Eurex ventures into OTC derivatives clearing

Swiss German derivatives exchange Eurex is in talks with infrastructure providers about introducing a clearing platform for the over-the-counter (OTC) credit markets.

The news comes just days after CME Group said it would expand clearing services to OTC interest-rate swaps and Markit and the Depository Trust and Clearing Corporation (DTCC) said they would form a joint venture for processing and confirming OTC derivatives.

Eurex says its new initiative - which is expected to launch in early 2009 - aims to "complement current US initiatives with a European solution".

The European OTC CCP platform will utilise existing Eurex Clearing functionality, as well as new tools for trade and risk management. The system will initially focus on iTraxx index exposures that are mainly traded out of Europe. Eurex says an extension to other asset classes - such as equity, fixed income - can be "handled flexibly" according to market demand.

The exchange says it is in discussions with several infrastructure providers concerning their involvement in a new platform. Names have not been disclosed but one of the providers is rumoured to be the DTCC.

Eurex says the new service is "designed to address recent developments in the OTC market which suggest that concerns about systemic risk due to the backlog of transaction confirmation and potential counterparty defaults require improvements in the market's infrastructure".

Thomas Book, responsible for clearing on the Eurex executive board, says customers would profit from straight-through processing, enhanced collateral management and multilateral netting for OTC trades which currently account for 84% of all derivatives traded.

Earlier this month Nyse Euronext subsidiary Liffe previewed plans to launch a new set of contracts based on the iTraxx European indexes with integrated OTC clearing through its Bclear operation.

Meanwhile in May the US Clearing Corporation (CCorp) said it had agreed a deal with the DTCC that will result in the launch of a central clearing facility for over-the-counter (OTC) credit derivatives in the third quarter.

Source URL: http://www.finextra.com/fullstory.asp?id=18763
Publish Date: July 23, 2008

DTCC, Markit to Create Single Point of Derivatives Confirmation

Washington's calls for efficient, automated processing of over-the-counter (OTC) derivatives has grown to a clamor that vendors and Wall Street firms can't ignore. Just today, Acting Under Secretary for Domestic Finance Anthony Ryan said, "With respect to market infrastructure, we are encouraging the development of an integrated operational infrastructure for the OTC derivatives market that ensures accuracy and timeliness of trade data submission, resolution of trade matching errors, and integrated processing. We are calling for a cash settlement protocol adopted by market participants and incorporated into standard documentation, and for netting, novation and clearing of OTC derivatives contracts by a centralized counterparty."

In answer to this demand -- an echo of earlier statements made by Alan Greenspan and Ben Bernanke -- the DTCC and Markit announced today the formation of a new company that will combine Markit's front- and middle-office trade processing services with DTCC Deriv/SERV's back-office post-trade confirmation and matching services, providing a single gateway for confirming OTC derivative transactions globally. Buy-side and sell-side OTC derivative market participants will be able to confirm trades and to gain access to additional services provided by Markit and DTCC through a common portal.

Industry observers responded favorably to today's announcement. "Buy-side firms are not keen to patch together a network of internal and external communication networks and systems, and have been waiting for a major dealer-backed solution," said Denise Valentine, Aite Group senior analyst. "Two dealer-backed entities " in the form of Markit and DTCC " have responded to the buy-side demand and have created a new entity to further the cause of automation and simplification."

And analysts at the Tower Group said, "This partnership will prove to be a critical turning point in the development of a single, global operating infrastructure for the full range of OTC derivatives. The combination of Markit Wire and Deriv/SERV addresses the inefficiencies associated with the current fragmented confirmations landscape, reduces the likelihood of radical regulatory intervention, and eases the strain on industry middle and back offices. Although broker dealers may be concerned that one organization now has monopoly power in OTC confirmations, TowerGroup anticipates that the governance structure will allow the industry to continue to influence the direction of the partnership. TowerGroup expects the partnership will yield a central data repository that can be the springboard for multiple new products, such as portfolio reconciliation and collateral management services."

The new company will comprise Markit's recently acquired Markit Wire platform (formerly SwapsWire) as well as its other trade processing services such as Markit Trade Manager, Markit Tie Out and Markit PortRec. DTCC will contribute its Deriv/SERV matching and confirmation engine and its AffirmXpress, MCA Xpress and Novation Consent services. Additional services that will not become part of the new company include Markit's data and valuation services and DTCC's downstream Trade Information Warehouse, centralized settlement and payment netting services.

This initiative may accelerate the adoption of electronic processing solutions across the rapidly growing, $454 trillion OTC derivative market where approximately 50% of transactions are still confirmed on paper.

The new company will be jointly owned by DTCC and Markit, and will be governed by an 11-member board of directors. Michael Bodson, executive managing director for DTCC's business management and strategy overseeing all DTCC business lines, will be chairman of the new company. Jeff Gooch, executive vice president of Markit, will be the new company's chief executive officer.

In addition to facilitating greater industry adoption of electronic confirmation, the new company will offer automated trade affirmation, trade allocation and novation consent solutions to the market on a cross-product basis. It will initially support both DTCC's and Markit's confirmation platforms.

The new company will be headquartered in London, with a second major centre of operations in New York City and representative offices in Europe and Asia. The combined business will have over 1,100 financial institutions as customers and annual transaction volumes of over 7 million across the OTC interest rate, credit and equity derivative markets.

The DTCC-Markit agreement will become effective following completion of due diligence, regulatory filings and approval by relevant global regulators, including those in the U.K. and U.S. The name of the new company will be announced at a later date.

Publish Date: July 21, 2008
Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=209400184

OTC Derivatives: Substantially Reducing Risk Through Automation

OTC derivatives and the challenges they pose for financial services firms continue to garner attention from both inside and outside the industry. In March a Newsweek article titled "Surviving the Crunch" cautioned consumers against dabbling in the hype of derivatives and other "adventuresome" investment vehicles: "Definitely not as easy as it sounds," the magazine advised, "and best not tried at home." A month later an article in The Economist was headlined "Taming the Beast: It Is Time to Simplify Derivatives Trading—But Not to Stunt It." OTC derivatives could certainly benefit from some positive PR in the mainstream media, but what these so-called adventuresome investment products really need are the benefits of a new technology focus called customer communications management (CCM).

CCM enables organizations to automate the creation and delivery of highly customized communications, including contracts, policies, statements, and correspondence. The ability to manage contract negotiations and confirmations online in a secure and easy-to-use environment expedites complex OTC derivatives processes with granular-level risk management capabilities.

According to TABB Group, an independent financial markets research and strategic advisory firm, paper-based contract negotiations and confirmations still pose a threat to the OTC derivatives market some three years after the US Federal Reserve urged financial services firms to improve their processing and tracking practices. During a single three-month period alone, June to August 2007, the total number of backlogged confirmations jumped 250 percent. The backlog of trade confirmation documents—the legal records—has left the financial services sector exposed to unnecessary risk and poor client and shareholder transparency.

In the study Blazing a Trail to Automation: Confirmation Creation for OTC Derivatives, TABB Group reports that the outstanding notional value of all OTC interest rate, currency, credit, and equity derivatives has grown nearly 30 percent a year since 2002. As of mid-2007 more than $400 trillion of notional value existed in outstanding OTC derivatives contracts. Yet as the market continues to expand, the automation of processes such as contract negotiations and confirmations has not kept pace. Indeed, nearly 10 percent of the world's hedge funds use OTC derivatives as part of their strategies, but only a fraction of those have automated processing systems.

Master agreements, confirmations, and workflow processes for OTC transactions all present unique challenges to financial services firms. Negotiating a complicated master agreement, for example, requires frequent back-and-forth counterparty communication, most of which is still performed manually, leading to the significant backlogs. Each trade might have 100-plus data points to affirm with the counterparty before a custom confirmation document can be created. The creation of this document is at the heart of the OTC derivatives backlog, which has resulted in unnecessary risk and poor transparency.

Customer communication management solutions allow for the acceleration of online negotiation of trades, no matter how complex. In fact, the more complex, the more these automated solutions are needed.

CCM has the ability to provide contract creation, negotiation, approval, and execution workflow for all types of contracts and other negotiated agreements, including prime brokerage agreements, margin agreements, ISDA master agreements, and CSAs. It could include a real-time dashboard that tracks and sorts every outstanding agreement, enabling load balancing, tracking, and auditing. In addition, it can offer detailed search and advanced tools for comparing all existing agreements down to the granular content level, highlighting potential exposure and managing risk. Risk management capabilities are also included to quickly review key risk metrics, including NAV triggers, collateral events, withdrawal provisions, and other data points. The goal is to boost automation, reduce risk, and expedite complex OTC derivatives processes.

That's what a CCM solution brings to the OTC derivatives market.

TABB Group Senior Analyst Kevin McPartland, author of the study cited above, summarized the market in a manner most mainstream media audiences could easily grasp: "The market has made strides toward automating the confirmation and overall processing workflow. There are third-party products to help solve this problem, and the innovations in the past few years have been nothing short of amazing. Now it is up to market participants to acknowledge the need for automation—not only through press releases but also through action."

McPartland adds, "Both producers and consumers of OTC derivatives must invest time and money to create necessary systems and processes that are both smarter and straightforward, allowing the most obscure instruments to be handled without human intervention. New product creation and smart trading decisions may drive profits, but unless treated with the utmost care and respect, the overall confirmation process can act as a mugger on payday. Let's not just work harder, but smarter."

Here's to working smarter.

Source URL: http://www.financetech.com/showArticle.jhtml?articleID=208800884
Publish Date: June 25, 2008

Study Reveals Massive Paper Backlog in OTC Derivatives Market

Paper-based processes of contract negotiations and confirmations in the $400 trillion over-the-counter (OTC) derivatives market have created a huge backlog of trade confirmations, according to a study by TABB Group.

Since 2002, the estimated outstanding value of all OTC interest rate, currency, credit, and equity derivatives has grown nearly 30 percent a year, TABB Group said.

But as the OTC derivatives market expanded, the automation of customer communication management processes such as contract negotiations and confirmations has not kept pace.

From June to August 2007, the total number of backlogged confirmations jumped 250 percent, TABB Group revealed.

"In this world where hundreds of millions of dollars are invested in nonstandard products, human error can lead to huge monetary losses and litigation," said Kevin McPartland, TABB Group Senior Analyst.

"Automation of the customer communications process is a must-have for any business competing in this market, as the potential for loss could be devastating," he said.

The backlog of trade confirmations has resulted in poor transparency and left the financial services sector exposed to unnecessary risk. In many cases, confirmations were not only unsigned, but uncreated, the study revealed.

Source URL: http://www.financetech.com/showArticle.jhtml?articleID=208800330
Publish Date: June 23, 2008

Bar on credit derivatives may hit fund raising by India Inc

Large corporates with aggressive investment plans may find it tough to raise funds locally. The Reserve Bank of India’s decision not to allow credit derivatives will mean that banks which had touched their exposure limit to large corporate houses cannot continue funding. It was earlier expected that banks could continue funding large borrowers even after touching the exposure limit by eliminating credit risk through derivatives.

In a statement issued here on Thursday, RBI said, “It has been decided to keep in abeyance the issuance of the final guidelines on introduction of credit derivatives in India. The decision has been taken so as to be able to draw upon the experience of the financial sector of some of the developed countries, particularly in the current circumstances, in which the entire dimensions of the recent credit market crisis have not yet been gauged.”

Credit derivatives are complex financial instruments which are mainly privately-held non-negotiable contracts that allow users to manage their exposure to credit risk. They are generally financial assets like forward contracts, credit default swaps, and options. For example, a bank concerned that one of its customers may not be able to repay a huge loan can protect itself against the loss by transferring the credit risk to another party while keeping the loan on its books.

RBI had initially issued draft guidelines for the introduction of credit derivatives in India in March 2003.

Thereafter, a second draft of the guidelines was issued in May 2007. The draft guidelines had proposed a phased approach, with only the basic credit default swap being allowed in the first stage. Primary dealers would have been able to transact in a credit default swap, if the objective is to protect against the credit risk in a tradable bond. Banks also could transact in swaps, if the credit risk arose out of a bond or any credit exposure such as a loan.

Further, insurance companies and mutual funds would have been allowed to buy or sell protection only when the Securities and Exchange Board of India (Sebi) and Insurance Regulatory and Development Authority (IRDA) allowed them to do so.

However, the draft guidelines had also placed a number of restrictions. Primary among this is a requirement that all parties are required to be Indian and that deals take place in rupees. The other requirement is that protection would be provided only in respect of borrowers who are rated. Unlike some credit derivatives which can be structured to provide protection for a set of borrowers, RBI’s draft prescribes that CDS can be only in respect of a single borrower.

Source URL: http://economictimes.indiatimes.com/rssarticleshow/msid-3146874,prtpage-1.cms
Publish Date: June 20, 2008

Credit derivatives clearing facility to launch in Q3

The Clearing Corporation (CCorp) has inked an agreement with the Depository Trust and Clearing Corporation (DTCC) that will result in the launch of a central clearing facility for over-the-counter (OTC) credit derivatives in the third quarter.

Chicago-based CCorp said in December last year that it had completed a major restructuring that transferred ownership of the organisation to 17 stockholders. The group's backers now consist of 12 of the biggest global dealers - including some of the largest credit derivatives dealers - along with three leading inter-dealer brokers, derivatives exchange Eurex and Markit Group.

The group said it would work to expand its product line to include a centralised clearing facility for a number of OTC derivatives products.

CCorp began working on developments with the DTCC earlier this year that would see it act as central counterparty for credit default swap transactions registered within DTCC's Trade Information Warehouse.

Now in today's statement CCorp says the initiative is targeted to launch in third quarter of 2008.

"The agreement with DTCC will allow CCorp members to utilise CCorp as the central counterparty (CCP) guarantor for OTC contracts in credit derivatives while continuing to utilise the Warehouse as the 'golden' record for net open positions and for post trade event processing," says CCorp in the statement.

Michael Dawley, CCorp chairman, says the new facility will "improve capital efficiency, increase regulatory transparency, lessen direct counterparty risk and reduce systemic risk relating to the multi-trillion dollar market in credit default swaps".

Initially the new service will support only CDX North American high yield and investment grade indices. CDS products such as iTraxx indices, index tranches, and single name products are scheduled for subsequent roll outs throughout 2008 and 2009.

In the initial phase, joint CCorp and DTCC Warehouse members whose OTC credit derivative trades are stored in the Warehouse can elect to replace their bilateral agreements with a new CCP guaranteed trade backed by the CCorp.

Source URL: http://www.finextra.com/fullstory.asp?id=18528
Publish Date: May 29, 2008

Back offices buckle under OTC volume surge

Despite concerted efforts since 2005 to improve operational efficiency in the credit derivatives markets, trading surges in the OTC markets since the credit crunch have resulted in corresponding spikes in unconfirmed trades clogging up back offices.

According to data released by UK-based Markit Group, average outstanding confirmations in the OTC derivatives markets jumped from around 6000 per dealer bank to about 13,000 between June and August 2007, at the same time as monthly trading volumes rose from an average of around 20,000 to more than 25,000 per dealer.

However the situation has improved over the past few months. Following a dip at the end of 2007, trading volumes rose again to near-peak levels of 25,000 trades per dealer for each of the first three months of 2008, but the average number of outstanding confirmations remained lower at around 7000 per dealer per month.

But despite the improving picture, regulators are still concerned about operational inefficiencies in the credit derivatives markets. Last month the Federal Reserve Bank of New York said the volume surges in mid-2007 showed that "processing challenges" still persist in the markets and warned that in order to support long-term growth "the processing infrastructure must be capable of processing transactions efficiently through periods of sustained high volume and market volatility".

A recent report from the Financial Stability Forum also cited the surge in unconfirmed credit derivatives trades during the credit crunch as an area of concern.

"Despite the significant progress that the industry has made in automating the infrastructure of the OTC derivatives markets during the last two years, the industry has not achieved a "steady state" in which spikes in trading volume do not lead to operational problems," says the FSF report.

Earlier this month reports surfaced that group of at least 10 major credit derivatives brokers are working to establish a central clearing house that would take direct exposure to counterparty risk.

According to a Reuters report Athanassios Diplas, chief risk officer for global credit trading at Deutsche Bank, told the annual meeting of the International Swaps and Derivatives Association (ISDA) that the clearing house would help "take a lot of risk out of the system" by enabling banks to trade without the fear that the default of a dealer could cause a shock to the market.

Some bank executives and analysts have voiced concerns that the default of a major derivatives broker could lead to a chain of counterparty failures and defaults, says the report.

It is thought the central clearing house would require counterparties in credit default swaps to put up collateral as well as initial margin to cover any decline in market value.

The brokers involved in the programme would contribute to a guarantee fund for the clearing house to cover potential losses from defaults, says the report.

Source URL: http://www.finextra.com/fullstory.asp?id=18377
Publish Date: April 23, 2008

Clearing the fog

Credit derivatives continue to boom, but the old order is under threat

BANKERS gathering in Vienna this week for the annual bash of the International Swaps and Derivatives Association (ISDA) had some big numbers to celebrate. The overall market for over-the-counter derivatives shot up to $455 trillion at the end of 2007. Some $62 trillion of that were credit-default swaps (CDSs), whose supercharged growth continues in spite of the crunch. But the emphasis this year was as much on playing down dangers as playing up volumes. ISDA was quick to point out that actual credit exposure was a mere 2% of the notional value of all contracts.

This coyness is hardly surprising. Regulators have been fretting since 2005 that the market's infrastructure was not keeping up with its growth. Then, in March, came the sudden implosion of Bear Stearns, a top-ten actor in CDSs, rescued partly because of the fear of chaos if such a large counterparty were to fold. The market's overseers may not agree with Christopher Whalen of Institutional Risk Analytics, a consultancy, when he describes off-exchange derivatives as an ?act of Satan?. But they want to see more robustness, especially in credit derivatives, and have hinted that they will impose their own solution if the market does not. ...

Source URL: http://www.economist.com/finance/displaystory.cfm?story_id=11060804
Publish Date: April 17, 2008

SuperDerivatives adds liquidation pricing to portfolio revaluation services

SuperDerivatives, the benchmark for derivatives pricing and the leading provider of multi-asset front-office systems, risk management, revaluation and online options trading solutions, today announced it will provide the liquidation price (or 'exit price') of all derivatives held within clients' portfolios.

Liquidation prices for the time of calculation or for any retroactive dates will be supplied as part of SuperDerivatives' independent Portfolio Revaluation service.

The enhanced offering addresses the need for valuations of portfolios that might be liquidated and aims to provide a fair value disclosure for investors that foresee a liquidation event. The demand for liquidation price-based valuations has been amplified during the recent financial crisis, as well as by specific regulatory requirements such as FAS 157.

SuperDerivatives will use its benchmark model for bid and ask prices to calculate the liquidation price for all types of financial portfolios, including those that contain illiquid OTC derivatives. This addresses many daunting challenges facing the industry today by:

• Accurately calculating the unique 'bid - offer' spread for each specific structure, replicating actual market 'entry' and 'exit' (liquidation) prices;
• Adapting spread levels to changing market conditions based on inter-product correlations - a need that has been dramatically demonstrated during the current crisis;
• Assessing a total portfolio's collective impact on liquidation price.

Under the terms of FAS 157, firms are required to define the exit price of all instruments to calculate fair market value or "…the price that would be received to sell an asset or paid to transfer a liability." Additionally, during times of distressed market conditions, the exit price is the only price that matters to the portfolio manager looking to redistribute risk exposures.

"The recent market turmoil has highlighted the need for accurate, independent valuation. Determining the liquidation price of derivatives, necessary for both regulatory compliance and to instil confidence in the investing community, can only be achieved with a combination of sophisticated modelling techniques and market data expertise," said Dani Weigert, head of revaluation services, SuperDerivatives. "Todday's financial crisis has proven that none of the available models, or 'standard analytics' can be used for universally calculating the fair value of options - and there is no off the shelf model for determining bid-ask spread. SuperDerivatives' liquidation price-based valuation is therefore unique and cannot be generated by other revaluation providers."

Source URL: http://www.finextra.com/fullpr.asp?id=20792
Publish Date: April 08, 2008