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November 2, 2016

LCH Move To Rewrite Processing for the Rates and FX Markets via SwapAgent

For those familiar with the DTCC Trade Information Warehouse, you'll know this was the first central end-to-end processing platform for OTC business. LCH has now moved into the Rates and FX space to perform a similar function. If you thought the pace of change was slowing, think again.

LCH SwapAgent Changes OTC Processing

Back in 2005 Tim Geithner shone a light in a dark corner of the OTC processing world – the growing chaos around secondary trading of CDS contracts which overtook banks’ ability to process the novations and settlement in any organised way. I happened to work for DTCC at the time, and out of this chaos was born the Trade Information Warehouse (TIW). Initially TIW tackled the upstream confirmation matching process, and a huge effort was made by banks to load and match their novation agreements which represented the sale and purchase of one side of a CDS contract.

Next came the relevant payments derived from these trades which the industry also couldn't agree on. A partnership with CLS was forged, from which the end-to-end process was completed, giving firms a route from confirmation to settlement with minimal involvement from bank staff (other than approving net payments each day and ensuring their systems reconciled to the TIW). At the time, the chaos in the market drove the forced march to automation without which the 2008 meltdown would have been even worse. At the time the ideas behind the TIW could have been applied to other OTC assets classes, and serious discussions were held to look at the case to build central automation for the rates market. Ultimately the industry didn't feel the move was justified so TIW remains CDS only.

Fast forward to today and such a move has been announced by LCH, that of 'SwapAgent'. As everyone knows the uncleared market requires huge investments in people and systems to service the OTC business. Even with the evolution of SwapsWire into MarkitWire, this doesn't guarantee that two parties to a contract will actually expedite the same payments on the same day with the same rates. In the collateral management environment, disputed margin calls still prevail, even though future capital rules may punish these one day.
LCH have announced a service which rips up the processing landscape and perhaps anticipates the cost pressures on banks in the back office.

Their summary of this new idea is shown in a table:

LCH SwapAgent Changes OTC Processing

The processing chain behind this new service would be relatively easy for firms to adopt:

  • Build a pipe from MarkitWire to SwapAgent
  • Agree with your counterparties to route eligible trades onto the platform
  • Reconcile your positions, cashflows, rates and valuations daily
  • Settle margin payments and coupons via SwapAgent daily
  • Sit back and read the paper

What makes this interesting is that almost all this infrastructure already exists within SwapClear, the main difference being an expansion of product scope into rates and fx business which may not be suitable for clearing, and the necessary market data and valuations for trades on the platform.

Impacts

This move could rewrite the landscape for the OTC market:

  • One net margin agreement via SwapAgent, no need to keep adding new CSAs for new counterparties
  • No margin call disputes
  • Net settlement – a big decrease in nostro reconciliations and failed payments
  • Independent valuations and pricing
  • Compression opportunities become easier due to a single consistent source of data

Winners and Losers

  • Winners must be firms which struggle to find the resources to book and process the wide range of OTC products, and everyone who tires of the endless reconciliations and breaks in the wild west of OTC processing.
  • Who loses isn’t clear, could a firm treat SwapAgent as their sole trade processing platform, or must they maintain their own independent records of trades? If the former is true, vendors of trade processing platforms will need to consider how they service smaller firms if this business could become centralised.
  • Regulators ought to welcome a source of clarity in the market on positions and valuations. Perhaps SwapAgent could become a better way to achieve reporting to SDRs and TRs given the quality of the data?

SwapAgent will launch sometimes during 2017, and within not long we may see third party services advertising their compatibility with SwapAgent as a necessity. Learn more at http://www.lch.com/lch-swapagent and in the attached PDF below.


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