Clearing Models in a SEF world


Kevin McPartland of the Tabb Group hosted a Fixed Income event last Tuesday in New York. According to our sources, the event was hugely oversubscribed – not surprising given Tabb Group & Kevin’s focus and insight on Dodd-Frank  and itss intended and unintended consequences.

According to Wall St & Technology, one of the areas of discussion was understanding how clearing will function so that execution risk is mitigated. In short, if a trade is done through a SEF, that trade is not complete until the clearer has accepted it. Which means that the counterparties (or their clearing agent/FCM) are still at risk until the acceptance has happened. Hence the focus on how that risk can be mitigated.

The proposals fall into two groups: (1) post-trade or (2) pre-trade. Post-trade means that the clearer will check the member’s or agent’s credit lines to ensure that sufficient margin exists to complete the trade. Pre-trade means that that credit-check step occurs prior to the execution on the SEF….which for many participants means a change in how they process trades. More details are here.

From my perspective, this has significant implications for the banks planning to aggregate SEFs as it will be very difficult to aggregate SEFs that are using different credit-check methodologies. Of course, the alternative is that all SEFs use one method. Or the other.

Also, based on our work in FX, the pre-trade check model is very similar to the model used for FX executable streaming prices that we see in many SDPs. And the lesson there is – the credit management system must be capable of sustaining a minimum of sub-ten millisecond response times AND ensure that all credit lines are updated in real time. Ideally across all business lines/asset classes.

Have you measured the real-time latency of your credit management systems recently?

4 Responses

  1. Can we have the content now? 😉

    • Hi Bill, apologies for the content being slightly behind the headline! Good to know you’re watching. 🙂 Scott

  2. Credit checking fixed income OTC trades pre trade isn’t as simple as most FX transactions a degree of calculation/modelling comes in which can only slow down a pre-trade check. Also many banks still have spot FX credit lines broken out to facilitate etrading whereas FI credit lines are often gridlocked with complex business that blocks the line for hours or days at a time until understood by Risk officers and cleared. Scott I agree that the bank who sorts out bilateral credit lines for etrading in FI will win substantial mkt share in the transition to a cleared environment.

  3. Hi David,

    I agree that many banks have yet to grasp the real-time credit management issues for FI *but* there are solutions in the clearing space. Bill has an example here (http://theotcspace.com/2012/02/01/follow-up-on-javelin-cme-real-time-irs-clearing/). John’s comment on the post is right on the money – what is the implication for collateral management?

    Scott

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