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One Great Big Risk? To Clear or Not to Clear

By Miles Reucroft, Thomas Murray
Originally published on TABB Forum

There is a prevailing attitude among global regulators that central clearing is the silver bullet to the previous financial woes. But concentrating risk from around the markets in one place could lead to a disaster. Deciding which products should and should not be cleared, and what collateral can be posted against those trades, is key to avoiding a crisis, says OpenGamma’s Mas Nakachi.

This is the second article in a series based on Thomas Murray’s exclusive interview with OpenGamma’s Mas Nakachi. Part 1 can be viewed here.

Mandatory central clearing has been a globally unanimous regulatory response to the financial crises that hit post-2008. Positioning a buyer to every seller and a seller to every buyer at the centre of financial markets is the route to ensuring that all trades are completed efficiently and safely. It encourages competition and new market participants, and places a layer of unanimity into the trading space.

These clearing houses, or CCPs, will also act as risk concentrators. Risk is being taken from around the markets and placed into one location. This in itself creates one great big risk. So is this the right way to go?

“You are taking risk from everywhere and putting it into a few places and ideally watching those places very closely,” says Mas Nakachi, CEO of OpenGamma. “The problem, of course, is if anything goes wrong at any of those ‘few’ places, then we will have to get automatic weapons and gold bars and run into the forest! It would be a very different world very quickly.”

In short, CCPs are ‘too big to fail.’ If one were to fail, then government bailouts would be essential, which is a direction that everyone was keen to move away from. “There is no danger currently, so any failure would be down to unforeseen consequences,” says Nakachi. “It is very difficult to predict, longer term, what will happen. We are concentrating a lot of risk and monitoring it closely, but what happens in a time of market stress is still somewhat unknown.”

It is the unknowns that have left many questioning the wisdom of concentrating so much risk into CCPs. It is, after all, rarely the foreseen consequences that cause financial crises.

The other fear is the handling of certain types of derivatives trades through CCPs. “No one should be pushing bespoke trades through a clearing house,” explains Nakachi. “Clearing houses should only trade highly liquid, highly fungible products that can be unwound in times of market stress. The clearing members or clearing member pool also has to be sufficient to take down the risk when one or two firms default. That is the whole point around not taking in certain types of trades.

“There has been a lot of debate around swaptions, for example. Certain dealers are adamant that clearing them should never happen, whereas other firms say that, if it is done correctly, it should happen right away. The point is that either way, there is a spectrum of financial products at which point you draw the line. Where that line should be varies according to the individual, but there is some line somewhere that needs to be drawn that says, ‘This product is too illiquid.’ It’s clear: Certain products should never go through a clearing house.”

The regulatory appetite for central clearing, however, is large. Whilst no one would ever put it so, there is a prevailing attitude that clearing is the silver bullet to the previous financial woes. Which products to put through clearing is a big issue and, as Nakachi points out, opinion is divided as to what should be excluded from clearing. It is the unwinding of trades that is the central point here. If a trade is too complex to be simply unwound, then losses will continue to mount.

In short, central clearing is the right way to go, but only for the right products. Some products are too complex and too bespoke and, therefore, carry a larger inherent risk that CCPs and their clearing members simply should not be exposed to. Deciding which products should and should not be cleared, and what collateral can be posted against those trades that are to be cleared, is another regulatory challenge and another risk in the space.

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Derivatives Plagued by Manual Processing – the Case for Automation

By Jorgen Vuust Jensen, SimCorp
Originally published on TABB Forum

Seventy-nine percent of capital markets firms report that they still rely heavily on spreadsheets and manual processes when processing derivatives, and 84% cite the need to create workarounds to support derivatives in their current middle- and back-office operations.

An increasingly global emphasis on derivatives strategies by asset managers has made the need for straight-through-processing (STP) greater than ever before. In a highly competitive industry, a firm with investment management systems characterized by a high degree of automated workflows and processes is in a better position than competitors that still contend with manual processes and workarounds. However, a new SimCorp poll shows that a large number of firms are still at the mercy of their legacy systems, using manual processes when processing derivatives.  

SimCorp recently conducted a survey of nearly 150 executives from capital market firms in North America to measure how important STP processing is and the current conditions that firms are working with. The poll revealed that 74% consider STP to be extremely important when it comes to derivatives processing. However, further poll results indicate that these needs are not being met by their current systems – 84% of respondents cited the need to create workarounds to support derivatives in their current middle- and back-office operations. Seventy-nine percent reported they still rely heavily on spreadsheets and manual processes when processing derivatives. Furthermore, 82% require at least two months to model and launch new derivatives products, and sometimes significantly longer, utilizing their current systems.

The findings of the survey demonstrate that firms are being exposed to major and unnecessary risk and as they continue to employ manual processes in a rapidly changing industry. As the study suggests, firms are conscious of new and improved solutions that will help them achieve a strong competitive advantage and improve the functions of their firm, but there is a major struggle to determine how they should move ahead with implementing these brand-new solutions.  

The changes in the OTC derivative space increasingly drive the need for front-to-back STP, and it is imperative that operations teams consolidate STP throughout the derivatives lifecycle in order to increase efficiency, reduce processing time, and cease dependency on spreadsheets and manual “systems.” STP assimilation also helps firms to provide transparent audit streams and ensure proper reporting to management.

The challenges in the derivatives market – ranging from regulatory demands to rapidly changing market conditions – make the case for STP even stronger. Since individual derivatives trades can have a considerable effect on the portfolio, especially in terms of exposure to several market factors, it is extremely important to have updated technology in place to integrate the process, provide optimal data operability and ultimately increase portfolio performance.

Capital market firms are essentially aware of the significant benefits of STP but seem hesitant to implement the process. As new market requirements continue to emerge, it has become crucial for asset managers to evaluate and update their IT infrastructure to include automation – which in turn will shorten processing cycles and increase efficiency, thus securing a competitive market edge.

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Swaps Compression: Impact on Clearing Fees and Margin

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

Swaps compression trades reduce line items, clearing fees and margin. But they come at a price. And determining whether they are cost-effective depends on the details.

In my recent article, “Swaps Compression and Compaction on TrueEX and Tradeweb SEFs,” I looked at the mechanics of these trades and the evidence in SEF and SDR figures, and stated that the benefit was to reduce line items and clearing fees. In this article, in order to determine whether the cost-benefit in terms of fees and margin is a positive factor on the benefit of reducing portfolio complexity by removing line items, I am going to take a deeper look at just the impact of compression on clearing fees and margin.

Client Clearing Fees

For clients, the first set of fees are those charged by their FCMs or clearing brokers.

Such fees typically consist of a new-trade ticket fee, a periodic maintenance fee and a portfolio charge – the latter for the funding cost implications of a segregated account, financial resource utilization and funding of default fund contributions.

The most convenient public disclosure on OTC clearing fees is that required by EMIR. On the assumption that such fees are similar to those charged to US firms under Dodd-Frank, let’s see what a few of these state:

  • Barclays Fees, £750 per new trade, £75 per quarter, 100 bps on Initial Margin
  • JP Morgan Fees, $1,500 per trade, 60 bps on Initial Margin
  • Citi Fees, $750 per trade, 50 bps on Initial Margin

The list shows a wide variation in list prices; however, we can be sure that after negotiation, actual prices will converge – provided a minimum annual revenue threshold of around $250,000 is met.

Let’s assume a client can negotiate a $500-per-ticket fee and 60 bps on IM.

Clearing House Fees

Clearing house fees are passed on by FCMs to clients under two types of plans: a standard plan and a high-turnover one.

Standard Plans:

  • CME OTC IRS fees are $0.25-$24 per million for a trade and then $2.00 per million, per annum, per line item and volume discounts.
  • LCH SwapClear fees are $0.9-$18 per million for a new trade and then $3.00 per million, per trade, per annum.

High-Turnover Plan:

  • Both CME & LCH are the same: $25 per ticket plus a monthly charge of 10 bps, annualized, on IM.

A client not only has the funding cost of the Initial Margin requirement, but as we see above, the clearing fees also have a component linked to the IM. Consequently, IM is an important and significant determinant of the overall cost.

Compression - A Simple Example

Let’s now look at an example of compression costs and savings in action.

Assume we just have a single 2Y Swap of $100 million receive fixed in our portfolio, which we executed one week ago and that we now no longer need.

What is the cost of the compression?

As we know from my prior blog, this involves entering into a new swap with the same terms but opposite direction (pay fixed) to the existing swap.

  • Let’s first assume there is no explicit execution fee (not unreasonable?), so we are left with clearing and SDR reporting costs.
  • Consequently, we need to pay $500 for client clearing fees and $250 for CME or $225 for LCH (assuming the standard plan).
  • For SDR reporting, let’s assume $15 per trade.
  • So $765 for CME and $740 for LCH.
  • Let’s call this $750.

And what is the saving?

  • First, we will not have to incur the annual clearing house charge of $200 for CME or $300 for LCH, which for two years is $400 or $600 respectively.
  • Second, we no longer have an IM requirement, as the net risk of the two trades is zero.
  • Which means that we no longer need to fund the IM requirement and will not have to pay 60bps on IM to our FCM.
  • So the saving is either $400 or $600, plus the reduction in funding cost and the IM fee saving.

To proceed we need to determine the IM for our 2Y Swap, which we do in Clarus’s CHARM, as below:

tabb 8 11 14 1

Then, for arguments sake, let’s assume our funding rate is 2% more than the interest we earn on the margin deposit.

So our monthly funding cost is $750 for CME and $950 for LCH, at least for the first month.

After that, IM decreases as our 2Y Swap ages, mainly as DV01 decreases with remaining maturity (a 1Y Swap has less than half the DV01 of a 2Y). As a rough approximation, let’s assume that the average IM over the life of our 2Y Swap is 40% of the IM at inception. Our funding cost over 2Y is then $7,200 for CME and $9,000 for LCH.

Using the same 40% assumption for average IM over the 2Y, we can also estimate the 60bps per annum of IM as $5,400 for CME and $6,800 for LCH.

Bringing all the above figures together:

  • Cost of compression trades is $750.
  • Benefit over the 2 years is $13,000 for CME and $16,500 for LCH.

So very clearly in this case the cost-benefit of compression is firmly in the positive.

However, in this simple example, given that the DV01 of the 2Y trade is approximately $20,000, the business imperative to neutralize this DV01 is of more importance than the cost benefit of compression.

Consequently, the decision to do compression is not determined by the cost-benefit of compression per se, but simply the use of compression to neutralize the DV01.

Compression - Another Example

Let’s now construct another example, one in which we have already decided to hedge the original Swap, one week later with a new 2Y swap (on-the-run and par), and we are now left with two Swaps with a small difference in fixed rate (e.g., 0.1 bps) and a 1-week mismatch in maturity dates.

We could choose to let these trades run down to maturity. However, let’s see whether compression is also worthwhile in this case.

Cost of compression:

  • Enter into two trades to offset the two existing ones.
  • So $1,000 in client clearing fees and $500 for CME or $450 for LCH.
  • For SDR reporting, let’s assume $15 per trade, so $30 in total.
  • A total of $1,530 for CME and $1,480 for LCH.
  • Let’s call this $1,500.


  • No annual maintenance charge for the two trades, so $800 for CME or $1,200 for LCH.
  • Reduction in funding cost and IM fee?

In this case, the reduction in funding costs is much less significant, simply because the 2 original trades are already almost but not quite perfectly hedged – except for 0.1 bps on fixed rate and 1-week maturity mismatch.

In fact, if we construct an account with these two original trades and run in CHARM, we get the following:

tabb 8 11 14 2

So we can see that there is still in fact a small Initial Margin – much less than we had before, but material nonetheless.

The funding cost of this (using the same 2% and 40%) over the 2 years is then $400 for CME and $970 for LCH.

And the 60 bps of IM over 2 years is $300 for CME and $700 for LCH.

Bringing all the above figures together:

  • Cost of compression trades is $1,500.
  • Benefit over the 2 years is $1,100 for CME and $2,300 for LCH.

So in this case, for CME the cost-benefit is not positive, while for LCH it still is.

However, if we were not on a standard plan but a high-turnover plan, our cost of compression would be just $1,100 as the clearing house fee would be $25 and the 10bps on IM.

This moves the cost-benefit toward positive territory for CME – as would a greater mismatch than 1-week and a greater difference than 0.1 bps.

So we can see that even with seemingly hedged portfolios, there is a cost-benefit in compression to get rid of the residual risk.

Compression - A Portfolio Example

Now, in the real world, we would not be looking at simple portfolios with just our 2Y Swap trade, but a portfolio with many existing trades.

In this case, compression to reduce line items in itself would generate significant savings in the clearing house maintenance charge (and even more savings if our FCM also charges this, as Barclays states).

Let’s say we had 100 line items with gross notional of $5 billion, and an average size of $50 million per trade.

The annual maintenance for these would be $10,000 for CME and $15,000 for LCH – not massive, but it still adds up over the life of these trades, which may be 5Y or 10Y or 30Y.

Meanwhile, the reduction in Initial Margin should be determined as the marginal impact on the portfolio margin of the compression trades.

I won't go into the details of this now, except to note that in some cases it may not be a reduction but an increase in margin and so not a saving but a cost! (If you are interested in details on the portfolio example, please send me an email).

For a compaction, in which we are seeking to not change the risk (or the margin), there would be no reduction in margin. So in this case, the focus is simply on the clearing fees, both the new-trade fees and the reduction in annual maintenance fees.

Very detailed, so thank you for sticking with it. (Any errors in the above calculations are all mine, so please let me know if you find any.)


Compression trades have a cost, as they are new trades that must be cleared.

The cost is in client clearing fees per trade paid to the FCM and clearing house fees.

The reduction in line items reduces portfolio complexity and often is the prime reason for compression.

While the new compression trades attract a new-trade clearing fee, the fact that they net down (extinguish) the existing trades means that there is no longer an annual maintenance fee payable to the clearing house.

The greater the number of trades (line items) removed, the greater this benefit.

Another benefit, often greater, is the reduction in Initial Margin, as this determines both funding cost and the FCM portfolio charge.

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Technology and Proprietary Trading Under the Volcker Rule: Unpleasant Surprises

By George Bollenbacher, Capital Markets Advisors
Originally published on TABB Forum

Banks may be ready for the Volcker Rule, but their technology vendors may not be. And that could be a big problem.

With the compliance date for the Volcker Rule just under a year away, most banks are fully involved in getting ready. But their technology vendors may be way behind – if they are even aware of the rule’s implications for their products. Unless tech companies get on the stick, banks may find that many of their compliance efforts are compromised, if not rendered ineffective, by technology partners.

First Things First

To understand the VR’s impact on technology, we first have to understand its structure. After exempting certain securities (US governments, munis and foreign sovereigns), the rule says no US bank – no matter how small – can trade as principal in any other instruments unless it has an exemption. In addition, the determination of whether a trade is exempt is up to the bank’s examiners, and will be made after the fact. The OCC has recently issued a guide for examiners and the five relevant agencies also have issued a set of FAQs that give us some insights into how the rule will be enforced. When we read them with the rule itself and the preamble, we get a clear picture of what is needed.

To begin with, every trade a bank transacts in a non-exempt instrument will have to be defensible to an examiner, possibly years after the fact. Needless to say, banks are worried about both intentional and inadvertent violations, which could get them into hot water with their regulators, and are placing a premium on automated ways of:

  1. Linking trades to exemptions.
  2. Alerting management when a potential violation occurs.

Those two requirements are where technology comes in.

The Basics

There are four main exemptions, all with different justifications and requirements:

  1. Liquidity management
  2. Underwriting
  3. Market-making
  4. Hedging

Since a single trading desk may execute trades under more than one exemption, and more than one desk may trade in the same instrument, the first requirement is a field to identify which exemption applies, such as (L)iquidity, (U)nderwriting, (M)arket-making, (H)edging, or (N)/A (for exempt securities). We should note that two trades in the same instrument might have different exemption codes. Making this a required field would prevent trades being entered without an exemption, and maintaining a list of exempt securities would allow the booking system to verify that ‘N’ coded trades are actually in those securities.

There are two other exemptions that need to be addressed: repo and securities lending. But these trades are usually done in special systems and may not need the linkage in the previous paragraph. However, examiners may require that repo and sec lending systems have built-in functions, such as requiring a two-sided trade for repos, in order to prevent a bank from using those systems to book prohibited trades.

The rules, instructions and FAQs all spend considerable time on the definition of a trading desk: “The smallest discrete unit of organization of a banking entity that purchases or sells financial instruments.”

The FAQ allows trading desks to book trades into more than one legal entity, but, “If a single trading desk books positions in different affiliated legal entities, it must have records that identify all positions included in the trading desk’s financial exposure and the legal entities where such positions are held.” Thus each trade will probably have to identify both which legal entity it was for, and which trading desk executed it.

Finally, the rule places a heavy emphasis on policies and procedures (P&Ps), and the examiners will be expected to judge the permissibility of individual trades primarily on whether they follow the P&Ps. There are different P&Ps for each exemption, but they all require three things:

  1. Specification of allowed instruments
  2. Specification of which desks may trade them
  3. Position and risk limits for each desk.

So another enhancement for trade booking systems will be checking that:

  • the instrument is allowed,
  • that the right trading desk is doing the trade, and
  • the trade leaves the desk within its position and risk limits.

Liquidity Management

Although this exemption has generated the least public scrutiny, it is important because it applies to pretty much any US bank, unless it restricts its liquidity portfolio to exempt instruments. The liquidity exemption requires a management plan that specifies:

  • which instruments can be purchased
  • the aggregate size of the portfolio, and
  • that the purchase is “not for the purpose of short-term resale, benefitting from actual or expected short-term price movements, realizing short-term arbitrage profits, or hedging a position taken for such short-term purposes.”

The rule specifically calls for “internal controls, analysis, and independent testing to ensure that the purchase and sale of securities” comply with the P&Ps, which function would logically fall under the various trade booking systems.

The typical logic process for entering a liquidity purchase would then be:

  • If exemption = L,
    • If instrument is on allowed list,
    • If desk is allowed under exemption L,
    • If aggregate position after trade < limit,
  • Then allow trade,
  • Else return alert.

One additional check, applied to sales under the ‘L’ exemption, would be whether the total number of sales in a specified period exceeds a set limit, defined either in absolute amount or a percentage of the portfolio. This would alert management that examiners may question whether the portfolio is being managed to benefit from short-term price movements.


In addition to the P&P requirements above, the underwriting requirement makes the first mention of something that will also appear in market-making – the “reasonably expected near-term demand” or RENTD. The rule – and the examination instructions – place a heavy emphasis on showing that position sizes conform to the RENTD at the time. The examiners’ instructions indicate that the RENTD should be based on a “[d]emonstrable analysis of historical customer demand, current inventory of financial instruments, and market and other factors regarding the amount, types, and risks of or associated with financial instruments in which the trading desk makes a market, including through block trades.”

Obviously, the RENTD can change over time, particularly when instruments are new to the market or fall out of favor. Thus the bank will need to keep a record of its RENTD analysis at the time of the trade, probably in a document management system. The ideal arrangement would then be for the trade booking system to have at least one additional field for a reference to that RENTD analysis. For trades where the exemption code is ‘U’ or ‘M,’ having that field empty should raise an alert.

Finally, the underwriting exemption requires that the P&Ps specify the “[p]eriod of time a security may be held.” Any position management system used for underwriting should have an alert function if positions with an exemption code of ‘U’ remain on the books for significantly longer than the P&P holding period.


The market-making exemption has received the most press coverage and commentary, largely because it will be the most difficult for examiners to verify. Partly for that reason the rule specifies seven metrics that large banks must start capturing and keeping as of July 1, 2014. They are:

  1. Risk and Position Limits and Usage;
  2. Risk Factor Sensitivities;
  3. Value-at-Risk and Stress VaR;
  4. Comprehensive Profit and Loss Attribution;
  5. Inventory Turnover;
  6. Inventory Aging; and
  7. Customer-Facing Trade Ratio

We are not going to go into the tech requirements for capturing and storing the metrics here, but banks will have to be able to link trades and positions to those metrics after the fact, in case an examiner questions the exemption. Of more value, though, would be alerts in cases where the metrics suddenly deviate from acceptable norms, or in cases where a trade is at odds with the metrics. 

As with underwriting, alerts are needed where the trade has no link to a RENTD document. And, of course, the combination of instrument and trading desk needs to be checked against the P&Ps. The examiners’ manual also refers to the holding period as a criterion, so the bank may want an alert where a position with an exemption code of ‘M’ is unchanged for an extended period (say, a month) which should reflect against the inventory turnover metric.


Of all the exemptions, hedging will require the biggest changes to a bank’s business processes and technology. To begin with, the only things that can be hedged are “the specific risks to the banking entity.” So, no hedging of positions or portfolios, only risks. In addition, the rule requires “analysis, including correlation analysis, and independent testing designed to ensure that the positions, techniques and strategies that may be used for hedging” are correlated to the risk. Finally, the rule requires that the hedge “[i]s subject to continuing review, monitoring and management” throughout its life.

We can see that any position where the exemption code is ‘H’ will need a link to the documentation of the risk being hedged, perhaps using the same field used for the RENTD link in underwriting and market-making, since RENTD doesn’t apply to hedging. In addition, the rule requires documentation of “[t]he specific risk-mitigating strategy that the purchase or sale is designed to fulfill,” so that additional link will be needed in the trade record as well, unless the risk and the strategy are contained in the same document. Given that there is a history of banks or traders claiming that a trade was a hedge when it wasn’t, a few additional checks may be needed, such as a large number of positions referring to the same risk documentation.

What can’t be hedged? The examiners’ manual indicates that the following are NOT hedges under the exemption:

  • Reducing risks associated with:
    • the bank’s assets or liabilities generally; or
    • general market movements or broad economic conditions;
  • Profiting in the case of a general economic downturn;
  • Counterbalancing revenue declines generally; or
  • Arbitraging market imbalances unrelated to the risks resulting from the positions lawfully held by the bank.

Other than that, the rule allows the hedging of any banking risk, as long as it is quantifiable and correlated. Given the wide range of risks that could be hedged, the correlation function might be fairly complicated, and monitoring that correlation might be a stretch for the usual bank technology. This is an area where creative technologists might capture a significant market share and profit.

Additional Implications

Of course, everyone knows the myriad of separate systems that a typical bank runs in its trading businesses, and this part of the VR doesn’t promise to simplify that any. Banks will have to determine where and how they will store the documentation that the VR requires, and tech vendors will probably have to build interfaces, calls and APIs to wherever it is stored. In addition, banks will have to determine how important automated monitoring and alerts are to them, and be prepared to pay for such functionality from vendors or build it themselves.

In the end, solving the technology hurdles inherent in the proprietary trading part of the VR will be a group effort, and should probably include the regulators to make sure any development will satisfy their mandates. At this point, though, if banks aren’t actively engaging their tech vendors with a set of requirements, they should expect some unpleasant surprises come next spring.

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Swaps Compression and Compaction on TrueEX and Tradeweb SEFs

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

The industry is seeing increasing volumes of cleared swap compression trades. But what are the mechanics of such trades?

Let’s start with the rational for compression trades. Every cleared swap trade shows up as a line item on a Clearing Statement, and over time we have more and more of these line items, each one attracting a Clearing Fee. The majority of these swaps start as MAT swaps (par coupons and on-the-run tenors), but as they age, they become non-par coupons and broken-date tenors. For some firms these trades may already have served their business purpose.

As termination is only available in the bilateral world, for cleared swaps the appropriate mechanism to get rid of these trades is to enter into equal and opposite trades. “Equal” meaning all the terms of the trade match (start date, end date, notional, fixed rate, floating rate, etc.) and “opposite” meaning pay instead of receive, or vice-versa.

When the clearinghouse sees these new equal and opposite trades, it nets them with the originals, meaning that we are left with nothing, or a reduced notional. This is exactly analogous to what happens when we buy or sell a Futures contract. So compression results in fewer line items and lower clearing fees.

Compression vs. Compaction

It should also be obvious that by entering into new offsetting trades, we are changing the risk and consequently the margin in the cleared account. This means that the transaction needs to be credit checked before proceeding.

Compaction refers to the fact that at the same time as compression, we enter into new swaps that seek to preserve the risk of the initial trades. So we still end up with fewer line items, but without materially changing the risk position or margin. Or conceivably changing risk to a desired goal.

The Mechanics

The business process is as follows:

  • A customer identifies a list of cleared trades that it would like to compress/compact.

  • This list of trades is loaded onto a SEF, credit checked and sent to dealers.

  • Dealers quote to enter into opposite trades, in essence an NPV for the list.

  • The customer agrees to execute with a chosen dealer.

  • The whole list is transacted in one go, with the NPV being paid or received by the customer.

  • The resulting executed trades are reported to an SDR and sent to a clearinghouse.

  • The clearinghouse extinguishes line items (in its overnight batch).

  • The next day the customer’s clearing statement shows fewer line items, resulting in lower clearing fees.

Note: CME and LCH are planning on relaxing the need to match the fixed rate exactly by introducing coupon blending approaches. One result of this is that the NPV will no longer be as large (so less cash changes hands) and another that more swap line items will net together.

Differences to TriOptima

For those of you familiar with TriOptima’s triReduce compression service, which has been running for many years in bilateral swaps trading, the differences should now be obvious. TriReduce is a service in which participants agree to terminate existing swaps with no change in market risk (or within a tolerance). The result of the multilateral compression cycle is binding and everyone then terminates their bilateral swaps. Note that these terminations are also reported to SDRs.

Real Data

Let’s now look at some real figures reported in the most recent two weeks by two SEFs. Using Clarus’s SEFView, we can isolate just trueEx and Tradeweb and do so for IRD:Vanilla in USD.

Which shows $22.674 billion reported by trueEX over seven business days in this 10-day period.


We know that for trueEX the reported volumes are exclusively from its PTC platform.

If we were to drill down on the July 14, 2014, figure of $2.589 billion, we would see that this is reported as a 2Y tenor transaction, but with no other details.

However, we know that these trades would also have been reported to an SDR.

Using SDRView Pro, we can select July 14 and instead of Spot, pick the sub-type “Old” (meaning trades with effective date prior to our chosen date of July14 ).

Sorting by time, we find the following four 2Y trades:

From which we can see that:

  • These 4 trades were all executed at 16:00 LON or 11:00 NY.

  • The original trades were 2Y swaps when executed in Dec. 2013.

  • The fixed rates these were executed at are 0.399, 0.43, 0.43 and 0.385.

  • Two of the trades are capped at $460 million.

  • So the total of the 4 trades is $1.34 billion, instead of the $2.5 billion shown in SEFView.

In addition if we were to drill down on these trades, we would see that two of them had additional fees of $471,115 and $866,852. These are the aforementioned NPVs, exchanged by the parties to enter into the offsetting swaps – which we could check by revaluing these trades on 14-July, on which date they would be 1Y and 5-months tenor.


Tradeweb on July 14, 2014, reported $37 billion, a much higher figure than on any other day in the period.

Let’s drill down on this figure:

From which we can see that:

  • 2Y has $15.8 billion.

  • 3Y has $11.6 billion.

  • 1Y has $5.6 billion.

  • Each of which are much higher than other tenors.

  • Each of which are much higher than other days for these tenors.

  • The total of these three tenors is $33.2 billion.

Can we find these trades in SDRView? Let’s try:

Sure enough, we can see:

  • 92 trades with $20.8 billion gross notional.

  • Remember that 4 of these are the trueEX deals (with $1.34 billion).

  • So we have 88 trades with $19.53 billion.

  • All of these are executed at 21:07 LON or 4:07 NYC, so we can assume they were transacted as one list.

  • 21 of the trades are capped, so we know the gross notional is higher than $19.5 billion.

In addition, if we drill down we find that only one of the trades has an additional fee, which is $3,276,805. We can assume that this is the NPV that changed hands for these 88 trades to be transacted to offset the existing aged 88 trades.

And the overall gross notional must have been close to $33 billion for these trades – probably a little less, as the Tradeweb SEFView volumes probably include other 1Y, 2Y & 3Y trades.

In my recent blog, A Six Month Review of Swap Volumes, I noted the sharp rise of Tradeweb volumes in June. We can now presume that some part of this was due to Compression and Compaction trades.


Compression and Compaction trade volumes are now significant.

These trades serve to reduce line items and clearing fees, by removing trades that are no longer needed.

The mechanics involve executing new trades with matching terms and opposite direction – which clearinghouses then net (extinguish) in an analogous manner to futures.

SEFs are natural platforms for automating the data and process that needs to flow back and forth between parties.

TrueEX launched its PTC service in Dec. 2013 and has shown good volume each week.

Tradeweb launched its compression platform in Nov. 2013 and executed significant volume in June and July, which accounts for part of its recent increase in IRD volumes relative to other SEFs.

SDRView can be used to see the compression activity, including the executed trade list and associated price (NPV).

New transparency for us all. Provided we have the time and tools to become informed.

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The Dodd-Frank Regulatory Marathon – Pacing Toward Effective and Efficient Financial Reform

By Larry Thompson, DTCC
Originally published on TABB Forum

While Congress may have sprinted to enact Dodd-Frank, over the past 1,460-plus days since the legislation became law, regulators have altered their pace and focused on simply crossing the finish line.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law four years ago and since then, the regulatory implementation of these reforms has turned into a marathon. While Congress may have sprinted to enact Dodd-Frank, over the past 1,460-plus days since the legislation became law, regulators have altered their pace and focused on simply crossing the finish line.

While progress has been made in a relatively short period of time, a significant amount of work still lies ahead. Take, for example, the role Dodd-Frank envisioned for trade repositories. Congress mandated that all swaps transaction be reported to swap data repositories (SDRs) to ensure that regulators and the public have transparency into the global over-the-counter (OTC) derivatives markets as a way to mitigate systemic risk.

Today’s reality is that regulators are no longer faced with a lack of data but rather with the challenge of deriving critical information from that data to effectively monitor risk and exposure. The financial industry has learned that while the act of collecting and transmitting the data appears fairly straight-forward, it is a complicated process. The bigger challenge, however, lies in the ability to standardize, analyze and draw conclusions from it.

Despite a near universal understanding of the critical role played by trade repositories, a lack of regulatory harmonization could unravel progress that’s already been achieved in bringing transparency to this market. Differences in data reporting standards and access, privacy laws and sharing requirements across jurisdictions only serve to complicate efforts to aggregate data. These challenges may also prevent regulators from identifying counterparty exposure and the build-up of risk in the financial system – critical components in obtaining a holistic view of the market. 

With the finish line still a ways down the road, regulators are focusing attention on addressing data challenges. For example, outgoing Commissioner Scott O’Malia of the Commodity Futures Trading Commission (CFTC) recently citeddata sharing and harmonization as a critical area of cross-border cooperation. To address this issue, he encouraged ongoing discussions regarding mutual recognition and global collaboration to harmonize both the form and format of data being reported.

US regulators aren’t the only ones focusing on addressing data reporting and access issues. At a recent industry conference, the European Securities and Markets Authority (ESMA) highlighted that privacy laws and indemnification clauses already in place in several jurisdictions could restrict access to critical OTC derivatives transactions data held by US SDRs. Fortunately, there is a bipartisan piece of legislation in the US Congress (H.R. 742) that would address this issue and eliminate the need for US-based SDRs to obtain indemnification agreements from foreign regulators prior to sharing critical data. H.R. 742 passed the House of Representatives in a 420-2 vote and the text of this technical fix was also included in the recently approved Customer Protection and End-User Relief Act (H.R. 4413).

In the race for financial reform, global efforts to enhance market transparency and mitigate systemic risk require global coordination. However, as the past four years demonstrate, this is a regulatory marathon, not a sprint to the finish line. It will take time to effectively and efficiently implement the financial reforms envisioned by the Dodd-Frank Act.

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Initial Impressions on Compression – Q&A with Tradeweb’s Michael Furman

The Dodd-Frank Act may just be the best example of unintended consequences in action. It seems like each new rule implementation has created a ripple-effect of reactions in the marketplace, some of which were anticipated and others that took everyone by surprise. Take the central clearing mandate, for example. On the surface, you can imagine how lawmakers envisioned a world in which every swap transaction cleared through a central party would create a more stable derivatives market. What lawmakers likely did not envision was the slew of other technical issues that were raised the moment the idea of a central clearing party was introduced.

One of these is compression. Developed initially at Tradeweb, a leading SEF, as a way to reduce clearing costs, compression allows traders to submit up to 100 line items to market making participants for pricing and execution at one time. Each of these trades can offset existing positions or aggregate other trades at the clearing house.  By netting these trades in this manner, traders effectively reduce the number of line items outstanding at the clearinghouse, which reduces overall clearing costs.

That all sounds pragmatic enough, but once market participants started using compression trading on Tradeweb, they also found that the process lent itself very nicely to custom swap lists, essentially making it possible to bunch a large number of unique trades together and for faster, more efficient pricing. To find out more about how market participants are experimenting with compression trading that grew out of Dodd-Frank, DerivAlert sat down with Tradeweb Managing Director Michael Furman.

DerivAlert: Tell us about this new compression functionality; what was your original intent when you launched it?

Michael Furman: The process of consolidating swaps at the clearinghouse is different than that of unwinding a bilateral trade. The clearinghouse requires an exact offset of the original trade to be executed and cleared. We wanted to provide our customers with a tool that allows them to manage their line item exposure, which ultimately aids in the reduction of clearing costs. With the new clearing mandate, you had this situation where a portfolio of swaps would sit at the clearinghouse as a bunch of individual trades each of which would be an outstanding line item on a customer’s book until the underlying swap reached maturity.  With our compression tool, offsetting trades can easily be netted to reduce the number of outstanding line items. 

DA: Did this concept exist previously or did it grow out of a response to derivatives reform?

MF: As a result of the clearing mandate and procedures implemented by the clearinghouses, customers are now required to execute an equal and offsetting trade in order to collapse a cleared swap position. So yes, this is new. Prior to the launch of the Tradeweb compression tool, the process was highly manual in that it relied on spreadsheets created by customers, each of which could employ varying formats. With our compression tool, we’re automating that process by making it electronic. This process makes it ultra-efficient for a market participant to pull together a large package of trades and shop it to multiple dealers.

DA: What are the initial reactions among customers?

MF: It’s been extremely positive.  We are able to compress lists of trades with as many as 100 line items, and we have executed compression trades as large as 85 line items. We are now at the point where we are executing 3-5 of these compression lists every day. In addition, our customers are quickly recognizing that there’s more to compression than just reducing the number of overall line items at the clearinghouse. By making the compression process electronic, we’ve opened up this opportunity for customers to create custom swaps trades with this tool. The framework lends itself to a new form of customization by market participants.

DA: Do you see this kind of functionality inducing more overall swap volume to move onto SEFs

MF: Tradeweb has been supporting electronic derivatives markets since 2005; our proposition has always been that if you make it easier and more efficient to trade electronically, the markets will eventually migrate in your direction. Compression is turning out to be a great example of that theory in practice. We’re seeing both MAT’d and un-MAT’d swaps show up in custom trades that have been built using our compression tool. This is a clear sign that the growth we’ve seen is more than just mandated trading, it is about efficient trading.

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TABB Group SEF Barometer Survey: Industry Perspective on SEFs

TABB Group is hosting an online survey of market participants’ activity on SEFs to gain insight from on their view of the new world order of electronic derivatives trading.

The survey will measure participants’ experiences with a variety of SEF-related issues, including MAT self-certification, swap trading activity, trading protocols, regulatory mandates and more.

Please note the survey is anonymous and will be available until August 4th. To participate in the SEF Barometer 2014 survey, please visit:

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Dodd-Frank at 4: Derivatives Reform Is a Glass Half Full

By Mayra Rodriguez Valladares, MRV Associates
Originally published on TABB Forum

Many challenges remain in implementing Dodd-Frank’s derivatives reforms, as swap dealers retool their technology to improve data collection, aggregation and reporting. But regulators, particularly the CFTC, have made strong progress.

A number of analysts, pundits, and financial journalists are observing the fourth anniversary of Dodd-Frank by pointing out that much of the law has not been implemented. That is correct. While a little more than half of the rules are now finalized, that does not necessarily mean that they have been implemented. Typically, financial and bank regulators give institutions a year or two to comply after a rule is finalized.

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Source: ‘Dodd-Frank Progress Report, Davis Polk, July 18, 2014.

It is very important to remember that a toxic political environment in Washington, regulators with significant resource constraints, very strong and continued lobbying against every single part of Dodd-Frank, and lawsuits against regulators have been significant deterrents. In addition, financial regulators cannot deploy all of their staff to the challenging task of Dodd-Frank rule writing; they already have their existing regulatory, legal, and supervisory responsibilities. Even while writing rules, regulators have been doing so in an environment where the US economy has been mostly growing anemically, and they have to think of the potential impact of the rules on institutions, markets, and the economy at large.

Despite numerous challenges, some of the agencies have finished many of their assigned tasks. For example, the CFTC, which is responsible for regulating and supervising the disproportionately largest part of the financial derivatives markets, has done an incredible job in finishing almost 85% percent of its assigned rules.

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Source: ‘Dodd-Frank Progress Report, Davis Polk, July 18, 2014, p.5.

The CFTC’s accomplishment is particularly impressive considering that is the smallest regulatory agency and has been a favorite target of Republicans who want to make sure that the agency has the smallest budget possible. Shockingly, the CFTC is still operating with a level of personnel and technology from decades before Dodd-Frank. This financial regulator is responsible not only for its existing mandate of regulating exchange traded products and derivatives exchanges, but also it now regulates over-the-counter (OTC) interest rate derivatives and index credit derivatives. In the US, these products represent about $200 trillion in notional amounts.

Also, CFTC professionals spend a good part of the day listening to comments and pleas from numerous market participants and lobbyists, as can be seen in their public website. (Actually, the CFTC is the only regulator that publishes its visits ahead of them taking place, as opposed to after they have already happened. Other regulators should learn from the CFTC’s transparency.)

In less than four years, the CFTC has finalized instrumental rules for derivatives reforms:

  • Created legal definition for a swap
  • Designated swap dealers
  • Defined what is a US person
  • Instituted swap transactions reporting
  • Released core principles for derivatives clearing organizations (DCOs), which are the central clearing parties approved to clear derivatives in the US, and
  • Has been conducting due diligence on and setting standards for the companies approved to be swap execution facilities (SEFs).

Yes, many challenges remain in implementing Dodd-Frank’s derivatives reforms, as swap dealers retool their technology to improve data collection, aggregation and reporting. Swap dealers, especially banks, also have to think continually of how to upgrade the skills of their existing middle- and back-office professionals, IT, auditors, and compliance professionals.

For its part, the CFTC will continue to be plagued by the roadblocks politicians place in its path. They ask it to do a better job and then tie its limbs by denying badly needed resources. Equally challenging for the CFTC will be to work with foreign regulators, especially in Europe. As long as rules and supervisory practices are different, the global derivatives market will be challenged by a potential lessening of liquidity. Importantly, if rules on both sides of the pond are not equally strong in the way that they are written, supervised, and enforced, then swap dealers will outsmart regulators through regulatory arbitrage.

The CFTC has new leadership. Given what I have seen by working both with swap dealers and training numerous CFTC professionals, I see Dodd-Frank’s derivatives reforms as a glass half-full. And I look forward to the next few years as it continues to fill up.

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Crunch Time for Clearinghouses as Regulators and Participants Shift Focus

By Radi Khasawneh, TABB Group
Originally published on TABB Forum

The concentration of risk among central counterparties in the new global market structure must be accompanied by a proportional increase in transparency and reporting at the CCPs.

We are at the implementation phase of a global regulatory shift that will force the majority of swaps into clearing. The idea behind the push was to give regulators a cleaner view of risk in the derivatives world; but ever since the intention was announced by the G20 in 2009, market participants (Lloyd Blankfein among them) have long been concerned that this in itself may be creating additional systemic risk.

After all, if most trades have to go through a limited pool of central counterparties (CCPs), the potential for a significant market shock increases. Conceptually, there are safeguards to prevent this concentration of risk in a handful of venues. Future Commission Merchants (FCMs) that facilitate clearing demand and post margin, and all clearing members contribute to the default funds that are there to minimize the fallout of a default.

TABB Group’s view has been that there is not necessarily a problem with this; but that the increase in the importance of CCPs in the new market structure must be accompanied by a proportional increase in transparency and reporting at the CCPs. Many of the safeguards are dependent on proprietary and often opaque modelling. They are owned or operated by a mixture of dealers and exchanges, meaning that everyone’s risks should be aligned – but a further level of assurance is necessary.

News earlier this month that indicated that two leading clearinghouses have agreed to provide additional disclosure on their default fund and all-important margin requirement models is therefore highly encouraging. This paves the way to the establishment of a formal disclosure standard by the International Organization of Securities Commissions (IOSCO) later this year.

This will go a long way to alleviating the still glaring differences in global clearing margin requirements and disclosure standards, analyzed in a recent TABB Group report, “Global Collateral Standards 2014: Breaking Through Regional Silos.” In that report, we pointed out that short-term fragmentation (with multiple entities split geographically) was likely to give way to consolidation and standardization over time. Regional clearinghouses cannot simply do their own thing and march to the local regulator’s tune, and huge differences remain in margin treatment globally (see Exhibit 1, below).

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Sources: Company reports, TABB Group

It is far more preferable that this comes from the clearinghouses themselves and, in fact, the efforts of many global clearinghouses to attract increasing flow across different products in order to boost margin efficiencies increases the complexity of the modelling question, making it even more crucial.

This is an inherently healthy process, but there are problems. Primarily, the problem is a political one, and the lack of clear progress on the issue of equivalence between the US and Europe is a particular concern. In June, comments on a panel at the IDX conference by the CFTC’s Ananda Radhakrishnan caused a stir when he said that he was tired of granting cross-border clearing exemptions for European CCPs, and that it would be simpler if they moved clearing operations to their jurisdiction.

So where does that leave us now? We still believe that standardized and periodic disclosure within a global and equivalent framework is the most likely outcome – probably facilitated by an increase in global tie-ups and cooperation agreements between the CCPs themselves. The need for assurance on the systemic issue is critical to all, and the CCPs themselves have begun to more stridently make the case for the benefits of the new system. Last week, Eurex (owned by Deutsche Boerse) published a white paper laying out the benefits of the new system versus the bilateral model. This in itself merely supports the moves by global governments to date, and increased transparency into risk models will help the case.

This all is a sign that CCPs are getting more used to the idea of operating in an open environment, a welcome and necessary step. A bit of pragmatism on all sides will go a great way to untangling the balkanized system we have today. 

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