STP and Credit Derivatives - European Credit Management(ECM)

At European Credit Management, Tom Willoughby strives to achieve seamless and efficient post-trade processing for credit default swaps.

When Tom Willoughby joined European Credit Management (ECM) in mid-2006, he made a virtual jump from one end of the financial services marketplace to the other. The 34-year-old derivatives specialist had worked in the front office at Barclays Capital and Deutsche Bank, but left the sell side to take up an operations role on the buy side.
Over the past 18 months, Willoughby has focused on improving processing at ECM, particularly for credit derivatives. His overriding objective: to achieve post-trade automation as a means of keeping the firm's costs under control and headcount static.

Credit Curve

Based in London's fashionable Mayfair district-the heartland of many UK hedge funds-ECM was established in 1999 as a traditional long-only asset manager trading predominantly fixed-income securities. In 2005, as a result of demand from increasingly adventurous investors, the firm diversified into credit derivatives and now trades credit default swaps (CDSes) on behalf of 11 of its 18 investment funds. By the end of last year, ECM's assets under management had swelled to €21.3 billion ($31.5 billion) with an overall staff headcount of 172.

The growth of CDS trading was the principal reason behind Willoughby's appointment to ECM, as the firm needed to move toward greater automation in the trade processing chain. While at first ECM might have transacted just 12 CDS trades per month, volumes have grown year-on-year, with a 300 percent rise last year. As many as 180 trades are executed on the busiest trading days.

"Like all businesses, ECM had developed a bespoke way of processing with no standard agreements or conventions in place," says Willoughby. When he took up the newly created post of derivatives operations manager, he was tasked with putting into place standards and systems to move ECM in the direction of more seamless and efficient post-trade processing.

At the top of Willoughby's agenda in 2006 was choosing a platform for confirming trades. ECM at that time decided on an ad-hoc basis whether to confirm through dealer-owned network SwapsWire or through the US-based Depository Trust & Clearing Corp. (DTCC), depending on the trade and the counterparty. Although SwapsWire is a "hugely successful system" for confirming interest-rate derivatives, Willoughby says he was not as confident in using it for credit derivatives. The system relies on the dealer to enter the trade and the buy side to affirm the trade in order to obtain confirmation, he says. Dealers usually confirm interest-rate derivative trades within minutes of execution, mainly because their real-time risk systems don't update until the trades are confirmed. But as risk systems are much more independent for CDS trades, there is no such motivation to confirm immediately and Willoughby says time was often wasted chasing up the sell side for confirmations.

DTCC Deriv/Serv better answers the challenge of the credit market, he says. Where SwapsWire requires dealers to input their trades manually-a process that is not scalable and prone to errors-DTCC offers a direct feed from the dealer's trading system.

"DTCC was a lot quicker in trying to answer the massive growth of the market," Willoughby says. "If we can leave the office every night and know that we've submitted our trades to DTCC, I feel in a better position than if we are waiting for counterparties to submit their trades to SwapsWire."

Under Willoughby's watch, ECM has migrated all of its CDS trades onto DTCC Deriv/Serv for confirmations, leaving interest-rate derivatives to be confirmed through SwapsWire, which he says is the best system for that market. But the firm has internally built its own reconciliation tool for interest-rate derivatives, which extracts the trades from SwapsWire, compares them to the trades in ECM's trading system and automatically affirms them if the details match. Building such a reconciliation tool for CDS trade matching would have been too complicated and costly, especially since DTCC's service was already available, says Willoughby.

Missing Piece

There has been much progress made since the US Federal Reserve called in the major dealers in 2005 to demand that they clear the backlog in unconfirmed CDS trades. DTCC's Deriv/Serv confirmation service and the trade information warehouse, which stores the golden copy of every trade, have greatly improved overall efficiency. But as Willoughby says, simply connecting up to DTCC is not enough to totally eradicate errors. "It's all well and good to submit a trade to DTCC on trade date, but if it's not correct then DTCC can quickly become a warehouse for unmatched trades," he says. "If trades were being captured and submitted incorrectly on the sell side, it could take days to resolve because you had to contact the relevant people at the banks to sort things out."

Willoughby looked to T-Zero, the Creditex-owned platform that markets itself as the "missing piece" in the credit derivatives processing puzzle. T-Zero allows buy-side firms such as ECM to "affirm" trade details with their sell-side counterparties before processing begins and the trade hits DTCC. This means that both sides start processing the trade knowing they have the same details recorded. There is also no discrepancy when a buy-side entity splits the trade across a number of its investment funds.

ECM went live with T-Zero in June 2007 but its progress has so far been hindered by the slow uptake on the sell side, he says. "Initially, there was a failure to recognize the extent of the problem that resided in the back office and hence the need for T-Zero," he says. "Most of the big banks felt that they were already paying for DTCC and shouldn't have to pay for another platform just to get the trade confirmed."

The last few months have seen a rise in the use of T-Zero and the platform, which was launched in 2005, has now signed up 14 major dealers and more than 160 buy-side firms. However, Willoughby says he questions how effectively the sell side is actually using it. "Three or four of our largest counterparties still don't use T-Zero and we are getting to the stage where our potential volumes are restricted by the fact that they don't have auto-affirmation," he says. "Once they use it effectively, we will be closer to the utopia of having DTCC as a pure warehouse of confirmed trades that have been auto-affirmed at T-Zero."

Willoughby's mission for 2008 is the same as it has been since he joined ECM: continuing on the eternal trail to automation. He says he has found the technology that fits the firm best and his mission now is to get all his sell-side counterparties signed up to the same platforms. "We have to get out to our counterparties and almost try to influence them in the direction they go," he says. "If we arrive in the morning to unmatched trades in DTCC, we have to question why that is happening." He looks forward to a time when all trades are confirmed by both sides on trade date. When ECM's employees no longer have to chase counterparties after the trade is done, the dream of no-touch STP for credit derivatives will be achievable.

By Joel Clark

ECM Stats
Headquarters: London
Offices: Capetown, Chicago, Frankfurt, Lisbon, Madrid, Singapore, Sydney and Tokyo
Assets Under Management: €21.3 billion ($31.5 billion)
Number of Clients: 426
Number of Investment Funds: 18
Total Staff: 172

Biography
Name: Tom Willoughby
Age: 34
Hometown: Hitchin, Hertfordshire, UK
Education: University of Portsmouth
First Job: FX clerk at SBC Warburg
Family: Just married in September 2007.
Last Book Read: The Night Manager by John le Carre.
Favorite Place: Chamonix, France
Last Holiday: My honeymoon in Antigua.
Last Gadget Bought: A remote-control toy helicopter for Christmas.
Best Part of the Job: The great diversity of the buy side.

Source URL: http://www.watersonline.com/public/showPage.html?page=702957
Publish Date: 1 February, 2008