Welcome to the Cleared Swaps World – Sign Here, Please

Welcome to the Cleared Swaps World – Sign Here, Please


The final wave of the swaps clearing mandate will hit in September. But entering into a clearing agreement doesn’t mean swaps trading will be risk-free, as CCPs hold the potential to be an extraordinarily risky part of the market.
As the last customer types prepare for the clearing of swaps in September, people are becoming more aware of the implications of clearing agreements and the relationships among the customer, his FCM and the CCP. However, there are a few reasons to be particularly careful in executing clearing agreements.

As a bit of background, the requirement to use CCPs actually serves to concentrate counterparty risk, at least for large players. Imagine a swap dealer (SD) that has $100 billion in exposure to 1,000 separate counterparties, converting that to $50 billion in exposure with each of two CCPs. Clearly, there has been a significant concentration of risk. Not a problem if the CCP is risk free; but a potential problem if it isn’t.

[Related: “A Familiar Model Emerges for Swaps”]

Now let’s look at the market – not the market for swaps or even clearing services, but the market for CCPs themselves. If a significant number of CCPs are chasing a finite volume of clearing, we might expect them to find ways to compete. One of those ways might be in initial margin, particularly on bespoke products. This “race to the bottom,” if it surfaces, could easily make CCPs an extraordinarily risky part of the market.

Finally, we need to understand the nature of financial panics. They always begin as muffled rumblings in the distance – trouble for someone else but not for us. Then the trouble spreads, and the market starts buzzing with rumors. At some point, the trouble reaches a tipping point, and everyone rushes to get out. At that point, it may be too late to save anyone’s bacon, no matter whom they clear through.


In light of all this, the International Organization of Securities Commissioners (IOSCO) and the BIS Committee on Payment and Settlement Systems (CPSS) have jointly issued a consultation document they call “Recovery of Financial Market Infrastructures.” In the introduction they say, “‘Recovery’ concerns the ability of a Financial Market Infrastructure (FMI) to recover from a threat to its viability and financial strength so that it can continue to provide its critical services without requiring the use of resolution powers by authorities. Recovery therefore takes place in the shadow of resolution.” In other words, this document addresses the worst of all worlds for market participants.

The report spends the first 10 of its 23 pages talking about recovery planning, certainly an important requirement. But then the report gets into recovery tools, and here’s where it really gets interesting. In Section 3.2 the report says, “FMIs can be exposed to legal, credit, liquidity, general business, custody, investment and operational risks. … The manifestation of the risks may have different causes and may also result in different types of failure scenarios.”

But the most startling section of the report is Section 3.5, “Tools to allocate uncovered losses caused by participant default.” This gets into the very difficult subject of who pays when a large default exhausts the CCP’s resources. Things get really interesting in Section 3.5.14, where the report says:

“An important example of a position-based loss allocation recovery tool is variation margin haircutting by CCPs. When haircutting variation margin, the CCP reduces pro rata the amount it is due to pay participants with in-the-money (net) positions, while continuing to collect in full from those participants with out-of-the-money (net) positions… Where a CCP does not have a direct contractual relationship with indirect participants (ie clients of direct participants [or customers of FCMs]), the impact on such indirect participants will depend upon their contractual arrangements with their respective direct participants.”

So if you have a winning position with the wrong CCP – one that might clear for a big loser or two – you might not get some of your winnings.

The final wave of the swaps clearing mandate will hit in September. But entering into a clearing agreement doesn’t mean swaps trading will be risk-free, as CCPs hold the potential to be an extraordinarily risky part of the market.
And this vulnerability isn’t restricted to VM. In a paragraph that has garnered lots of publicity, Section 3.5.19 says:

“Initial margin haircutting could be limited to the initial margin of direct participants. On the other hand, the tool could be applied to the margin of all participants (direct and indirect) providing this is consistent with the laws and regulations to which the CCP is subject and the rest of the CCP’s rules. Like variation margin haircutting, even where the CCP applies margin haircuts only to direct participants, the contractual arrangements between direct participants and indirect participants may cause the haircutting to have an impact on indirect participants.” (Emphasis added)

So if a market participant has a winning position, but clears at a CCP that is in trouble, not only could the market participant’s VM be withheld, its IM could also disappear into the financial black hole. Not a pretty thought!

Some Legal Advice

So it is especially welcome that attorney Sherri Venocur has written an informative article called, “What Customers Should Look Out For in FCM Clearing Agreements.” In one section, she cautions:

“Section 724(a) of Dodd-Frank restricts an FCM’s use of its customer’s collateral and specifies the instruments into which an FCM may invest its customer’s collateral. Nonetheless, most Clearing Agreements give the FCM the right to rehypothecate collateral and otherwise to deal with it as though it were the FCM’s own property… Thus, customers should push for the inclusion in the Clearing Agreement of a provision containing language similar to that in the proposed rule, and it would seem unreasonable for an FCM not to agree to include it.”

Another point Ms. Venocur makes is that banks that are FCMs often have many affiliated entities that perform related functions, such as trading, lending, or money transfer. A clearing customer may have relationships with some of those affiliates, so, she says:

“It is most important for the customer to understand the possible consequences of [any] cross-affiliate provisions in light of the customer’s particular circumstances. To that end, the customer should: (i) review the customer’s existing relationships with the Bank and inquire about anticipated future relationships; (ii) review all documents relating to such relationships; and (iii) based on this review, (A) understand what actions the Bank can take with respect to the customer or its property in the event the customer defaults or another circumstance occurs that gives the Bank the right to take certain actions (either specified or described broadly in the documents) and (B) understand what remedies are available to the customer in the event the Bank breaches its obligations under its various agreements with the customer or the customer otherwise wishes to terminate one or more relationships with the Bank.”

In conclusion, Ms. Venocur says:

“The implementation of Dodd-Frank and the regulations promulgated thereunder marks a radical change in the way OTC derivatives are executed, documented and implemented. While ISDA Master Agreements continue to be required, customers also need to execute Clearing Agreements with FCMs so that they can enter into derivative transactions that are subject to the mandatory clearing requirement. It is essential that customers understand the risks within Clearing Agreements and negotiate these agreements with their FCMs in order to reduce or at the very least, to manage, such risks.”

Technology, Transparency and Choice Drive Buy Side’s Investment in U.S. Options

Technology, Transparency and Choice Drive Buy Side’s Investment in U.S. Options


Volumes in the options market are estimated to increase by more than 5 percent as electronic trading fuels access to the U.S. marketplace.
The U.S. market for exchange-traded options took off during the past decade. The buy side is increasingly looking at options as instruments to hedge risk exposure and generate alpha, according to TABB Group’s recent report on the state of the U.S. options markets. In fact, TABB estimates that volumes will increase by more than 5 percent by year-end, even as market volatility wanes. So what is continuing to fuel growth in the options markets?

[Related: “Buy Side Is Getting Smarter at Trading Options”]

Market transparency and growing adoption of electronic trading technologies are key contributing factors. The changes in regulation and increasing use of electronic trading helped raise volume an average of 21 percent a year from 2000 to 2010 on seven U.S. options exchanges. Today, the options markets are supported by 12 exchanges and electronic venues where traders can access legitimate, reliable prices and order information so they can confidently and quickly execute a trade.

While the increase in trading venues has increased competition and lowered transaction costs for investors, fragmentation has also forced continued investment in technology on both the sell side and buy side. One area of investment on the buy side is platforms that help aggregate liquidity across multiple counterparties and exchanges. To access liquidity and capitalize on momentary market opportunities, institutional investors are adopting electronic platforms that offer integrated pricing monitors, trade analytics, risk monitors, and other tools. For the second year in a row, TABB’s study found Bloomberg Execution Management System (EMSX) is the most popular electronic trading platform for U.S. options. Now, I may be biased, but what I believe this reveals is that options market participants value unparalleled technology and transparency – but they also value choice.

With trading volumes stagnant in the past few years, the buy side has also sought to balance technology and commission spend with necessary efficiency drivers. Especially among hedge funds, the desire for un-conflicted choice has fueled growth in broker-neutral electronic platforms that connect to a broad network of brokers, functionality algorithms and counterparties.

From hedge fund traders looking for an edge, to long-only asset managers that use options to manage risk, electronic trading is fueling access to the U.S. options marketplace. As the industry evolves and trading options becomes even more commonplace for the institutional investor, platforms that offer the buy side choice, access and sophisticated trading tools will succeed along with the market itself.

Cross-Border Swaps Deal to End U.S., EU Regulation Overlap

U.S. and European Union financial regulators broke a deadlock over rules for the $633 trillion global swaps market, saying the accord will protect banks from overlapping requirements and additional costs. The U.S.

via Pocket http://www.bloomberg.com/news/2013-07-11/cross-border-swaps-deal-to-end-u-s-eu-regulation-overlap.html July 11, 2013 at 07:51PM

CME Group Announces First Trade of New USD-Denominated Palm Oil Swaps – Jul 1, 2013

CME Group Announces First Trade of New USD-Denominated Palm Oil Swaps – Jul 1, 2013.

Transition from Swaps to Futures changing the global energy markets trading landscape

Before the Dodd-Frank Act was enacted, the choice for energy market traders was between swaps and futures, two separate, distinct markets, but due to new regulatory requirements, trading is increasingly occurring in listed-futures instruments, a dramatic structural shift forcing market participant

via Pocket http://www.commodities-now.com/reports/power-and-energy/14825-transition-from-swaps-to-futures-changing-the-global-energy-markets-trading-landscape.html July 01, 2013 at 06:36PM

Prism Valuation Enhances Lat-Am Derivative Valuation Service

Prism Valuation Enhances Lat-Am Derivative Valuation Service


Prism Valuation has recently introduced two enhancements to its Derivative Valuation Service for Lat-Am products. Firstly, it now offers its clients the choice of discounting valuations for Brazilian Real (BRL) CDI zero coupon swaps using a curve constructed from USD/BRL non-deliverable forwards and swaps. This is in addition to the already existing option of allowing forecasting of the forward CDI rates using either an on-shore or an off-shore curve.

The non-deliverable curve discounting option is now being delivered to several clients trading these instruments. In addition, Prism has recently added support for the valuation of Colombian Peso (COP) OIS swaps, which can also be discounted using deliverable or non-deliverable curves. In addition to BRL and COP, Prism currently delivers IRS and other derivative valuations for Chilean Peso (CLP), Mexican Peso (MXN) and Peruvian Nuevo Sol (PEN) in the Lat-Am region.

“Supporting non-deliverable discounting for BRL and other Lat-Am and Asian interest rate swap types reflects Prism’s continuing commitment to providing a flexible, robust framework to meet clients’ derivative valuation requirements. We are always willing to make the effort to broaden our coverage and utilize emerging methodologies in order to deliver the best possible service” comments Keldon Drudge, CEO.


Pole Position in the New Swaps Market :: TabbFORUM – Where Capital Markets Speak

Pole Position in the New Swaps Market :: TabbFORUM – Where Capital Markets Speak.

ISDA/FOA swaps clearing template an “important” step

A standard contract for buy-side firms and their clearing members “will make life easier” when clearing OTC derivatives across central counterparties (CCPs), according to those involved.

via Pocket http://thetradenews.com/news/Asset_Classes/Derivatives/ISDA/FOA_swaps_clearing_template_an_%E2%80%9Cimportant%E2%80%9D_step.aspx June 12, 2013 at 07:00PM

Traiana’s management tool for swaps to goes live

Traiana’s risk management service for swap clearing is set to go live with users after the post-trade solutions provider completed testing with its first futures commission merchant (FCM).

via Pocket http://thetradenews.com/news/Regions/Americas/Traiana_s_management_tool_for_swaps_to_goes_live.aspx May 18, 2013 at 01:59PM

375 Buy-Side Firms Unprepared for June 10 Category II Swaps Clearing Deadline, Says TABB Group

375 Buy-Side Firms Unprepared for June 10 Category II Swaps Clearing Deadline, Says TABB Group


May 16, 2013, 8:00 a.m. EDT
375 Buy-Side Firms Unprepared for June 10 Category II Swaps Clearing Deadline, Says TABB Group
Swaps Market Liquidity Set to Compress by US$55 Trillion in Notional Terms

NEW YORK & LONDON, May 16, 2013 (BUSINESS WIRE) — With the June 10 date for phase two of the OTC clearing mandate fast approaching, a large portion of buy-side firms say they are not ready to meet the Category II Clearing Deadline for swaps.

According to TABB Group estimates drawn from new research, “Category II Clearing: Expediting Readiness,” 500 buy-side firms will fall under the Category II mandate. As many as 75% of them – 375 institutions – will fail to meet the CFTC deadline, writes Will Rhode, a TABB principal and director of fixed income research. Adding Separately Managed Accounts (SMAs), the universe is wider, with up to 3,000 funds needing to get “Know-Your-Customer (KYC)” documents in place before an intermediary will set them up for clearing.

“This failure will lead to a compression in US swaps trading activity and a liquidity drain of approximately US$55 trillion in notional terms,” Rhode says.

Category II applies to commodity pools, hedge funds and non-swap dealer banks, as well as insurance firms who are reconsidering their Category III status and those that fell under the Category 1 deadline of March 10 but managed to delay.

May 15 was the cut-off date for selecting a futures commission merchant (FCM), leaving a buy-side firm a week to complete legal documentation, two weeks for account opening and, if lucky, a day or two for testing. The onboarding process includes negotiating legal documents with FCMs, middleware providers and derivatives clearing organizations (DCOs), as well as executing brokers. From an operations point of view, buy-side firms have to establish connectivity to clearinghouses, set up legal entity identifiers (LEIs) and upgrade their trade-management and portfolio-reconciliation systems.

“The grim reality for those that have yet to engage with an FCM is that much of the bargaining power over the critical elements of clearing relationship has already been lost,” Rhode writes. “With just four weeks left to go until mandatory clearing, time is against the buy side to comply. Many will simply have to accept the terms FCMs present in order to avoid being locked out of the market.”

DCOs and FCMs recommend that the buy side clear at least a few trades in each relevant asset class before the start of the mandate. The industry experienced ID-mapping issues during phase one in March and the risks of failures in phase two is higher, given that approximately 10-times more volume will be going through the system. “It’s unknown how the overall system will handle the sudden escalation of clearing volume on June 10,” says Rhode. “There’s no way to know where stresses and breakages may occur. There’s no precedent for this degree of clearing onboarding.”

Since the June 10 deadline announcement was issued, clearing at the CME has increased 150%, reaching US$1.4 trillion in outstanding interest as of May 2. Average weekly client-side clearing flows at the CME for the eight weeks prior to November 28 were $4.9 billion. In April, average weekly clearing flows increased nearly six-fold, to $26.2 billion, and are still climbing with some weekly flows topping $50 billion. At LCH.Clearnet’s SwapClear, client-side notional values outstanding have increased more than 158% since the timeline announcement to $6.1 trillion.

For buy-side firms not ready in time, Rhode says their only option is to proxy hedge with other instruments – cash treasuries, futures or swap futures – until a clearing arrangement is in place. The CFTC will have little tolerance for firms that miss a widely anticipated deadline. Intermediaries will have little incentive to flout the new rulebook. “One thing is clear,” says Rhode, “The period of procrastination is over.”

The 9-page report with 6 exhibits is available for download by TABB Group Research Alliance Fixed Income clients and qualified media. For the Executive Summary or more information, visit http://www.tabbgroup.com. To purchase the report, write to info@tabbgroup.com.

About TABB Group

With offices in New York, London and Asia-Pacific, TABB Group is the only research and consulting firm focused on capital markets, based on the proven interview-based, “first-person knowledge’ research methodology developed by Larry Tabb. For more information, visit http://www.tabbgroup.com. In 2010, TABB launched TabbFORUM, the online global capital markets community covering peer-to-peer opinions and analyses on current industry issues, tracked daily by more than 16,000 professionals.

OTC Clearing and Regulations

My views on OTCs and Regulations

Knowledge Problem

Commentary on Economics, Information and Human Action


4 out of 5 dentists recommend this WordPress.com site

Aditya Ladia

Save, Invest & Grow Your Wealth

Soltis Consulting, Inc.

Business Concepts, Ideas, and Information


An Endeavor To Explore The Uncertanity

All About Cyber Security and Financial Technology and Beyond

The Future of FinTech and Cybersecurity are Interlocked: Creating the Secure Future of Financial Technology Today


Read about latest trends in Algo Trading in India or visit our website symphonyfintech.com

Trading Smarter

Thought Leadership, Insight and Product Information from TradingScreen

Tales from a Trading Desk

Noise from an Investment Bank

NPA Computers

Bringing you info about the latest on Internet Technology


An online journal of International Energy Trends, Green Building, Sustainability and Climate, A&E, Data, Security, CryptoCurrency and Social Media

Trade News in Brief

International Economic Affairs & Relations / Regional & International Organizations / Global Commerce & Business


The Single Dealer Platform Community

Carl A R Weir's Blog

A Cross Asset Connectivity and Finance WordPress.com site

%d bloggers like this: