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Calling All Margins: Automation On Center Stage

Calling All Margins: Automation On Center Stage

Calling All Margins: Automation On Center Stage

June 7, 2010
By Chris Kentouris

Sending email messages and faxes are the primary mechanisms used to make margin calls on trades in the $605 trillion market for over-the-counter derivative securities. But those cumbersome and manually means of communication could soon be a thing of the past.

The new tack: standardized electronic messages.

But here's the catch: There might well be more than one standard. And there may be more than one service provider offering those standards.

One choice is formatting in the Financial Products Markup Language (FpML), a popular message protocol in the OTC derivatives market. Last November, the collateral committee of the International Swaps and Derivatives Association (ISDA) picked FpML, when it devised a best-practices manual on the content and workflow of margin calls, interest payments on cash collateral and substitution of collateral.

But the Society for Interbank Financial Telecommunications (SWIFT) is coming up with new messages for margin calls that adhere to the International Organization for Standardization's ISO-20022 format.

Yet another alternative that relies on proprietary message formats is AcadiaSoft, a privately held firm in Boston and London. The firm offers a hosted communications platform run on BT Radianz's network. This will allow users of proprietary collateral management platforms, custodian bank systems as well as third-party collateral management systems to communicate with each other. So far, Credit Suisse, HSBC and JP Morgan-all members of the G14-have committed to using the service.

The Federal Reserve Bank of New York has not endorsed any software vendors or message types for margin calls, but 14 of the world's largest broker-dealers known as the G14 have now promised the Fed they will test standardized and electronic margin call messages. They will do so by December 31 with their "chosen vendor or utilities contingent on the viability of a commercially viable solution."

Although insisting it is not offering a dedicated message hub, SWIFT does provide a secure network over which to send the ISO-20022 margin call messages. And those messages will be available for testing in the fall. SWIFT is working with a separate ISDA-led committee devising FpML formats for margin calls to reduce as many discrepancies as possible between its message formats and the FpML formats.

Users of FpML messages can send them over SWIFT's network but won't likely be able to communicate with users of SWIFT's ISO-compliant messages unless their firms use some sort of internal reformatting engine or a third-party translator.

The need for automated and standardized margin call messages and appropriate workflow wasn't overwhelmingly clear until the collapse of Bear Stearns, the bankruptcy of Lehman Brothers and the bailout of AIG in late 2008. Then, market players realized the importance of managing the risk of counterparty failures. That meant having enough collateral on hand to cover transactions when a counterparty disappears and knowing where that collateral is.

As the Securities Industry and Financial Markets Association's Financial Technology Expo arrives in New York on June 22, OTC markets are recovering and counterparties are using lower levels of collateral.

But according to an ISDA survey, about 70 percent of OTC trades were collateralized in 2009 including 93 percent for credit derivatives. The figures were even higher for the largest derivatives dealers-about 78 percent of their OTC trades were collateralized while 97 percent of their credit derivatives trades were.