State Street Mulls ISDA Engine Amid Calls for Pricing Alternatives
March 30, 2009
State Street Corp. may begin offering its buy-side clients a credit default swaps (CDS) pricing engine that is being freely distributed by the International Swaps & Derivatives Association (ISDA).
ISDA is hoping that its pricing model will help bring transparency to the credit derivatives sector. Getting a custodian as large as State Street to sign on would be a significant step in that direction.
State Street already provides in-house models for CDS valuations and access to third-party models. It is considering adding the ISDA engine because it might just become the industry's "de facto standard," says Neil Wright, SVP and product manager for derivatives servicing at the custodian bank.
Developed by JP Morgan Chase & Co., the model--now called the ISDA CDS Standard--was transferred to the trade group early this year and made available for download last month. Markit Group, a provider of data and valuation services, is acting as administrator for the engine. Last week, Markit released XML specifications for calculating standard interest rate curves based on the fixed 1 percent and 5 percent coupons the industry is establishing.
Wright says that the ISDA system would sit alongside the other pricing services offered through OTC Hub, State Street's processing platform for derivatives. "For us, it's just running one more model," says Wright. "But the industry has very much gone away from relying on the dealers solely for pricing."
The demand for access to multiple analytics systems has grown as asset managers have soured on dealers' valuations, particularly for instruments like credit derivatives. State Street will "agree with the client on the source that they want to use for valuing derivatives," explains Wright. "Some clients want to use more than one source, so we have what we call a 'pricing hierarchy,'" which can include models from State Street and vendors, as well as a customer's own.
To meet clients' demands, administrators and custodians will need to combine proprietary modeling and Web 2.0 technologies, according to Michael Henry, Accenture's head of financial services strategy in North America. As regulators call for more standardization and disclosure, "the pricing models that emerge will use available data in different ways: more conservative correlations; more use of non-standard data such as credit-card late payments and Google click-streams."
Henry says the ISDA model will help standardize general pricing formats, but he does not believe larger firms will rely on it solely. "Open-source valuation engines make some sense for small players," he says. "But large buy-side firms who make money in this business will always use their own models. The administration business is about cost and scale, not innovation."
State Street launched OTC Hub last year, with investment firm Pimco as its first user. The hub, which covers credit derivatives, interest rate swaps and equity derivatives, is still being integrated with State Street's accounting systems, says Wright, as well as with third-party pricing vendors like Markit and SuperDerivatives.
