LSOC Doesn’t Have to Painful for FCMs

LSOC Doesn’t Have to Painful for FCMs’t-have-to-painful-for-fcms?utm_source=TabbFORUM+Alerts&utm_campaign=c54a7482d5-UA-12160392-1&utm_medium=email&utm_term=0_29f4b8f8f1-c54a7482d5-271568421

The exceptions to generalized rules often provide business value and inspire innovation. True to form, the exceptions to the LSOC requirements present potential contractual-based opportunities and advantages for FCMs and their customers.
New rules have recently come into effect that substantively change the customer collateral asset protections relevant to central clearing. Specifically, the Dodd-Frank Act prescribed that the CFTC adopt rules that provide for enhanced protections of customer margin collateral for cleared swaps. The mandate is known as “legal segregation with operational commingling,” or LSOC.

LSOC provides a fundamental change in how futures commission merchants (FCMs), as members of central clearing counterparties (CCPs), must manage customer margin collateral. As a result of these rules, there was an initial flurry of activity to automate compliant processes. The first phase of implementation simply provided a bridge whereby FCMs reported excess collateral without reaching individual-customer-level granularity.

In this instance, a complete compliance implementation is iterative. The industry is now moving into the next phase of implementation, which ultimately requires full disclosure of the customer’s portfolio of rights and obligations.

Providing a portfolio of rights and obligations means that FCMs are required to report client-specific values and identifications to the relevant CCP. The portfolio of rights and obligations may be reported as: (I) belonging to a specific customer; (II) provided by the firm (the “firm contributed value,” sometimes called “firm contributed assets” or “residual value”); or, (III) unallocated client value.

The duties concerning the portfolio of rights and obligations have substantial implications for both FCMs and their customers. This is true because the general LSOC rule only prohibits an FCM from “permitting a lien on cleared swaps customer collateral held by the FCM.” However, consistent with generalized rules, often the exceptions provide the greatest value and move to inspire innovation. LSOC falls within this category and is an example of leveraging the exception to create potential contractual-based opportunities and advantages for certain FCMs and their customers.

For example, LSOC does not expressly prohibit a cleared swaps customer from affirmatively granting a lien or security interest on its own margin collateral held by the FCM. Nor does the rule prohibit the FCM from taking action to induce the cleared swaps customer’s grant of such a lien. Hence in this instance, contractual agreements concerning the use of the margin collateral may supersede the rules.

Simply put, customers may contractually opt out of the greater protections afforded under LSOC in favor of other ancillary value offered by their FCMs by allowing a lien or security interest to be placed on their funds.

Although this is logically the other side of the same coin, the literal interpretation will likely inspire business opportunities for FCMs, as well as transaction efficacy for their customers – when asserted appropriately. Opportunities may consist of greater flexibility regarding FCM use of funds. Customer benefits may include lower transaction costs or certain netting efficacies.

The exceptions to generalized rules often provide business value and inspire innovation. True to form, the exceptions to the LSOC requirements present potential contractual-based opportunities and advantages for FCMs and their customers.
It is certain that the migration to a contractual waiver of LSOC necessarily involves the requisite disclosures between FCMs and their customers that must be supported by automation. For example, any process migration away from the general rule in favor of a loophole or exception requires robust permission-based workflows and quantitative tracking that adequately monitor specific actions, such as rehypothecation or investments.

If implemented properly, the consent-based waiver reasonably seeks to alleviate the FCM’s burden of contributing to residual value and relieves FCMs of firm contribution that is generally required by the FCM to support its customers’ positions. The key to leveraging this opportunity, however, is capable automation.


Can Open Source Models Fix the Credit Ratings Industry? ( from the TABB Group)

Can Open Source Models Fix the Credit Ratings Industry?

Widely blamed for the 2008 financial crisis, credit rating agencies can – and must – do better. Open source, transparent credit models and methodologies would eliminate conflicts of interest and bring the benefits of mass collaboration to the world of credit ratings.
Next week’s SEC Credit Ratings Roundtable offers an important opportunity to debate reforms to an industry widely blamed for the 2008 financial crisis. The relative lack of reform and perpetuation of biased and inadequate rating methodologies leaves our economy more vulnerable to future credit bubbles and crashes.

Accurate credit assessments are important because they help ensure that interest rates properly reflect the risks of fixed income securities. Interest rates, like prices in any other industry, provide signals that affect the supply of and demand for new bonds. If these price signals are wrong, our nation’s savings will be improperly invested and our prospects for much needed economic growth will be reduced.

Rating agencies and alternate providers of credit insight thus serve a crucial role in our economy. As a former executive at a rating agency, I know that these companies can and should do better. The question is, “How?”

Before I offer my solution, I need to explain what best practice in credit assessment looks like. Methods that rely solely or primarily on the subjective evaluations of human inspectors may be appropriate for grading eggs ‘Double A’ or ‘Single A,’ and they made sense when John Moody created the credit rating industry a century ago. But in today’s world of big data, abundant computer processing power and advanced social science research techniques, we should be relying more heavily on models to assess the millions of bonds available to investors. Such models would ideally churn out numerical default probability or expected loss estimates rather than letter grades that don’t have clear and consistent meanings.

While certain credit models failed during the financial crisis, this fact does not imply that the application of computer modeling to credit assessment is inappropriate. Instead, it implies that we need better models populated with more complete, more accurate and more objectively derived data.

Credit modeling, like most intellectual processes, can benefit from peer review. Indeed, the progression of corporate credit modeling from Altman’s Z Score in the 1960s to Merton’s option based approach in the 1970s to the more recent innovations of Duffie, Jarrow and others has taken place in peer reviewed academic journals. While much of this research is now embedded in proprietary commercial models not subject to peer review, one implementation is free, transparent and open to feedback from other researchers. This open corporate credit model is maintained by the National University of Singapore’s Risk Management Institute. RMI’s Credit Risk Initiative publishes model-derived default probabilities on tens of thousands of firms each day.

Transparent credit modeling tools and software have been announced – but not yet implemented – by a number of analytics firms in structured finance. This writer has developed open source models for sovereign and municipal bonds. In 2012, I published a Public Sector Credit Framework on GitHub (an open source repository) that enables analysts to create and run government bond rating models using a multi-year fiscal simulation. More recently, I developed a logistic model of municipal bond risk for California cities in response to a request from a unit of the State Treasurer’s Office. This fully documented model is now under peer review.

These early initiatives show the potential for open source credit models to take their place next to proprietary software and agency ratings in the panoply of tools available to fixed income investors. These alternatives can all improve through competition with one another.

[Related: “Why Open Source Is Conquering the Street”]

The SEC and other regulatory bodies can take a major step to encourage the development of open source, transparent, academically derived credit models and methodologies. Section 939A of the Dodd-Frank Act requires regulatory agencies to replace references to NRSRO ratings in their regulations with alternative standards of credit-worthiness. I suggest that the output of a certified, open source credit model be included in regulations as a standard of credit-worthiness.

Thus far, regulatory changes have involved substituting a fixed formula or the judgment of the regulated entity for NRSRO ratings as credit-worthiness standards. Fixed formulae are readily circumvented (or “gamed”). For example, a regulator may define an investment grade structured finance security as one with a minimum percentage of overcollateralization. An issuer can defeat the intent of this regulation by providing the mandated overcollateralization but trapping excess spread in a reserve account for later distribution to subordinated bondholders. An open source methodology can evolve more quickly than regulations to address such structural innovations.

The danger of relying upon the judgment of the regulated entity is demonstrated by the spate of financial industry bailouts starting in 2008. Some of the institutions requiring bailouts were able to reduce their capital requirements by availing themselves of Basel II’s Internal Rating Based approach. While financial institutions can increase profits by taking on additional risk, allowing them to self-regulate involves conflicts of interest every bit as serious as those that afflict the credit rating agencies.

Transparent models maintained by university research centers and other neutral parties can remedy this conflict of interest. To be effective, these models must undergo a rigorous certification process designed by the SEC. The certification process itself should be administered by an independent body – perhaps by the rating assignment entity created under the Franken Amendment, if implemented.

The past two decades have demonstrated the incredible power of mass collaboration techniques such as open source software and Wikis to better our lives. Coming from nowhere in 1992, the open source Linux operating system is now the dominant program for running Internet servers. Wikipedia has replaced encyclopedias as the world’s repository of accessible knowledge.

By empowering open source credit assessment methodologies, regulators have the power to bring the benefits of mass collaboration to the world of credit ratings. As we look back from 2013, we can see the great wisdom of government officials who, in the early 1990s, opened up the Internet to users outside the defense industry and universities. Now financial regulators have an opportunity to make a similar enlightened decision.

Earthport and Viamericas to Expand Remittance Payments Services

Cross-border payments service provider Earthport has entered into an agreement with Viamericas, a provider of remittance payments for Latin America, to support the latter’s push for strategic growth outside of the Americas.

via Pocket May 11, 2013 at 06:29PM

Swedbank Robur Leverages Graz’s Hinc Data Warehouse to Expand Its Business Intelligence Capabilities

Graz Sweden AB, a leading data warehouse provider for the financial industry, announced today the first installation of its newest business intelligence module, Sales Navigator, at Swedbank Robur, Scandinavia’s largest fund management group with over US $100 billion AUM.

via Pocket May 11, 2013 at 06:27PM

Eurobase Launches synergy2 – Specialty Lines and Reinsurance Administration Platform

Eurobase Insurance Solutions Introduces synergy2 – an Inspired End-to-End, Fully Configurable Specialty Lines and Reinsurance Administration Platform That Delivers a ‘Single Version of the Truth’ Eurobase Insurance Solutions (Eurobase), a leading global software and services provider to the glo

via Pocket May 11, 2013 at 06:25PM

MarketPrizm Provides Low Latency Data And Access For NASDAQ OMX NLX

MarketPrizm, a leading provider of market data and trading infrastructure services, today announced that it will provide market data and execution connectivity across Europe for NASDAQ OMX NLX (“NLX”).

via Pocket May 11, 2013 at 05:12PM

With speed like this, can humans even hope to make money in a market dominated by high-frequency traders? Yes—but it entails trading smarter.

The Growth of High-Frequency Trading HFT is growing because it is immensely profitable. A 2012 study by Baron, Brogaard and Kirilenko reports that HFT firms made $29 million in profits from the e-mini S&P 500 stock index futures market during August 2010 alone.1 And they did so bearing little risk.

via Pocket May 11, 2013 at 05:10PM

BATS’ European Arm Wins Exchange Status

BATS Global Markets said Thursday that it had secured regulatory approval for its European trading platform to become a fully-fledged stock exchange, providing access to retail investors and listings business.

via Pocket May 11, 2013 at 05:08PM

European federation of energy traders (EFET) overview

European federation of energy traders overview

EFET is a group of more than 100 energy trading companies from 27 European countries dedicated to stimulate and promote energy trading throughout Europe.

EFET Vision
We foresee energy markets throughout Europe,
in which traders efficiently intermediate in the value chain on the basis of clear wholesale price signals, thereby optimising supply and demand and enhancing security of supply,
to the overall long-term benefit of the economy and of society.

Standardisation and harmonisation of energy contracts and electronic data exchange are prerequisites for optimising the potential benefits of the liberalisation of the European energy industry.

This secton offers further information and materials about:
– standard contracts
– standard electronic data exchange

EFET European Federation of Energy Traders Annex G to the Individual Biomass Contract Sustainability Requirements

Individual Biomass Contract Sustainability Requirements

Sustainability Principles for Woody Biomass Sourcing and Trading

Initiative Wood Pellets Buyers (IWPB) – Working Group on Sustainability
August 2012

Sustainability policy
The Initiative Wood Pellets Buyers has designed the sustainability principles that are listed and detailed in the first part of this Annex G.

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