantalizing solutions. Settlements, reconciliations, and the security apparatus around these processes, all of which can theoretically move to a blockchain, are massive drivers of cost for a financial enterprise. 

At the same time, digital currency and distributed ledger startups had to reinvent themselves after the price of bitcoin slid throughout 2014. Realizing that budding interest from capital markets offered a lifeline, these companies moved away from digital currencies and toward concepts such as enterprise blockchains, colored coins, metacoins, side chains, smart contracts, etc.

This union of convenience between cost-conscious financial firms and revenue-hungry technology firms propagated visions of a new operating paradigm in finance, but has yet to produce a long-term framework that gets us there.

Instead, the industry distracted itself with a spate of false choices: It is “Bitcoin” or “The Blockchain?” Should a blockchain be “public” or “private?” Is this technology “the end of banking” or “just a database?” These questions prevent us from exploring the real elegance of blockchain technology.

If blockchains are to play a revolutionary role in financial services, 2016 must be the year that firms agree to disagree about the role of blockchain, forge their own paths, and dare others to follow.

Blockchain technology presents a new model for the architecture of the global financial system. That’s why consensus building, however well-intentioned, often results in a focus on the least common denominator, dimming our understanding of the bigger picture.

Speaking at the South by Southwest conference, Mark Thompson, CEO of The New York Times Company, explained how he thinks about new technology, specifically applying virtual reality tools to news reporting: “You can’t wait for someone to jump off the cliff; you have to jump first. … We want to be braver than our rivals and be out there and be smart about it. Don’t make crazy bets when you’re not sure. But we cannot be complacent. We know what complacency leads to and we have to be brave.”

The financial industry must adopt the same mind-set with blockchain. We can start with cost saving initiatives that digitize assets and agreements, but need to also understand blockhain’s potential to transform management of collateral and securitize a range of financial products represents new market opportunities that will captured by truly forward thinkers in the industry.


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Tags: Technology, Disruption, Blockchain

Timothy Massad on European Clearing Equivalence: ‘Cleaning Up The Spider-Web of Opaque Complexity’

Posted on Mon, Mar 21, 2016 @ 12:00 PM

CFTC Chairman Timothy Massad addressed the Futures Industry Association on March 16, offering more detail on the historic agreement with the European Commission on cross-border clearinghouse recognition. The example was used to illustrate the CFTC’s ongoing efforts to remove regulatory complexity and maintain stability in global financial markets.

Cross-border clearing equivalence has been a hot-button issue for market participants and regulators in the U.S. and Europe, one that Massad has repeatedly stressed a top priority. With the agreement, the CFTC and European Commission have agreed to recognize one another’s clearing requirements, easing uncertainty around cross-border trading between market participants. 

In the speech, he outlined the final specs of the agreement and explained how the deal has become a blueprint for further collaboration with European regulators:

  • Modest Changes on Both Sides of the Atlantic: Revisions to clearing requirements are being made in the U.S. and Europe. For example, European central counterparty clearinghouses (CCPs) will likely have to follow the U.S. regulatory model governing the collection of customer margins, while U.S. CCPs will need to comply with the European requirement for two-day liquidation periods for house margins. 

  • Substituted Compliance with EMIR:  The CFTC has already fulfilled a “substituted compliance” determination that will permit European CCPs to comply with many of the U.S. rules by adhering to the corresponding European Market Infrastructure Regulation (EMIR) requirements. 

  • Next on the Agenda – Cross-Border Margin Rule Harmonization: With the success of the U.S./E.U. clearing equivalence accord under their belts, the CFTC is now turning its attention to margin rules for uncleared swaps. The final U.S. rules were developed late last year with an eye toward consistency with global standards, and the CFTC will soon propose cross-border application of the U.S. rule in Europe and Japan. 

Massad also discussed the agency’s work on global clearinghouse resiliency and clearing member customer protections in the event of a market shock. Ultimately, he proffered the message his agency is working hard to protect markets without getting in the way of their efficient operation. In his own words, Massad described his role as: “cleaning up the spider-web of opaque complexity that arose from the bilateral OTC world, complexity that threatened to lead to domino-like defaults in the crisis.”

Read his full speech here.  

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Tags: U.S., CCPs, Timothy Massad, CFTC, E.U., EMIR

SBSDR: The SEC Version of a Swap Data Repository

Posted on Mon, Mar 21, 2016 @ 09:40 AM

By Tod Skarecky, Clarus Financial Technology
Originally published on TABB Forum

In waiting to publish rules for swap data reporting until February 2015, the SEC has taken it a bit easier in its rulemaking than the CFTC. While the regulator was smart enough to adopt much of the CFTC’s SDR framework, however, it’s unclear when – or to whom – the data needs to be reported. Clarus’s Tod Skarecky deciphers the requirements.

The CFTC began publishing rules about Swap Data Reporting in 2011, and we’ve come a very long way since then. There is a world of data now on this once-opaque market.

The SEC, however, took it a bit easier in its rulemaking for the reporting of swaps under its jurisdiction. It wasn’t until February 2015 that it put out its final rule that requires swaps to be reported to an SDR.

I wanted to get a handle on the SEC’s rules in anticipation of being able to begin reporting on this market. So of course I dove into hundreds of pages of various legislation. I will try to digest it for you below.


First, let’s get some basic terminology straight. If you know the CFTC lingo for swaps, all you need to do is pre-pend an “SB” to your favorite acronym. But the majors:

  • SBS – Security Based Swap. I tend to think of single-name credit default swaps, but technically other swaps such as total return equity (single name) swaps should be included as well. Interesting as well that the SEC leaves the door open for other asset classes outside of CDS and Equity; not sure what that would be.

  • SBSDR – Doesn’t roll off the tongue, but Security Based Swap Data Repository.

  • SBSD – Securities Based Swap Dealer.

  • MSBSP – Major Securities Based Swap Participant (bonus points if you realized this is not just SB+MSP).

The Rules

There were actually 3 rules published in February 2015:

  1. Final Rule: SBSDR Registration, Duties, Core Principles (467 pages).

  2. Final Rule: Reporting/Dissemination final rule (644 pages).

  3. Proposed Changes to Final Rule #2: Reporting/Dissemination Proposed Rule/Guidance (245 pages).

What the Rules Say

I’ll start with #1 – the SBSDR Registration rule. Fairly boring for someone like me who primarily cares about the public data that will come out of an SBSDR. This covers how to register and a bunch of conformities and principles, such as needing to have a Chief Compliance Officer. Read this only if you want to start an SDR. I was interested to see any language on fees, and it seems to say you must make any fees “Fair” and apply them consistently across participants.

The interesting document is #2, as this details what has to be reported to SBSDRs and what has to be publicly disseminated, and sets out obligations for SBSDRs to generally do more than just regurgitate data that was reported to them.

Document #3 is quite oddball. It’s basically a suggested update to Document #2, where it proposes language for sections that were left as “[Reserved]” in the Final Rule.

So let me step through the key points. Generally, it is much the same as CFTC SDR reporting but with some tweaks. The highlights:

  • The reporting counterparty is the SEF (if executed on venue) or a dealer (generally the same as CFTC). Cleared trades, after the initial execution report, get reported by the DCO (presumably to the SBSDR of their choice), but of course not publicly disseminated (the original execution is still reported just not the clearing trades).

  • §242.901 lays out public dissemination obligations. SBSDRs must disseminate “Primary Trade Information”:

    • Product ID is to be used, if there is one. Presumably like a CUSIP. Otherwise, specific terms (underlying asset, effective/maturity dates, indices, etc.)

    • Price

    • If the trade details reported are not enough for someone to price the trade, then a flag to say that. This is akin to the CFTC “other price effecting term” flag.

    • A flag for dealer-to-dealer! (a notable improvement to CFTC SDR)

    • It claims that trade lifecycle events will be publicly disseminated; it seems akin to the CFTC termination events we see on the public tape, but in the world of equity and credit this might be stock splits, credit events, etc.

    • Any flags that the SBSDR has deemed relevant. (More on this later)

  • Platform (e.g., SEF) IDs and clearing house names are required for private reports as part of “Secondary Trade Information,” but not to be publicly disseminated.

  • Having read through various SEC documents, it seems the SEC did not feel comfortable with the effects that public dissemination could have on liquidity. Hence the regulator seems not to have defined the block trade rule as yet, though it claims it knows it has to at some point. This has a few implications:

    • While the CFTC has “As-Soon-As-Technologically-Practicable” for reporting trades (meaning immediately reported or 15 minutes for blocks), the SEC went with a 24-hour delay across the board.

    • Practically speaking, the SBSDR always has to disseminate the trade immediately; however, the reporting counterparty has 24 hours to submit it to the SBSDR. (I do wonder what an execution venue would do – report it right away, or hold onto it for 24 hours?)

    • This does, however, imply that trades could be reported and disseminated immediately. The reporting counterparty will dictate when it is reported.

    • It does not appear that any trade sizes will be capped (which makes sense because it’s 24-hour delayed, but is a nice transparency enhancement compared to CFTC rules).

  • SEC has allowed and required SBSDRs to define fields and submission formats (and publish them). It also asked the SBSDR and participants to police it – so if something is missing, the SBSDR has to go back to the dealer/reporting counterparty and ask for it – and the dealer has 24 hours to comply.

  • No private daily valuation reporting (the CFTC has this requirement for private data).

  • Some back-loading of trades that were dealt after 21 July 2010. Unfortunately, however, these would not be publicly disseminated.

General Tone

The general tone of the rules, comments and preamble seems to say two things:

  • The SEC doesn’t want to tinker with, and possibly impact, a market that it is not convinced is tremendously healthy to begin with. Hence its deferral on any block trade rule and a 24-hour reporting timeframe until it starts seeing data.

  • The SEC has chosen to be less prescriptive. It seems to want the SBSDRs to figure out what is important in a trade report, determine the format, make sure it’s reported (as defined in SBSDR’s rules), and police it!

Notably, the SEC has suggested that there be “Conditional Flags” reported on trade records, that the SBSDRs must define and adopt, if they deem them relevant. A couple of good examples are mentioned as plausible:

  • Identifier for Package Trade

  • Identifier Netting / Compression trade

  • Identifier for Inter-Affiliate

So we could see further transparency, but it will be left up to the SBSDRs to decide.

So When Does It All Start?

Truth be told, I intended to blog about the SEC rules back in February 2015, when they were announced, but given the 1 year lead time, I thought I’d wait to see how the news panned out. Oddly, there just hasn’t been much news that I have seen on the topic. So let’s go back to the rules and see what the timeline is:

  • The two rules were published into Federal Register on March 19, 2015.

  • Effective date of March 18, 2016, for SBSDR Registration (#1)

  • Effective date of May 18, 2015, for Reporting (#2)

So before you panic that the Reporting rules began in May of last year, there are two very important milestones:

  • New trades need to be reported to SBSDRs 6 months after the first SBSDR commences (is ready for business).

  • Public dissemination will begin 9 months after the first SBSDR commences.

So it seems this is akin to the CFTC SEF rule which said you have to trade on SEFs, and then there was a massive launch of SEFs in 2013, but technically speaking nothing had to be traded on a SEF until some SEF declared a product “MAT” – only then did everyone begin to scramble.

So, OK, you say, just go look at the SEC website to see who has registered as an SBSDR, right? Not quite that easy. I could not readily find any registrations; however, I did stumble across:

  • A filing for “SDR Partners” – but alas that is a hedge fund fulfilling its typical SEC duties

  • The official form to fill out if you would like to register as an SBSDR.

  • website that would seem to be the place the SEC would tell the world about any registrations

  • Recent (Feb 2016) comment letters from the DTCC with language that included “If we apply for an SBSDR…

So hold on – if the DTCC is still not convinced it’s going to register as an SBSDR, just what the heck is going on?

The Latest

The most recent activity seems to be those comment letters responding to an SEC proposed rule that states that they want SBSDRs to give them the data in some standard such as FpML or FIXML.

Interestingly, this echoes my suggestions I published in last week’s blog regarding the CFTC’s recent request for comments on improving the quality of SDR data. I suggested they adopt existing industry standards (e.g., FpML) and somewhat jokingly suggested they even assess non-existing “standards” such as the blockchain. It seems the SEC is wise to the notion of leveraging industry standards from the start.


The TLDR version of SEC SBSDR reporting:

  • SEC adopted much of the CFTC SDR framework.

  • SEC has given the SBSDRs more authority to dictate what is reported and how, but at same time has required them to police the data better. Very wise.

  • The public can look forward to a few more flags on the public data, such as dealer-to-dealer flags, and possible things like package identifiers (if the SBSDR deems it relevant in its rules).

  • I can see very little trace of anyone actually applying to be an SBSDR.

  • Even after the first application to be an SBSDR is submitted, only then do the 6- & 9-month clocks start ticking for participants.

  • Hence it would seem we still have at least a year before the public begins to see any data come out of this market.

I should note one final catch-all in the comments of regulation SBSDR that says that trades should be reported “to a registered security-based swap data repository or, if there is no registered security-based swap data repository that would accept the information, to the Commission.” So apparently, the SEC has considered what happens if an SBSDR does not exist. Well then, everyone just has to report directly to the SEC.So get crackin’!


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Tags: Dealers, DCO, SDR, regulation, CFTC, SEFs, SBSD, MSBSP, Swaps, SBSDR, SEC, DTCC, SBS, CUSIP