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Technology Meets Derivatives Trading

June 26, 2006
By Maria Trombly

Hedge funds tend to trade complex products such as credit derivatives far more frequently than do other buy-side firms, and many of these trades are still executed manually. Many are customized and negotiated individually, which limits the potential for automation--and makes them susceptible to errors.

"There's been an exponential growth in trade volumes," says Jeremy Lee, operations manager at London-based fixed-income manager Cedaris Portfolio Management. This increases the risk that trades will be booked incorrectly, he says. In fact, as many as 20 percent of these orders have errors in them, according to Mark Beeston, president of T-Zero, a London- and New York-based company spun off last year by credit default swaps (CDS) trading platform Creditex to automate confirmations and related, historically manual and problem-prone workflows.

"We're taking a version of the trade from our client and serving it up on the Web to the counterparty to the trade."

T-Zero's service lets buyers and sellers confirm orders before they are booked, which reduces errors, saves time and decreases market risk. T-Zero's real-time affirmation product is free to buy-side firms, about 50 of which, primarily hedge funds, have signed up. The first trade was processed through the system last October. Six sell-side firms are on the platform, including Goldman Sachs & Co., JP Morgan Chase & Co., Deutsche Bank, Royal Bank of Scotland and Lehman Brothers. Five more are in the process of adopting it.

"This product should quickly become the market standard," Francisco Arcilla, director of trading at KBC Alternative Investment Management, a London-based hedge fund, said in a statement. "This mechanism will reduce operational risks and enhance the transparency of the post-trading process with our counterparties."

T-Zero provides a real-time link to the Depository Trust & Clearing Corp. in New York In trades between KBC and Goldman Sachs, T-Zero processed multiple single-name CDS. Within minutes of a trade, information was sent to Goldman Sachs' trade capture system and the T-Zero platform. KBC electronically affirmed and simultaneously allocated the trade across multiple funds--a process that normally took up to ten days.

The system also addresses common problems such as unconfirmed trades, cash breaks and margin management, according to T-Zero. "We're taking a version of the trade from our client--from the bank--and serving it up on the Web to the counterparty to the trade, who's checking it over," says Beeston. "There's a real-time discussion until they both agree on a single understanding of the trade."

It's possible to do the negotiations over e-mail or instant messaging, Beeston says, but T-Zero's system provides an audit trail and can be integrated with other systems, so there's no need to re-key trade orders. The system can also be linked to the sell-side firm's trade capture environment, Beeston says.

The fact that it connects to multiple trading systems is a selling point, considering the securities industry's heterogeneous environment. That interoperability may go a long way to averting a paralyzing back-office paper crunch.