CDS Processing to Benefit Interest Rate Swaps

Processing interest rate swaps (IRSes) should benefit from post-trade improvements in over-the-counter (OTC) credit default swaps (CDSes), according to industry insiders who spoke at a recent conference of capital markets professionals.

Most of the improvements will be in OTC interest-rate derivatives trade reporting, says James McLoughlin, managing director at MarkitServ, a gateway for OTC derivatives trade processing formed as a joint venture of Depository Trust & Clearing Corp. (DTCC) and Markit, and launched in October 2009.

Service provider TriOptima launched its OTC Derivatives Interest Rate Trade Reporting Repository (IRTRR) in January. MarkitServ and its parent, DTCC, are planning their own repository marketplace for later this summer, according to McLoughlin.

"The key drivers for improvement in the number of outstanding confirmations are standardization, industry best practices, innovation and automation," he says. "The industry is focused on building standardization to allow firms to submit and confirm transactions in a better and more automated, streamlined fashion. These steps wouldn't have taken place without the involvement of the regulators."

In 2005, the Federal Reserve Bank of New York began efforts to improve the handling of CDS trades, obtaining commitment letters from major dealers and market participants to make improvements. In the years since, the average CDS dealer went from an outstanding confirmation backlog of 10,000 transactions in September 2007 to having 99 percent of all CDS transactions electronically confirmed today, observes McLoughlin. As a result of electronic confirmation, 87 percent of the trades are confirmed on trade date and another 6 to 7 percent are confirmed by the day after trade date, he adds. Also, of transactions that were part of the 2007 confirmation backlog, on average 3,000 of them were more than 30 days old, he adds.

According to Raf Prichard, CEO of TriOptima North America, interest-rate swaps will be the next asset class to see processing improvements as the market grows. "Last year, interest-rate swaps did $25 trillion in trades and this year we have already reached $21 trillion to date," he says. "Throughout portfolio reconciliation services, we are seeing 5.5 million OTC trades on a regular basis across all the asset classes and instrument types."
 
Building on IRTRR’s January launch, TriOptima began issuing public reports for interest-rate swaps on April 29, after previously issuing these reports solely to regulators and participating firms, notes Prichard.

OTC derivatives traders can expect a new focus on measurement of the effectiveness of securities collateralization, which will be achieved via automating and standardizing the trade processing, according to Prichard. "First, the population that trades has to agree on the value of those trades and the collateral," he says. "Second is acknowledging the exposure and making timely margin calls and seconding the margin. Some of those calls don't get accepted and then get disputed. That is why we need a robust process to manage those situations.”