Section 2 - FTSE

AUTOMATING OTC DERIVATIVES
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Karel Engelen, policy director and head of FpML at ISDA, says the
summer volume surge spilled over into novations, which are much less
automated than regular trades. A novation allows a new legal entity
to substitute for one of the original counterparties to a bilateral
derivative contract, so it requires the consent of all three parties.
Photograph kindly supplied by ISDA, October 2007.
Novations caused much of the paperwork backlog that
drew regulators’ attention to credit default swaps in the
first place two years ago. In response, ISDA developed its
Novation Protocol to standardise and speed up the
procedure. That helped the industry get backlogs under
control, but the process still requires manual
intervention. “There is a renewed focus on looking for
electronic solutions for novation consents,”says Engelen.
Up to now, automation has focused on immediate posttrade
processing but market participants are starting to
explore electronic solutions for the entire product life
cycle, including novations, portfolio reconciliation and
collateral management.
Engelen expects the spread of electronic processing to
facilitate the introduction of new products, too. A higher
degree of automation makes it easier to handle new products
and shifts the point at which automated processing is
economic earlier in the product life cycle. Manual processing
will never disappear, though. It takes time for market
participants to agree on standard terms for new products and
until they do automation is virtually impossible.
Janet Wynn, general manager and managing director of
DTCC Deriv/SERV, says the firm’s electronic platform and
data warehouse have already proved their worth. For
example, when a troubled hedge fund is taken over, the
entire credit default swaps portfolio can be assigned to an
acquirer through DTCC’s platform in just a few days. In the
past, a buyer had to print out and pore over thousands of
pages of documentation just to see what was in the
Mark Beeston, president of T-Zero, a London-based electronic affirmation
service.The immediate crunch was in booking trades and executing
documents, but the whole operations function was swamped, notes
Beeston.“You cannot borrow bodies out of your other areas,”he says,“At
the time you need those resources they are exceptionally busy doing their
own thing.”Photograph kindly supplied by T-Zero, October 2007.
portfolio and how to handle the assignments, a process
that could take several weeks.
Wynn notes that although backlogs increased over the
summer they were nowhere near as bad as when regulators
sounded the alarm in September 2005. She points out that
back office staff had enough capacity to handle other
projects over the summer as well. The big firms finished
loading their historical portfolios into DTCC’s data
warehouse and participated in a test of payment
calculations for the settlement system DTCC will launch
later this year.“There is no paralysis out there,”Wynn says,
“Everybody is working very hard. There are a lot more
exceptions to handle but it is very much under control.”
The industry cannot afford to sit still, however.
Automation frees up back office resources to focus on
novations and breaks, but if OTC derivatives keep up their
breakneck volume growth the need for staff is bound to
increase, too. “Without DTCC’s platform the volume of
trades could not have happened,” says Wynn, “And they
could never have handled this surge.”
So far, automation has helped back offices stay one step
ahead of the game. They have moved away from
processing every trade toward handling exceptions, but
that function isn’t scalable. If it takes 50 people in a
dealer’s back office to sort out 20% of today’s trades it will
take twice as many when volume doubles – and qualified
staff are hard to find. At some point, the industry has to
tackle the error rate, through either greater reliance on
affirmation or electronic trading.
NOVEMBER/DECEMBER 2007 • FTSE GLOBAL MARKETS