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Article: OTC Derivatives Regulatory Reforms and the changing role of Middleware platforms

27 October 2015 | Samantha Hodgson

Background:

In response to the financial crisis that began in 2008, the leaders of the Group of Twenty (G20) nations agreed to a series of measures following concerns about systemic risks in over-the-counter (OTC) derivatives markets. The financial Stability Board (FSB) tasked with revamping the system initiated steps ranging from transparency of the over-the-counter (OTC) derivatives market, protecting against market abuse and mitigating systemic risk.

The G20 countries had envisioned the creation of a central database for all OTC transactions- an entity that would serve as a powerful new tool for preventing systemic risk. Today, a few years after the decision in 2008 aimed at streamlining swaps data- that vision is beginning to come to existence and become a reality—however there is a twist. Instead of one central source, the data will flow into a number of entities that are competing to serve as repositories.

Many new entities like the SEFs, CCP, DCOs and SDRs have also been introduced to the OTC derivatives trade lifecycle process. There are also independent repositories for each of the regulators – CFTC, ESMA, and HKMA among others.

By applying for license in multiple regimes, DTCC, CME group and ICE trade vault are some of the key players in the trade repository world.

This has caused need of a higher efficiency in areas like near-real-time reporting of trades, shorter durations for posting allocations, submission of trades for clearing post execution, and basically operating in an exchange-like world.

Renewed role of the Middleware Applications:

While today’s business processes such as affirmation / confirmation platforms may be on decline, especially for the contracts executed on electronic venues, middleware applications have proved crucial in creating software solutions that can provide real-time compliance with reporting requirements by providing connectivity to the various market players.

Markit‘s flagship offering MarkitServ was initially essentially a trade confirmation platform but in a post regulatory world has evolved to have unparalleled industry connectivity that connects all participants for efficient counterparty access. MarkitServ now connects trading counterparties, execution venues, clearinghouses and trade repositories, helping market participants to streamline trade processing workflows across asset classes and meet regulatory obligations.

Middlewares cater to two big industry needs.

  • They connect the expanding numbers of OTC market players – the counterparties of a trade, their clearing brokers, the central counterparties (CCPs) that will clear all standardised trades, SEFs and the crucial swaps data repositories to which trade data has to be reported.
  • They allow the counterparties to compare and affirm the details of the trade they are executing.

Industry experts reiterate the above thought. “There will still be a big need for middleware services, even if the affirmation side of it does disappear for trades executed on a Sef,” says Jeff Gooch, chief executive of MarkitServ in London (in an article to a magazine). “The value proposition of middleware – the ability to plug in once and connect to many different people – still stands. Affirmation is only a small part of what we do. For example, status messaging is important for clients. They want information on whether the CCP has cleared the trade – and whether the data warehouse has accepted it – flowed back into their systems.

Mandatory Clearing requirements and need for Collateral management:

Mandatory clearing has added complexity to the OTC trade lifecycle process.Swap dealers and Futures Commissions Merchants (FCMs) are reengineering their technology infrastructure considerably to support CCP clearing on multiple clearing houses, while clearing a portion of the swap contracts bilaterally – a part that are not clearing-eligible.

Collateral management is another key feature. Trades are accepted by the clearing house for clearing, based on the collateral posted by clearing members at the time of executing the trade. This makes mandatory the real-time routing of trades to the CCP to confirm clearing acceptance. Hence connecting to the CCPs electronically is important. Messaging platforms such as MarginSphere from Acadia soft - an online service that facilitates and manages communication of collateral calls, has risen in popularity due to need of real time collateral management.

Also a connection to multiple CCPs and trade repositories is important for any SEF and none can take the risk of being associated with a single entity in this rapidly changing and evolving market. The industry spending on technology is rising and firms will be choosing clearing members who have with good technology.

The Need of pre-trade credit checks:

Regulations have mandated a clearing member to perform credit checks for each transaction to ensure clearing certainty. Therefore, there is a growing importance of real-time pre-trade credit checks, as otherwise the trade getting executed on Swap Execution Facilities may get rejected from clearing by the client’s FCMs. This requires SEFs to connect and access clearing members to confirm credit lines prior to trade execution and ensure “Certainty of Clearing”.

MarkitServ‘s new offering Credit Centre looked to serve this requirement.

Credit Centre was a cost effective, pre trade credit checking service. It delivered ultra-low latency verification of customers' credit with their FCM for orders placed on electronic execution venues, such as swap execution facilities (SEFs). Using Credit Centre, traders could manage their credit lines across multiple venues in real time from a single web-based dashboard. It supports regulatory requirements for mitigating risk of clearing-eligible trade being rejected at the clearinghouse due to insufficient credit.

Credit centre may have been ahead of its times, but in the times to come can prove as a game changer as markets evolve

Straight Through Processing (STP):

The New regulations have also seen the growth of FpML: a critical tool in the new OTC regulation environment.

Initially developed by a small group of IT business developers and technical architects for standardized modelling of OTC derivatives the model gradually took the official designation of Financial products Markup Language (FpML).

From its 2001 collaboration with ISDA, FpML has for years been rolling out new functionality.

The introduction of FpML 5 has created a clean slate for the regulatory reforms and has become a critical tool for supporting functions, such as clearing and trade reporting, in the new OTC regulatory environment.

There is increased demand of mechanisms that would take the client XML and transform it into the standard FpML to be delivered to the counterparty and clearing houses.

MarkitSERV ‘s TradeSTP solution can deliver the details of executed trades in customer-specified formats, providing support for industry standards, including FIX and FpML. By integrating post-trade messaging flows within TradeSTP, customers gain effective access to Market participants already supported by MarkitSERV for post-trade STP.

In times of the proliferation of trade repositories, CCPs and SEFs, the focus is clearly on connectivity, pre trade credit checks and straight through processing (STP) to provide real-time clearing compliance with reporting requirements and middle wares such as MarkitServ hold the key in this space.