Consultation Paper 91-401 on Over the Counter Derivatives Regulation in Canada - CSA (November 2010)

See http://www.osc.gov.on.ca/documents/en/Securities-Category9/csa_20101102_91-401_cp-on-derivatives.pdf

Source: Canadian Securities Administrators Derivatives Committee

Report on Implementing OTC Derivatives Market Reforms - FSB (October 2010)

See http://www.financialstabilityboard.org/publications/r_101025.pdf

Source: Financial Stability Board(FSB)

Overview of progress in implementing the G20 recommendations for Strengthening Financial Stability – FSB (June 2010)

This is the Report of the Financial Stability Board to G20 Leaders.

See http://www.financialstabilityboard.org/publications/r_100627c.pdf

Source: Financial Stability Board(FSB)

Wall Street Project Management Offices Focus on Derivatives

In addition to forcing firms to reexamine their risk management controls, the recent credit derivatives meltdown has given Wall Street's project management offices (PMOs) -- the groups that zealously monitor and sometimes manage the status of IT projects -- a new focus. "A major challenge Wall Street firms are struggling with is the need to develop a derivatives platform," notes Mike McKeon, SVP at IT strategy and consulting firm Booz Allen Hamilton.

"The derivatives business has been growing significantly. Some products are fairly mature, and the technology and processes used for them have matured," McKeon continues. "But for other products, the business hasn't matured and the processes are highly manual."

While many financial services vendors hawk derivatives processing solutions, "Often [vendor] products are just a piece of the puzzle," McKeon adds. "It's a lot of integration work." This is where a PMO comes in -- to manage and lead the efforts to integrate technologies and design new processes to use the technology effectively.

At State Street, a newly formed project management office was heavily involved in the development of a derivatives processing platform that the firm currently is piloting, according to Mike Bullock, the firm's senior vice president of global product management. He notes that State Street expects to go live with the system in May.

The new platform is based on FpML -- the Financial products Markup Language, an XML message standard used by the OTC derivatives industry -- and links into DTCC's DerivSERV and Markit Partners' SwapsWire confirmation and settlements services, Bullock explains. Once a trade is fully FpML-compliant, he says, there's no need for the faxes, phone calls and e-mails that are commonly used today to settle a derivatives contract.

Fostering Adoption

As State Street began developing the derivatives platform in October 2007, Bullock relates, the firm formed a four-person PMO to help with business adoption of this and other projects. The group is responsible for client prioritization and conversion, product architecture, rate cards, operating and technology roles, the operating model, the operating architecture, technology development and technology implementation, he describes. "If there's any software or hardware infrastructure that needs to be set up in our offices around the globe, the PMO works with IT to ensure the delivery of help desks, security or other business continuity needs," Bullock says.

The PMO's role in prioritization helped drive the derivatives processing platform to completion within a matter of months, according to Bullock. "What's important to the business and what we've heard from a product point of view is that derivatives is a top initiative for 2008," he says. "The amount of interest on the part of our clients hasn't let up. We know we are spending money in the right place."
In addition to helping set priorities, the PMO also figures out how to roll out new software programs, such as the derivatives platform, efficiently around the world, Bullock notes. "We invest in products, but, more importantly, we need to get them in the hands of our business and clients as quickly as possible, and we need to do that concurrently around the globe," he says. "It can't be a sequential rollout -- our clients are global and they want to see it Day One."

Meeting Customers' Needs

The PMO, Bullock explains, keeps track of where customers' accounts are based and therefore to which countries a new platform must be immediately extended. It communicates with external and internal customers as products are being built to make sure all concerns and requirements are being met.

State Street's PMO pays for itself in a variety of ways, Bullock says. In the firm's middle-office business, for example, the PMO generates opportunities to provide derivatives processing outsourcing for clients. It's also helping to reduce risk and gain operational efficiencies, Bullock adds, noting that the group provides integrated project reports through an online portal, versus an earlier, scattershot approach.

According to Bullock, the PMO will manage the development and rollout of all new platforms going forward. The templates built for the derivatives processing platform, he notes, will be used for a forthcoming SWIFT messaging platform and a collateral management system, so the best practices discovered during the building of the new derivatives platform can be repurposed.

Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=207200824
Publish Date: April 15, 2008

OTC derivatives trading remains a slow process, report finds

Industry group promises improvements, but no quick fix likely

While the processing of the over-the-counter derivative transactions has improved over the past few years, it is still a surprisingly slow process.

That state of affairs was underscored by a report released today by Aite Group. In it, Aite reports that the bulk of over-the-counter derivatives processing is done by hand. That, in turn, can lead to errors.

A single contract traded verbally and recorded on paper can involve between 80 and 100 variables in terms and conditions. In addition, many parties take part in the process, including not only a buyer (such as a hedge fund) and a seller (such as an insurance company), but also processing entities such as broker-dealers and prime brokers.

Part of the problem stems from the staggering growth in the market. The derivatives market stood at $516 trillion in outstanding notional value as of June 2007, according to the Bank for International Settlements, and it continues to grow. Interest-rate derivative contracts represent the largest chunk of the market, but credit derivatives are the fastest growing segment.

Trading systems have not kept pace, and industry players are clearly aware of the problem. In late March, a group of trade associations and major broker-dealers submitted a letter to the Federal Reserve Bank of New York and other regulators that confirmed their commitment to improving the processing of credit and equity derivatives.

The Aite report noted that a firm can upgrade to a fully automated system and still see little gain. Why? “OTC derivative trade processing is unique is that counterparties are tied to each other in a way that does not exist in the listed markets,” wrote Denise Valentine, senior analyst with Aite Group. “Ultimately, a firm is only as automated as its counterparty’s processing capability.”

To satisfy customer requests, many broker-dealers are paying for the development of electronic systems. “Yet, the large volumes and lack of automation in the non-listed derivative business still mean a manual maintenance routine for many firms,” the report noted.

By Marine Cole

Source URL: http://www.financialweek.com/apps/pbcs.dll/article?AID=/20080403/REG/998586512/1036
Publish Date: 03 April, 2008

Markit’s Moving Fast Into Derivatives Processing

When we saw Markit Group buy SwapsWire and then BOAT in quick succession, we knew it was time to take a closer look at the aggressive British entrant into the U.S. derivatives processing market.

Founded in 2001, Markit started out as a provider of independent credit derivatives pricing. Its derivatives indices, such as ABX and CDX, have become critical in firms' struggle to accurately determine the value of outstanding derivatives contracts whose underlying assets may be murky. ABX, for instance, tracks the performance of a set of credit default swaps based on U.S. subprime home loans (the derivatives prices themselves are provided by a consortium of 16 investment banks).

It is widely understood that Markit's indices effectively are the only independent means (other than complex mathematical models that cannot take into account factors such as underwriting quality) available to estimate the value of certain types of derivatives. But not everyone is a fan of the indices.

"They're fallacious because they reflect an environment that doesn't exist," contends Dick Bove, analyst at Punk Ziegel. For instance, Markit's CMBX index of commercial mortgage-backed securities recently reflected a 6 percent to 8 percent imputed loss in U.S. commercial real estate when the actual loss was a quarter of 1 percent, according to Bove. "People buying the securities are estimating a far worse disaster than is actually occurring," he says. Accounting rule FAS 157 requires banks to mark certain products down to the implied value of the indices, even if they still are performing well, Bove notes. What firms should do, he believes, is value securities according to how well they actually are performing, rather than based on indices that reflect only what securities buyers think.

Markit concedes that its indices are not perfect. "What an index tells you is where the derivative category is moving; to some extent, that's a symptom rather than a cause," responds Jeff Gooch, EVP and head of trade processing and valuations at Markit. "It helps, because it gives you something to watch. And it does, to a certain extent, reflect some liquidity issues as well as everything else that goes into valuing these products."

Markit also provides a Reference Entity Database (RED) Service -- a set of business entity identifiers to which dealers can refer in order to standardize documentation and avoid mistakes. RED has become so essential to the credit derivatives market that the DTCC has said it will soon start rejecting contracts coming into its Trade Information Warehouse that lack RED coding.

A Thirst for Operations

Markit began its foray into derivatives automation in May 2006, when it acquired White Plains, N.Y.-based Communicator, which offered an OTC derivatives processing platform for trade confirmation, pricing, valuation and trade lifecycle events (the product has been renamed Markit Trade Processing). "We made a very definite decision to get into the processing space," recalls Gooch, who previously ran global OTC derivatives operations at Morgan Stanley.

"The general health of the OTC markets is very dependent on processing efficiency," he continues. "If the industry collectively is going to sort out the problems in derivatives processing, it's going to need to move the bulk of the volume for confirmation in those markets over to electronic platforms."

According to Gooch, across all asset classes, less than half of current derivatives contracts are confirmed electronically. "We think there's going to be a need for a lot more electronic solutions in the processing area," he says.

Last November, Markit announced its agreement to buy SwapsWire, an electronic confirmation network for dealers, interdealer brokers, prime brokers and buy-side firms to exchange trade data and confirm OTC transactions. Gooch believes the move will help electronic adoption by providing some needed vendor consolidation.

"If you look at the current landscape, it's split across a number of vendors -- SwapsWire being one very big player; DTCC with their DerivServ offering being another; and also Markit's Trade Processing Platform. Then there's a number of very small firms, such as TZero. ... That's confusing to people," Gooch explains, adding that system integration difficulties often arise for firms that are connected to multiple vendors.

"We believe there's a need for consolidation in this space -- that the dealer community needs to have some influence and control over what's going on, and Markit is 70 percent owned by major dealers," Gooch adds.

Markit specifically chose SwapsWire, according to Gooch, because the platform is front-office oriented, suiting Markit's natural client base. "It gets the traders involved with resolving the issues on a given trade, and it does so very quickly after execution," he says.

It also helped that SwapsWire was another dealer-owned consortium that, incidentally, shared many of the same dealer owners as Markit. "There's very little geographic or product overlap, which is fantastic in terms of creating synergies," Gooch notes.

Head-to-Head With the DTCC?

The SwapsWire acquisition could bring Markit head-to-head with the Depository Trust & Clearing Corp., which provides clearing, settlement and information services for equities, corporate and municipal bonds, government and mortgage-backed securities, money market instruments, and over-the-counter derivatives. But, Gooch notes, DTCC is owned and controlled by the same banks that own and control Markit, and the two organizations have a shared agenda.

"Our current trade processing platform is the biggest single provider of trades to their platform -- we send them 30,000 to 40,000 trades a month," Gooch relates. Although Markit and DTCC have individual products that compete with one another, he says, that is being worked out.

But while Gooch says Markit and DTCC "have a very active relationship in both directions," he adds, "I'm hoping this deal with SwapsWire doesn't change that."

According to a DTCC spokesperson, "We have a strong, long-standing relationship with Markit, as we do with a host of complementary service providers, and we look forward to continuing to work with them to enhance operating efficiencies and reduce operational risks in the OTC derivatives market. For example, we built our Trade Information Warehouse -- the centralized global repository and post-trade processing infrastructure for servicing credit derivatives contracts -- with an open architecture to enable access by third-party service providers, including Markit and SwapsWire."

The DTCC automates the clearing of credit derivatives trades, of which 90 percent now are handled electronically. But only about 20 percent of equity derivatives and 40 percent of interest rate derivatives trades are electronic -- both types of trades that SwapsWire processes. "We need to try to convince those people that are on paper to move to automation, particularly in equities," Gooch insists. "Otherwise, collectively, there's going to be a problem."

Markit Predictions

So what's Markit's road map for getting there? According to Gooch, major initiatives include growing the company's footprint in the equity space and leveraging its January acquisition of BOAT, a platform for the collection and distribution of European OTC pre- and post-trade information.

Markit also will expand its valuation products. The company is working with six investment banks to develop a platform that will aggregate the banks' and Markit's derivatives pricing data to help institutional investors and fund managers value OTC derivatives and determine portfolio performance. Markit aims to launch the platform, Markit Valuations Manager, in the second half of 2008 with coverage of bonds and derivatives. It later will be expanded to include more banks and all major cash and derivative asset classes, the company has said.

Source URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=206904019

Publish Date: 17 March, 2008