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A New Generation of Credit Market Solutions

January 1, 2007
By Maureen Nevin Duffy

Risk Management Policy Group (CRMPG), led by Goldman Sachs Group managing director and former Federal Reserve Bank of New York president E. Gerald Corrigan, identified deficiencies in post-trade derivatives processing as a serious systemic risk to financial markets. Two months later, taking off from that report, the New York Fed called representatives of top dealer banks together to begin to map out an improvement plan, and the progress since in automating over-the-counter credit default swaps (CDS) processing has been dramatic.

As of mid-November, when Depository Trust & Clearing Corp. (DTCC) announced that its Trade Information Warehouse, a key element in post-trade CDS automation, had gone live, 80 percent of credit derivatives trades globally were being electronically confirmed on the DTCC Deriv-Serv platform, up from 15 percent in 2004. In a Nov. 21 letter to the New York Fed's current president, Timothy Geithner, 17 dealer firms said they were turning attention to the next area of need: equity derivatives.

There is no letup in the growth and complexity of derivatives products, nor in the demand for technological solutions. "Innovation from a product point of view is changing on a monthly basis," said Brad Bailey, senior analyst with Boston-based research firm Aite Group.

The DTCC warehouse was a milestone among processing developments. It holds the official legal records for all contracts eligible for confirmation through the three-year-old Deriv-Serv automated matching and confirmation service. Thomson TradeWeb, MarketAxess Holdings, DTCC and T-Zero, a spin-off of New York-based CDS trading network Creditex, are all equipped to capture trade data. Interdealer brokerages GFI Group and Icap, as well as Markit Group of London and New York, have been leaders in collecting pricing and valuation data, Bailey noted. Their products and services have enhanced transparency as CDS trading migrates from voice brokers to electronic platforms. "TradeWeb is set up to do prime brokerage trades through their system," noted Bailey, "which is very exciting for hedge funds."

The push to automate post-trade processes has spurred partnerships and acquisitions. For example, T-Zero, which offers a workflow-based approach that enables same-day affirmations of CDS trades, in July announced a deal to make its platform available to all users of the Bloomberg Professional service.

"There is no reason for a single CDS trade or index or transfer trade to be outstanding-from a documentation point of view-by end of trade date," said T-Zero president Mark Beeston. "Our strength is the combination of real-time accuracy and transparency of the data and status of the data, combined with the willingness to send it wherever the clients want it sent."

In May, Markit Group acquired Communicator of White Plains, N.Y., whose portfolio of electronic businesses included a post-trade processing business that rivals T-Zero's. Markit also plans to launch a new intraday pricing service for CDS and other asset classes. Calypso Technology, a San Francisco-based developer of a multi-asset-class trading systems, now offers T-Zero and Markit Trade Processing through its platform.

Other providers of workflow-management systems to streamline confirmations include Sunnyvale, Calif.-based Interwoven, with Scrittura Buy Side and Scrittura Messaging, and Surrey, U.K.'s Thunderhead.

There has, meanwhile, been growing adoption of the financial products markup language, (FpML), a standard sponsored by the International Swaps & Derivatives Association (ISDA) and based upon extensible markup language (XML). Aite's Bailey said that FpML and ISDA's novation protocol have contributed to the automation of the derivatives market. In February, ISDA updated the 2005 novation protocol, now calling it NPII; it enables trading counterparties to modify the notification requirement to a simple electronic communication. In September, ISDA announced a protocol to permit cash settlement of single-name, index, tranche and certain other common credit derivative transactions. The settlement mechanism will join a revision of ISDA's Credit Derivative Definitions that the group expects to publish in 2007.