Panel Adopts Communication Standards for OTC Derivatives
July 28, 2009
A committee of the International Securities Association for Institutional Trade Communication (ISITC) has come up with a set of common standards for how investment managers should communicate details of transactions in over-the-counter derivatives to third parties such as custodian banks, accounting agents and prime brokers.
The goal of the new standards, administered by ISITC, is to eliminate or at least reduce the amount of paper-based communications and disparate message content flowing between fund managers and their service providers. That should lead to fewer errors in recordkeeping and collateral management and valuations. The standards were developed over the past two years in conjunction with the Asset Managers Forum and the Financial Products Markup Language protocol group, which is administered by the International Swaps and Derivatives Association (ISDA).
Because of the large increases in OTC derivatives trading volume, investment managers have put a high priority on automating notifications to relevant third parties, said Genevy Dimitrion, vice president of global product management at State Street and chair of ISITC. The 130-member OTC derivatives committee is co-chaired by Franklin Templeton Investments and Barclays Global Investors, representing fund managers and Bank of New York Mellon and State Street representing custodian banks.
The standards, to be used in the notification process between investment managers and third-party agents, include adopting the use of Financial Products Markup Language tags for communications as well as the type of information to be used in the message formats. The notifications involve the initiationor terms of the contract the increase in the notional amount; any change in obligations under the contract, any amendment to the terms of the contract and the termination of the contract.
The multi-trillion dollar OTC derivatives market has been attracting plenty of attention over the past two years as securities watchdogs and professional organizations try to reduce the risks inherent in trading and processing on both sides of the Atlantic. In March, the Asset Managers Forum, which operates under the umbrella of the Securities Industry and Financial Markets Association, is moving to standardize the way fund managers, broker-dealers and custodian banks reconcile post-trade positions and collateral requirements for OTC derivatives.
BNY Mellon and State Street also serve on the AMF derivatives committee as does Putnam Investments, Promark Global Advisors, Lord Abbett & Co and messaging consortium Swift.
According to the ISDA, credit derivative volumes fell last year as market participants sought to compress their portfolios, or terminate existing trades and replace them with a much smaller number of transactions. The notional amount outstanding of credit default swaps (CDS) dropped 38 percent in 2008 from $62.2 trillion to $38.6 trillion, according to ISDAs year-end survey. For interest rate derivatives, the notional amount outstanding dipped 13 percent from midyear 2008 from $464.7 trillion to $403.1 trillion though it rose 5 percent for the year, up from $382.3 trillion.
The lower notional amounts outstanding reflect the industrys focus on shrinking its balance sheets and allocating capital more effectively. Portfolio compression results in portfolios that have the same risk profile but less capital exposure.
The ISITC, which consists of 1,500 members from 350 firms worldwide including fund managers, custodian banks, broker-dealers, vendors and market utilities, develops standards to improve operational efficiencies in trade processing. In February, ISITC also released market practice guidelines for standing settlement instructions among investment managers, custodians and broker-dealers.