Banks urge bolstering operating framework of OTC derivatives

By Susanna Moon

Chicago, Oct. 31 - The financial industry presented a case for strengthening the operating infrastructure for over-the-counter derivations amid turbulent economic times in a letter dated Oct. 31 to Timothy F. Geithner, president of the Federal Reserve Bank of New York, from 16 financial companies and three industry associations.

The letter recommended improving derivative market processing as well as risk mitigation and transparency.

"The impact of recent market events has been far-reaching but particularly evident in the derivatives industry, giving rise to significant operational processing demands and challenging the infrastructure to manage increased trade activity and risk management," market participants said in the letter.

"These events have brought into even sharper focus the systemic risk concerns the industry faces. While scalable OTC derivative processing and infrastructure are key elements to successful market growth and resiliency, they become even more critical during stressed markets," the letter continued.

The letter outlined progress in mitigating risks associated with derivatives in the past several years:

• Achievement of 92% aged confirmation backlog reductions in credit derivatives;

• Increased rate of electronic confirmation automation in credit derivatives to 95% in 2008 from 19% in 2006;

• Increased rate of electronic confirmation processing to 91% in credit derivatives since 2006 from 46% and to 94% of eligible trades between major dealers in equity derivatives since February 2007 from 34%;

• Increase of certainty around novation processing by eliminating assignments without consent on trade date in interest rate and credit derivatives;

• Since January 2008, the notional value of credit default swaps outstanding has decreased by $24.4 trillion through trade compression;

• Increased use of LCH.Clearnet as a central counterparty to reduce counterparty credit risk among dealers for interest rate derivatives;

• Establishment of a DTCC trade warehouse in credit derivatives to increase transparency, automate payments and ease credit event processing;

• Establishment of a successful auction-based mechanism actively employed in 14 credit events including Fannie Mae, Freddie Mac and Lehman Brothers, allowing for cash settlement;

• Agreement among major dealers on a standard close-out methodology; and

• Efforts in recent weeks to accelerate central counterparty clearing have achieved a measure of success.

Despite these efforts, the group said more work lies ahead. To make further inroads, the group established seven goals for the market:

• Global use of central counterparty processing and clearing to significantly reduce counterparty credit risk and outstanding net notional positions;

• Continued elimination of economically redundant trades through trade compression;

• Electronic processing of eligible trades to enhance T+0 confirmation issuance and execution;

• Elimination of material confirmation backlogs;

• Risk mitigation for paper trades;

• Streamlined trade life cycle management to process events between upstream trading and confirmation platforms and downstream settlement and clearing systems; and

• Central settlement for eligible transactions to reduce manual payment processing and reconciliation.

The letter was signed by Bank of America, NA, HSBC Group, Barclays Capital, JPMorgan Chase, BNP Paribas, Merrill Lynch & Co., Citigroup, Morgan Stanley, Credit Suisse, Royal Bank of Scotland Group, Deutsche Bank AG, Societe Generale, Dresdner Kleinwort, UBS AG, Goldman, Sachs & Co., Wachovia Bank, NA, International Swaps and Derivatives Association, Inc., Managed Funds Association and Asset Management Group of the Securities Industry and Financial Markets Association.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.