Thursday, May 02, 2013 11:24:07 AM

Buy-side needs automated systems for swap clearing – TABB

Institutional investors risk higher margin requirements if they cannot eliminate errors when communicating swap transaction data to clearing houses, according to a new report from TABB Group.

Will Rhode, director of fixed income research at the research group, said buy-side firms must adopt new communication systems before US central clearing rules kick-in for OTC derivatives on 10 June.

"Without a system than can communicate with the clearing house to ensure all necessary fields and coding requirements are met prior to execution, the buy-side will find it impossible to manage their swaps portfolios effectively in a centrally cleared world," he said.

Whereas brokers were forgiving of Excel spreadsheet errors in bilateral trades, clearing houses would be less so, he said. Rhode argued data mistakes could result in clearing houses failing to recognise a trade that has been placed to offset another. Missed opportunities to net trades would therefore lead to higher margin requirements.

"In the bilateral world, it is understood that the affirmation process doesn't have to be exactly precise," he said.

"But clearing houses' systems are far more automated and they will say, 'if we don't see exactly which line items you are trying to compact to have an equivalent trade, we'll register a brand new line item'."

The new trade will require additional margin. "This entirely negates the benefits of portfolio margining at the clearing house," says Rhode.

The buy-side needs messaging technology containing detailed, machine-readable trade and position information to communicate with clearing houses, replacing the old Excel spreadsheets, he said.

"There are systems available, you just need to install it and get into your workflow."

Clearing old for new

Market players are preparing for new OTC derivatives rule changes both in the US and in Europe, which include mandatory reporting and central clearing of standardised swaps. 

Custodians, clearing houses, and other organisations involved in the post-trade cycle have been rolling out new services and technologies to allow for more efficient, standarised flow of data, including automated messaging systems that replace fax and emails. 

Rhode said the news rules may also lead to firms using pre-existing bilateral trades on their books to offset new trades in the clearing process.

"If you have old positions already on your books, you could theoretically start to employ those to realise netting efficiencies on the new trades you are putting on," he said.

Rhode said it was only a matter of time until clearable swaps - from interest rate swaps, overnight index swaps and basic swaps to forward rate agreements, credit default swaps and energy-related swaps - cease to trade bilaterally altogether.

"The world of bilateral trading has engendered a proliferation in line items and now the process of rationalising swaps portfolio needs to begin," he said. 

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