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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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What Is a Basis Point Worth?

By Edward Talisse, Chelsea Global Advisors
Originally published on TABB Forum

Ten years ago, no one wanted to inconvenience themselves to try to pick up a few basis points. But today's investors are falling over themselves to collect those very same basis points. Here are 6 risky strategies to combat a flattening yield curve – and why you probably should avoid them.

Ten years ago I started working in Japan as a fixed income sales trader for an international investment bank. I was frequently called upon to travel to other parts of Asia, including Beijing, Hong Kong, Seoul, Singapore and Sydney. My mandate was to invite clients to explore the many money making opportunities available to them by trading the (G4) U.S., German, U.K. or Japanese yield curve.

The touchstone recommendation always seemed to be some combination of going long or short U.S Treasuries and establishing an offsetting position in like maturity German Bunds. Most of our trade ideas were simple variations of a basic mean reversion strategy – optimistic to pick up a few basis points along the way.

After my pitch, I was frequently met by the same incredulous reaction: "Eddie, we are not interested in making a few basis points. ... We want full points, preferably in multiples of 10." No one wanted to inconvenience themselves and stoop down to try to pick up 10, 20 or even 50 basis points! Of course, being in Asia, the clients were always very professional and extremely polite, but my colleagues and I usually left empty handed. We did not win a lot of new business out there. 

Back then 10y yields ranged between 4.25% and 5.25% in the U.S., U.K. and Germany and about 1.75% in Japan – so maybe some investors could afford to ignore a few basis points here and there. Well, we have all moved on since 2004 and 10y yields now range between just 0.53% in Japan and 2.72% in the U.K., with the U.S. and German yields sandwiched in the middle. Today's investors are less finicky and are now falling over themselves to collect those very same basis points.

So what do you do when you are now faced with a diminutive and none-too-generous yield curve – and you need income? Here are some (very risky) strategies:

  1. Sell a Tail- increase leverage and borrow on margin; borrowing money to increase long exposure is effectively selling the left tail in a distribution of potential outcomes.
  2. Sell Volatility- sell options outright and or engage in covered call writing.
  3. Sell Convexity- or go long instruments like MBS or callable bonds.
  4. Sell Quality- that is, go long lower rated, more risky instruments, such as High Yield.
  5. Sell Liquidity- that is, buy highly illiquid instruments like Emerging Market debt denominated in local currency.
  6. Buy Structured Products- that is doing all of the above in one handy trade.

The concern, in my view, is that all of these alternatives are now almost completely exhausted. Look at a table of Bond Benchmark Performance and you will see that just about every index is near its 52-week low in spread. That means you don't get many basis points (forget about full points!) by engaging in the highly risky strategies numbered above.

As an asset class, risky bonds look, well ... very risky. The upside is measured in basis points, while the downside is measured in points.

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A Simpler View of Complex Markets – Q&A with Fidessa’s David Polen

Whoever said technology would make our lives easier didn’t trade futures and options on five or six different exchanges spread out across a dozen different time zones.  Thanks in large part to universal connectivity market participants can access liquidity in virtually any asset class anywhere in the world.  But with that capability comes a great deal of complexity.  Different regulatory regimes, trade processing requirements and various technical intricacies give each asset class in each market around the world a unique set of rules that can challenge even the most sophisticated market participants.

Recognizing the need for global reach without the technical and regulatory complexity that comes along with it, Fidessa is hard at work to help guide clients in the new world order of electronic trading.   DerivAlert caught up with David Polen, global head of electronic execution to discuss how the industry is simplifying global markets.

DerivAlert: You’re in a new role at Fidessa as global head of electronic execution. Tell us more about the direction you’re headed

David Polen: This is all about taking the next step in helping our clients access markets more efficiently than they ever could have done before.  Whether you are trading Treasurys in New York, equities in Brazil, or futures and options in Japan and Australia, you want to have a reliable framework.  We want to make accessing these markets as consistent as possible so our clients can focus on trading instead of navigating technicalities.

DA: Ironically, just as technology has made it easier than ever to trade electronically around the globe, regulatory reform made it more complex than ever to execute trades; is that phenomenon driving your thinking at Fidessa? 

DP: Fundamentally, we’re dealing with market structure issues and compliance issues.  You need to be able to understand how those variables work together before you can start to make it simple and give clients a normalized view of hundreds of different markets.  That’s the value we’re bringing: we’ve organically solved many of the most challenging execution issues from a compliance perspective so we can bring all of these markets together in one place electronically.

DA: What markets are you currently serving and where do you see yourself expanding?

DP: For electronic execution, we cover equities, futures and options, liquid equity options and Treasurys across 220 markets around the globe.  We’re continuing to expand this list into several asset classes. Swap Execution Facilities (SEFs), for example, are an area where we see tremendous potential.  We believe the buy-side wants to be able to trade electronically globally, and brokers want to facilitate those global trades instead of running different stacks for each market. 

DA: How are you improving efficiency for brokers in these markets; can you give us an example?

DP: Let’s take futures, for example. For a client located in Chicago, whether that client wants to execute a trade on the CME or wants to execute in Hong Kong, they send a Direct Market Access request into the Fidessa cloud in Chicago and, using co-location hubs located around the world, we provide access to over 40 futures markets with very low latency.  We can make that experience very consistent with what they are doing in equities, Treasurys, etc.  And then we can provide post-trade analytics that let them benchmark performance.  It’s really about making the workflow more efficient for our clients so they can focus on the markets.

DA: What do you see coming down the pike over the next year to eighteen months?

DP: We’re committed to continuing to expand into new asset classes, in a world that is moving quickly into electronic trading.  Our philosophy is that there is enormous value in giving our customers a consistent execution framework and a simple, normalized view of these markets so they can focus on their business and value-add instead of infrastructure issues.

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Collateral Damage: Regulatory Fallout Is Transforming Collateral Management

By Thomas Schiebe and Neil Wright, Sapient Global Market
Originally published on TABB Forum

Regulatory reform has transformed collateral management into a complex, costly exercise involving higher volumes of collateral, increased margin calls, and interaction with more counterparties. But while fewer than half of market participants feel strongly that their institutions have efficient processes for collateral management, there are opportunities for quick wins.

New legislation around the globe – including Dodd-Frank, EMIR, and Basel III – has created a tangled web of rules designed to increase market stability and resiliency, enhance transparency and accountability, and reduce counterparty, operational, and liquidity risk. The fallout of regulatory reform for most banks and capital market participants has transformed collateral management into a complex, costly exercise involving higher volumes of collateral, increased margin calls, and interaction with more counterparties.

A recent Sapient Global Markets survey examined some of the key issues for firms, including collateral availability, strategies, dispute management, and the systems and process used to support the collateral management function.

That survey revealed that 95% of respondents expect the amount of OTC clients with collateral agreements to increase, as well as the amount of daily collateral calls. Additionally, more than half expect disputes to significantly increase as a result of new participants in the collateral space.

With such a significant evolution of the market underway, these results are unsurprising. Many market participants have cobbled together fragmented systems, manual processes, and siloed approaches for collateral management in order to ensure compliance with various regulatory requirements. Unfortunately, such efforts have made managing and processing collateral a very inefficient and costly component of their businesses. In fact, fewer than half (45%) of participants in that survey felt strongly that their institutions have efficient processes for collateral management, particularly in the area of communication and dispute management.

While regulatory change continues to drive firms’ investments in new technology and infrastructure, there are also a number of trends influencing the desire to increase efficiency and reduce costs, the most prominent of which we’ll discuss in further detail below.


At the same time that demand for collateral has increased, circulation of existing collateral has decreased. According to economists at the International Monetary Fund, declining confidence in issuers and counterparties has reduced the circulation rate of collateral between counterparties from three times its original value in 2007, to just 2.4 times today. With issuance of highly rated securitized debt also shrinking, predictions of a worldwide collateral shortfall are possible.

This puts greater pressure on firms to identify eligible collateral, locate it, and then match it with the collateral demands they face. If they lack the collateral eligible to meet one of those demands, they have to work out how to obtain it. Mismanaging collateral can damage performance and reputations, as well as increase costs.

Technology and efficient processes play a critical part in steering clear of shortfalls.

Cross Asset Netting

Netting on counterparty exposures decreases the amount of collateral a firm must maintain to cover credit risk and protect the balance sheet. Being able to perform pre-trade scenario analysis of counterparty usage and execution can offer significant cost savings to firms.

Unfortunately, tools to perform cross asset netting are still in development as technical standards have not been finalized by regulators. Once available, firms will be able to more easily estimate exposure and the impact of a trade and make cost-effective decisions as to which counterparties to trade and clear through.

Collateral Optimization

When it comes to collateral management, it seems that everyone is striving to achieve optimization. The “optimization” of collateral seeks to make the best use of available assets. Using algorithms, applying compression/netting across assets, or simple prioritization rules can reduce costs and improve liquidity. For Service Providers, optimization can also mean generating increased revenue by offering collateral funding and transformation services.

In order to achieve optimization, firms must have sufficient levels of automation and straight-through processing, as well as technology in place to help identify eligible collateral, prioritize its use, and deliver the lowest cost, mutually acceptable form of collateral across an entire firm.


New regulations now require derivatives market participants to post collateral with counterparties for both cleared and uncleared transactions. This makes it imperative for firms to have systems in place to know exactly what eligible collateral they have available to meet a collateral call—a requirement that could be problematic for some firms. The Sapient Global Markets’ survey revealed that only 51% of market participants have a complete view of their entire inventory of eligible assets to be posted as collateral across business units.

If a firm does not have sufficient, available assets, it can either borrow from a firm through a straight-forward lending agreement, or, for a fee, have its lower-grade assets (with significant haircuts applied) transformed into eligible assets. Such transformation services create a new revenue stream for those that can source high-quality collateral and deliver it to clients that need it.

Given the revenue potential, more than half (66%) of custodians surveyed intend to offer or already have a partial transformation service.

How to achieve greater efficiency

While traditionally, collateral management has been an administrative, back-office function set up as a cost center, the business model is changing dramatically, driven by new regulations and cost pressures. As a result, market participants are currently exploring new revenue streams through transformation services, efficiencies with cross asset netting, bringing improvements to processes such as dispute management and communication, and reducing costs by implementing collateral optimization strategies. Successful execution requires solid planning, advanced technology, and improved processes.

To realize quick wins and be highly effective in reorganization, reprocessing and reengineering, firms should focus on six key areas: inventory management, risk management, data management, reporting and analysis, dispute management, and communication standards.

These six elements, alongside the various challenges to implementing collateral management systems, are discussed in further detail in a Sapient Global Markets white paper, available to download here.

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Does Risk Come Mostly From Volatility, or From Correlations?

By Damian Handzy, Investor Analytics
Originally published on Quant Forum

When it comes to risk attribution, most people look at the contributions made by different asset classes, sectors or investment strategies. But very few look to assign attribution to volatility and correlation.

When it comes to risk attribution, most people look at the contributions made by different asset classes, sectors or investment strategies. Some look at factors such as momentum or size. But very few look to assign attribution to two of the very inputs into most Value-at-Risk calculations: volatility and correlation.

Part of the reason is that the various approaches to calculating VaR don’t lend themselves to isolating these two parts very easily. But a closely related quantity – the square of the VaR number – can indeed be separated into two additive parts: one purely dependent on volatility and the other on correlations.

Investor Analytics’ white paper on this topic, “The Russo Ratio: Decoupling Volatility and Correlation” (which can be downloaded here), introduces three new analytics: CCR – the Correlation Contribution to Risk; VCR – the Volatility Contribution to Risk; and the Russo Ratio – CCR/VCR, which provides a compact way of understanding how much diversification benefit is inherent in the portfolio. The paper explains these measures and analyzes three different portfolios using these new measures to show the effects of low and high diversification.

The Volatility Contribution to Risk is always a positive number, since volatility always increases a portfolio’s risk. The Correlation Contribution to Risk can be either positive or negative, reflecting the potential lowering of risk through diversification. As a percent of total, it is therefore possible to have more than 100% coming from volatility, with a negative percent coming from correlation. For example, in the white paper we show periods of time in early 2005 when an asset-class diverse portfolio showed 110% risk from volatility with -10% risk from correlations. For a given portfolio, we show that the Russo Ratio of CCR/VCR is remarkably stable over time.

This Russo Ratio has a lower limit of -1, reflecting perfect hedging in which the correlations reduce the volatility risk perfectly. Values between -1 and zero represent partial hedging situations in which the correlations partially reduce the risk. Values near zero imply that the correlations don’t reduce or contribute to risk – that all the portfolio’s risk comes from volatility. While the Russo Ratio has no theoretical upper bound, values above 1 indicate that correlations contribute the bulk of a portfolio’s risk.

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We received a number of interesting comments about the paper. While almost everyone had never seen such a decoupling of volatility and correlation, one correspondent indicated that he had implemented something very similar about 10 years ago while managing risk for a prominent hedge fund.

Several managers shared the view that CCR, VCR and the Russo Ratio are most useful when viewed over time to gain both familiarity with the values and to quickly identify outliers. In addition, one correspondent indicated that this is a new way of looking at risk information that can have an advantage in certain situations.

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