Multilateral Backloading for OTC IRS

Our seamless mechanism for backloading trades into clearing or settlement venues leverages the multilateral benefits of bulk optimisation and processing connectivity via OSTTRA MarkitWire, allowing customers to benefit from efficiencies and processes such as CCP conversion events.

 

Participants simply submit their non-cleared trades with the expected PV impact from backloading. Our algo identifies the maximum number of trades that satisfies each participant’s tolerances, and the existing trades are amended in OSTTRA MarkitWire to automatically send for clearing.

 

Benefits

o    Pre-conversion – clearing eligibility check

o   Post-conversion: bulk backloading to clearing

 

The service was launched in 2023 for  SGD-SOR & THB-THBFIX but now includes

·         USD, EUR & GBP Inflation Swaps

·         CAD-CDOR IRS

·         MXN-TIIE 28D IRS

·         PLN-WIBOR IRS

 

 

Conversion of non-cleared cross-currency swaps

Our cross-currency swap conversion service offers proactive conversion of non-cleared cross currency swaps that reference legacy benchmarks. The service provides flexibility whilst mitigating the risks involved in converting to the new alternative RFRs.

 

Standard Ibor-Ibor USD-CAD CCS trade
Before Conversion After Conversion
Floating Rate Index CAD-CDOR CAD-CORRA-OIS-COMPOUND
USD (resetting) leg USD-LIBOR USD-SOFR-OIS Compound

 

To minimise risk impact and resulting PV difference subject to cash compensation, the conversion process generates overlay transactions in the form of market standard cleared interest rate swaps and overnight index swaps. Only a small residual PV impact from the conversion is settled in cash between the participants of the run, making the process market risk neutral.

 

Cleared overlay trades

 

 

Highlights

Participants select single-leg or full-trade conversion chosen at a currency pair level

 

This is pre-defined ahead of the exercise & applied to the non-resetting leg of the amended cross-currency swap

 

All participants will be aligned on the conversion method & the conversion spread leading into the exercise

 

“Our engagement with the industry over the last two years highlighted that market participants are committed to finding innovative solutions to reduce their exposure to legacy benchmarks. We are pleased to provide our non-cleared conversion service to help market participants overcome the technological and operational challenges of implementing fallback procedures and waiting until the deadlines for the respective legacy rates.”
– Vikash Rughani, Business manager at OSTTRA triReduce and triBalance

 

The service is available to customers with legacy benchmark exposure in cross-currency swaps referencing any indices subject to cessation, including those in MXN, PLN, ZAR and CAD.

Delivered by OSTTRA triReduce and triBalance, non-cleared trade amendment and connectivity to CCPs for the overlay swaps are provided via OSTTRA MarkitWire.

 

 

Benchmark Conversion

Manage the transition of legacy benchmarks in OTC swaps portfolios

Eliminate legacy benchmark transactions from OTC swap portfolios whilst proactively and iteratively converting the remainder onto alternative reference rate benchmarks. OSTTRA’s Benchmark Conversion cycles allows firms to manage the pace of their benchmark transition.

Compression first…

OSTTRA Benchmark conversion - compression first

Maximise gross notional reduction in legacy and alternative benchmark swaps.

 

…Converting the remainder.

OSTTRA Benchmark conversion - converting the remainder

Convert remaining legacy benchmark swap exposure to the alternative benchmark.

 

Key Features

 

If you are a market participant with cleared swaps, you are eligible. Contact info@osttra.com to find out more.

OSTTRA Capital Optimisation – Now with SwapAgent

We are pleased to announce that the OSTTRA triBalance Capital Optimisation service is now live with SA-CCR optimisation of settled-to-market netting sets by proposing new overlay trades designated into SwapAgent. This functionality is now available in both our Interest Rate and FX optimisation runs.

In December last year we completed the first Interest Rate cycle where we optimised bilateral and cleared exposures alongside participants settled-to-market exposures. The first FX cycle to include SwapAgent overlay trades followed shortly thereafter and was completed in January.


“Leveraging SwapAgent and its STM procedures presents new opportunities for our clients to further reduce capital costs under SA-CCR.”
Christina Högegård, Business Manager OSTTRA triBalance

 


Counterparty credit risk impacts a firm’s cost of trading due to capital requirements, driven by RWA and Leverage Ratio, and funding costs driven by Initial Margin. We are running frequent optimisation cycles in both FX and Interest Rates where our customers can proactively manage RWA and Leverage Ratio requirements, calculated using SA-CCR or Internal Model Method, while simultaneously optimising Initial Margin

 

Semi-annual FX and interest Rate Capital Optimisation

 


“We welcome OSTTRA triBalance using SwapAgent’s risk management and standardisation process for the bilateral market as a building block in their margin and capital optimisation.”
Nathan Ondyak, Global Head of SwapAgent

 


To discuss your capital optimisation needs, contact info@osttra.com.

 

2022 USD LIBOR Benchmark Conversion in Review

Following the LIBOR cessation events in CHF, EUR, GBP & JPY at the end of 2021, focus turned to managing down outstanding exposure to USD LIBOR in 2022. At the beginning of the year, the market appeared to take a deep breath and debrief on the positive outcomes of the conversion activities and fallback implementations, as well as planning for the areas that could be improved upon ahead of the upcoming cessations.

Outstanding USD-LIBOR exposures gradually declined through the year and we in turn saw quarterly declines through 2022 in notional terms.

However, we observed exposure in trade count terms materially tick up in Q4 through a combination of our continued calibration of the prioritisation given to legacy benchmarks, as well as bringing new participants into the network.

 

Cleared USD LIBOR Terminations in 2022
Cleared USD Libor 2022

 

As market participants have geared towards proactive and iterative reduction of their legacy benchmark exposure, we have seen consistent quarter-on-quarter growth in the use of our OSTTRA triReduce benchmark conversion cycles, as well as the adoption of our most advanced methodologies for compression and conversion.

The charts below show how this usage has trended over the year, laying a great foundation for a big push this quarter in 2023.

 

USD Benchmark Conversion Participation

 

Risk Replacement Trade Adoption

 

USD Benchmark Conversion Participation 2022 Risk Replacement Trade Adoption 2022

 

To discuss your benchmark conversion needs, contact info@osttra.com.

Delivering Certainty in Uncertain Times

triReduce’s benchmark conversion service offers users an iterative approach to mitigating uncertainty about the future of legacy benchmark swaps. Swap market participants can proactively reduce both their gross and net exposure to legacy benchmarks at the same time as increasing their adoption of the alternative reference rate for each respective currency. This service will be provided for trades cleared in all major central counterparties (CCPs) as well as for trades referencing legacy benchmarks held in non-cleared portfolios. A single process, in which participants retain control of the transition within their portfolios, is key to managing the change in your own mid-market valuations. By ensuring all compression and conversion takes place iteratively and at each firm’s own valuations, the service brings clarity to discussions about how to adopt alternative risk-free rates (RFRs) in swap portfolios.

 

Reviewing the data requirements

To better understand what is required, the image below illustrates triReduce’s benchmark conversion service. As they do today, participants will submit their existing swap portfolios, where it is likely they will have legacy benchmark and alternative RFR referencing trades. This enables the service to compress where possible and convert into the alternative RFR where compression is not possible.

Participants will provide discount factors and their own mid-market valuations, as well as any measures of risk they would like to control through the process for their existing trades and for additional template trades. These template trades are a standard representation of alternative RFR trades that will be used to establish additional liquidity at specific maturities to facilitate the conversion.

With this information and the corresponding risk-based limits that participants define, triReduce’s benchmark conversion service will return a proposal of fully terminated, amended and replacement trades that reduce exposure to legacy benchmarks in a controlled manner. Once accepted by each participant within a finite window of time, the proposal is passed on to the CCP for processing in the case of cleared trades.

 

Reduced legacy benchmark over-the-counter swap exposure

The result is a reduction in exposure to legacy benchmarks achieved through a simultaneous reduction of gross notional exposure and conversion of net risk exposure. TriOptima combines these two objectives and delivers outsized results by bringing together its world-leading portfolio compression network and new participants with core net ICE Libor over-the-counter swap portfolios (see below image).

To discuss your benchmark conversion needs, contact info@osttra.com.

OSTTRA compression service unlocks additional compression potential for G-SIBs

LONDON, 2 November 2022 – OSTTRA, the global post-trade solutions company, today announced that its market-leading portfolio compression service, OSTTRA triReduce, has compressed $26.4 trillion of interest rate derivatives in September as Global Systemically Important Banks (G-SIBS) look to reduce notionals before year-end.

More than $1 trillion in additional notional was compressed in September as a result of OSTTRA triReduce’s innovative trade refactoring solution. The patented solution, currently implemented by four financial institutions, transforms swaps portfolios to efficiently minimise gross notional exposures. Previously, market participants would experience a build-up of historic trades lacking the necessary offsets to unlock compression. Trade refactoring opens the historic population of trades, which can lead to a lower steady state of gross notional. This method has delivered an increase of nearly a third (30%) in gross notional compressed for market participants vs September last year.

“Being classified as a G-SIB is a fundamental component of financial institutions’ overall regulatory capital. It is key for banks to have a detailed understanding of their G-SIB scores, particularly as classification is assessed relative to their peers,” said Magnus Jonsson, head of business management triReduce and triBalance, at OSTTRA. “The challenge is that G-SIB assessments are highly sensitive to gross notional of derivatives contracts. This is why we are seeing such a big uptick in market participants looking to significantly reduce their notionals before the year closes. We’re happy to see our latest innovation being adopted by more participants and the significant increase they are seeing in results, and we continue to innovate to support current and future market participants in maximising their notional compression.”

 

For more information please click here or email us on  info@trioptima.com.

USD LIBOR Cessation: 2021 Blueprint Paves the Way but Requires Action Now

With LIBOR transition now in full swing with the first round of major index cessations at the end of 2021, the focus is now squarely on the upcoming USD LIBOR cessation deadline in mid-2023. OSTTRA has been heavily involved in the LIBOR transition from day one and through its various industry solutions. In this article, Vikash Rughani, business manager, triReduce and triBalance and Peter Altero, head of rates business development reflect on the milestones of the recent 2021 LIBOR transition. Read on to learn more about how post-trade market infrastructure adapted across compression, netting and trade processing to support firms as they navigated the 2021 RFR transition and how this post-trade blueprint supports firms as they prepare for the cessation of USD LIBOR in 2023.

MarkitServ has supported the Secured Overnight Financial Rate (SOFR)—the benchmark chosen to replace LIBOR in the US—since 2018, when customers requested the new risk-free rates (RFRs) be added to the OTC derivatives processing platform. At the time, there were no strong data points to refer back to for these RFRs, so MarkitServ worked closely with the industry to agree on the standard conventions and market agreed trade processing capabilities required. This was so that MarkitWire could support the efficient trade affirmation, confirmation and life-cycle event processing of trades referencing SOFR instead of LIBOR. Liquidity has grown significantly since SOFR was first published in 2019. Data from September 2022 showed that around 75% of all new USD swaps were referencing SOFR. (Source: OSTTRA)

 

A compression roadmap

 

Once RFRs became available, firms began learning how to price and trade instruments referencing them, book trades in their systems and make sure they seamlessly flowed to all downstream processes, including payments and settlements. Participants began submitting those trades into TriOptima’s triReduce compression cycles, demonstrating that they could extract the transactional information necessary, obtain prices for those SOFR transactions in their portfolios, and that they were comfortable compressing trades and calculating market risk on them. To constrain the effect on market risk, firms set tolerances on the compression platform and carried out the steps needed to be able to compress RFR trades and process them downstream via the central counterparty (CCP).

As volumes started increasing in 2019, TriOptima, in support of the ARRC’s paced transition plan shared its own roadmap for proactively and iteratively reducing exposures to legacy benchmarks. By May 2020, triReduce had compressed its first SOFR swap, which became the template used for USD as well as for any other new alternative RFR. The platform can scale to whatever benchmark the market shows interest in — for example, it compressed its first Bloomberg Short-term Bank Yield Index (BSBY) swap in January 2022.

Benchmark Conversion functionality was also added to triReduce, which is a tool to further assist market participants in both reducing their gross notional exposure to legacy benchmarks and converting the remainder onto new RFRs. Firms can use this new conversion service for both centrally cleared and non-cleared OTC swaps trades and to unlock greater efficiencies.

Liquidity lessons learned from UK transition to SONIA

 

When the UK market began transitioning from LIBOR to the Sterling Overnight Index Rate (SONIA), there was little liquidity over 18 months, because SONIA swaps had traditionally been a short-dated instrument. For instance, if a firm had a 20-year LIBOR exposure they wanted to convert, there were no equivalent SONIA trades available to replicate or offset against. TriOptima’s innovation extended the capabilities of their service to enable banks to create new trades they were confident to price even though they had not yet executed many similar trades in the new benchmark.

More recently, it has been a similar situation with SOFR. In the beginning, SOFR liquidity did not go beyond three years. The industry had a chicken and egg problem of how to grow the duration of the SOFR curve. So how was this done?

Firstly, trade booking was enabled through the MarkitWire platform, which allowed firms to enter into longer-dated trades. Then there was the discounting switch in 2019, where CCPs’ discounted cash flows for both variation margin (VM) and initial margin (IM) from Federal funds over to SOFR. Overnight, this put firms into long-dated SOFR exposure they needed to hedge. Although it is mostly dealers that are active in hedging their discounting risk, this acted as a significant catalyst for building liquidity at the longer end of the SOFR curve.

A trade processing blueprint for USD LIBOR transition

 

USD market participants are currently running through questionnaires internally and planning for the upcoming benchmark conversion. OSTTRA has a proven blueprint that was successfully adopted by the industry during the first four currency conversions: Swiss Franc, Euro, Yen and Sterling. The combined experience of Markitwire and triReduce coming together in one company allows for a comprehensive suite of solutions aimed at mitigating risk and providing firms with tools that allow them to manage their exposure ahead of USD LIBOR benchmark cessation.

OSTTRA offers platforms that scale to meet the challenge of larger volumes as well as the functionality to help with the conversion of legacy benchmark risk. OSTTRA also supports the legal aspects of transactions under the International Swaps and Derivatives (ISDA) fallbacks Protocol. In late 2020, MarkitServ partnered with ISDA and engaged with customers via its industry working groups to explain how their rulebook would incorporate the ISDA Fallbacks Supplement and to help dispel any ambiguity as to whether new and legacy non-cleared positions were protected by the Fallbacks Supplement and Protocol. In the few scenarios where it was not straight-forward to determine if such positions were protected by this framework, such as in a legal novation of an existing bilateral transaction, OSTTRA MarkitWire implemented a new field enabling the remaining party and transferee to incorporate the IBOR Fallbacks Supplement.

 

“2021 brought a lot of change including LIBOR-SONIA conversion, the October 2021 [definition change], as well as all of the Uncleared Margin Rules (UMR) deadlines. When so many industry-wide events occur in short succession, firms tend to focus only on the most imminent priority. As a result, many firms did not take advantage of resources available to them, like the clearinghouse conversion dry runs that were taking place in advance of the CCP Conversion related exercises for Swiss Franc, Euro, Yen and Sterling. This was a missed opportunity that firms will be seeking to learn from this time around.”

Tackling transition burden with netting synchronisation

 

The conversion of legacy LIBOR transactions into the alternative RFR, SOFR, is a once-in-a-lifetime transition. Building tools or capabilities to support the transition process and consuming message feeds from the clearinghouses represent a meaningful amount of sunk cost for a limited-use build.

The OSTTRA MarkitWire CCP Synchronisation service provides two-way API connectivity between the MarkitWire interface and the clearinghouse, built natively to support different post-trade events on cleared trades. As an example, firms using OSTTRA triReduce to compress trades – with the output of full terminations and risk replacement trades—can simplify their internal build and support costs through the CCP synchronisation API. Most firms which leverage OSTTRA MarkitWire for rates trade processing workflows connect to the interface via a proprietary API which feeds directly downstream into their risk system. CCP synchronisation is built off this same API which consolidates BAU flow with post clearing activity. Firms can reap the benefits of connecting once through a familiar interface to process termination and risk replacement trades across 6 different clearing houses, as well as compression/optimisation vendors who service the cleared interest rates community.

When clearinghouses announced they would perform bulk cleared conversions, the OSTTRA CCP synchronisation tool helped normalise workflows for clearing participants. CCP synchronisation was utilised for both the basis swap splitting exercises and the subsequent legacy benchmark conversion exercises in 2021. OSTTRA supported firms through the conversion events in all four currencies through a standard interface across The Japan Securities Clearing Corporation (JSCC), Eurex, the Chicago Mercantile Exchange (CME) and LCH, resembling a multi-tenant multi-clearinghouse offering. It will now be extended to USD as well as to any further conversion events performed by these and other CCPs.

Instead of multiple—often manual—processes, this is all automated through a single highly-scalable platform. OSTTRA has undertaken extensive performance testing to ensure resilience in the face of the extreme volumes that are widely expected to be processed during these future exercises.

 

Dry runs offer an opportunity for rehearsal before transition

 

2021 brought a lot of change including LIBOR-SONIA conversion, the October 2021 definition change, as well as all of the Uncleared Margin Rules (UMR) deadlines. When so many industry-wide events occur in short succession, firms tend to focus only on the most imminent priority. As a result, many firms did not take advantage of the clearing house conversion dry runs that were taking place in advance of the CCP Conversion related exercises for Sterling. This was a missed opportunity that firms will be seeking to learn from this time around.

Considering the sheer size of the USD LIBOR swap population, firms should plan to participate in the dry runs being run by the CCPs. Some are already working with OSTTRA MarkitWire to facilitate the backloading of production-like portfolios into the OSTTRA MarkitWire UAT environment which is linked to test environments of global clearing houses so they can maximise the value of those dry runs.

In addition, firms are preparing to support all variations of SOFR swaps that will be created as part of the CCP conversion exercises and in many instances may not have traded such variations before. Firms prefer to see the results of the USD dry runs feed OSTTRA MarkitWire UAT as the environment is connected to their risk system, enabling portfolio pricing simulations.

A major lesson learned from last year is that firms can never start their planning early enough. At the start of 2021 many firms were surprised that the CCPs were not simply going to implement the ISDA Fallbacks but would legally convert legacy benchmark trades to the alternative RFR. In turn, it took firms some time to understand the corresponding need to reduce their exposure to not only index cessation but also to the CCP conversion exercises by getting down to their core net risk positions.

As part of the CCP conversion exercise, every single trade that is subject to cessation is run through the conversion process, leading to a doubling or tripling of the number of trades in their book. Firms must consider the impact such an explosion in trade count and notional would have on operational processes and technology infrastructure.

Even for non-cleared trades, from both a technological and operational point of view implementation of those fallbacks was not straightforward. Firms have recognised that the shift from term rates to compounded in arrears rates means that whereas a coupon payment would be known three months in advance for a typical LIBOR swap, in a SOFR world, the payment is only known two days prior to payment date. This means firms may only have two days to resolve any breaks with their counterparties. OSTTRA triResolve, the daily reconciliation platform that enables firms to discover and fix breaks proactively, can assist by tracking potential sources of reconciliation breaks throughout the coupon period and until the coupon payment is actually settled.

Compression via OSTTRA triReduce helps shrink the number of outstanding swaps down to the core net risk position and mitigate risks relating to the conversion exercises. It also enables firms to consciously and, in a risk-based manner, convert their risk from legacy benchmarks onto the alternative RFR—whereas the CCP conversion exercises approach it at a trade-level. Between now and June 2023, firms can chip away every two weeks at their ticket count and overall Libor exposure, converting over to SOFR in a single battle-tested process. The more they reduce their pool of outstanding legacy swaps, the less the CCP conversion runs will impact them.

 

Unique challenges for the USD market

 

The choice of alternative USD rates was not as straightforward as with other currencies. SOFR is based on a particular segment of the market and most importantly – actual transaction activity. However, that transaction activity is rooted in the repo market. SOFR, a secured rate, behaves very differently from LIBOR by virtue of not having a credit component and not being a term rate.

“The conversion of legacy LIBOR transactions into the alternative RFR, SOFR, is a once-in-a-lifetime transition. Building tools or capabilities to support the transition process and consuming message feeds from the clearinghouses represents a meaningful amount of sunk cost for a limited-use build.”

Key takeaways

 

Firms should start early and engage their vendors to understand the services available to assist them during this momentous time. They should participate in any dry runs that are offered and encourage consistency where appropriate between clearinghouses.

They should also look at their legacy stock of trades in both the cleared and non-cleared worlds across all global desks & books without forgetting products like non-cleared cross-currency swaps where a significant portion of trades utilise USD LIBOR as the interest rate benchmark on one side.

So much energy has gone into establishing SOFR and making it the market standard over the last four years. Now, even if firms want to transact using LIBOR, this rate is quoted with reference to SOFR. Any LIBOR trades that go beyond the end of 2023, will turn into a quasi-SOFR trade from a valuation and risk perspective and should therefore be viewed as such following the cessation date. Firms then need to assess what their exposure to LIBOR will look like over the next 12 months and how LIBOR volatility might be impacted by the winding down of legacy exposures in the benchmark.

 

For more information regarding Benchmark Reform click here or contact us.


Authors

 

Vikash Rughani
Business manager, triReduce and triBalance
Peter Altero
Head of rates business development

Trade Refactoring Unlocks Additional Compression Benefits

Following the launch of Trade Refactoring one year ago, we have seen an increase in adoption over the last few months. This has enabled OSTTRA triReduce to unlock additional benefits for compression participants, resulting in USD 1 trillion of additional gross notional reduction in LCH SwapClear during September 2022 alone.
Trade Refactoring is the most sophisticated form of portfolio compression available for cleared OTC Interest Rate Swap portfolios and will remain a key tool as major global banking institutions ready themselves for their end of year regulatory reporting requirements.

 

Benefits:
How it works:

Two spot trades that cannot otherwise be compressed in risk-free netting, or in multilateral compression without offsets in the CCP, are replaced with a forward starting trade.

 

 

There are no additional submission requirements for firms running with Trade Revision.

Contact us at info@trioptima.com to learn more or request a demo.

 

Useful Links

Trade Refactoring Press Release

Article Preparing for Further Index Cessation 

Portfolio Compression

Managing CCR to reduce the all-in cost of OTC derivatives portfolios

There are a multitude of risk factors that contribute to the cost of trading OTC derivatives and maintaining a derivatives portfolio over time. As the industry transitions to the risk-based calculation method for capital requirements, referred to as SA-CCR, or Standardised Approach to Counterparty Credit Risk, we examine how counterparty credit risk contributes to these costs by highlighting the intricacies involved in OTC credit risk management.

The importance of managing counterparty credit risk effectively became evident during the financial crisis 14 years ago. It subsequently became a central theme in the regulatory changes that followed, including mandatory central clearing, the requirement to secure non-cleared exposures via Variation Margin (VM) and Initial Margin (IM), and, most recently, the implementation of the updated capital regime, SA-CCR. Over time, each of these regulatory initiatives has increased the cost of counterparty credit risk, in turn incentivising effective risk management and proactive mitigation.

Mandatory clearing has made the financial markets more resilient by ensuring that liquid and vanilla risk is centralised, netted down, and facing a financially robust counterparty. However, risk exposures that were traditionally intended to hedge one another but originated from different product types is sometimes scattered between different netting sets, resulting in fragmentation since not all products are eligible, or indeed suitable, for clearing.

The advent of Uncleared Margin

After the introduction of the mandatory clearing rule, regulatory focus switched to the mitigation of bilateral risk, with firms required to exchange margin with their counterparties. This became mandatory for the largest firms in the first wave of the Uncleared Margin Rules (UMR) in 2016/17. UMR thrust counterparty risk back into the spotlight and the cost of funding initial margin has become a real consideration when maintaining an OTC portfolio.

Many of the most active FX trading participants witnessed their initial margin requirements quickly growing since FX positions are typically fragmented across many currency pairs, multiple counterparties and have historically only been cleared or netted to a limited extent. The UMR product scope differentiated between FX products, specifically those with and without physical delivery. This, again, impacted well managed netting sets as non-deliverable risk from FX instruments now attracted bilateral margin, whilst deliverable FX risk did not.

This encouraged the industry to reduce risk using a combination of pre- and post-trade optimisation tools, as well as promoting scalable initiatives to help achieve this. The resulting solutions optimise risk allocation between bilateral counterparties and the CCP(s), which reduces the size of margin calls and the associated funding costs. The clear benefits of these new multilateral services resulted in rapid adoption and incorporation into the banks’ daily operations. These initial solutions were very efficient, given the focus was purely on counterparty credit risk, and left market risk unchanged. In FX products alone, the cost savings achieved through the optimisation of credit risk amounts to savings exceeding USD 100 million annually.

 

 

Adoption of the SA-CCR capital regime

The recent introduction of SA-CCR as the standard capital measure for calculating counterparty credit risk altered the dynamics of FX credit risk again, adding another dimension to be considered when minimising the all-in-cost of trading. Existing risk management and optimisation solutions have been extended to include the additional complexity, and new solutions such as selective post trade novation, compression and clearing have been, and continue to be, analysed.

Actively managing FX exposures and counterparty risk for UMR and/or SA-CCR, or concentrating exposures by clearing, can reduce the associated risks and costs. However, the complexity of managing multiple measures and different types of netting-sets all need to be considered simultaneously if firms are to achieve the objective of minimising all-in derivative portfolio costs.

 

 

UMR and SA-CCR are both driven by counterparty credit risk, and each of them affects the cost of trading FX. They are interconnected and cannot be considered in isolation – active risk mitigation in one risk measure may result in an adverse impact on the other. They need to be addressed in tandem, not only because of their similarities but also because there are some important differences that are unique to the FX market:

Managing the all-in cost of capital associated with OTC derivatives

FX exposures can, for the benefit of both UMR and SA-CCR or IMM, be simultaneously and independently optimised by leveraging the differences in instrument coverage. Clearing increases netting efficiency, reducing the size of outstanding exposures whilst causing deliverable FX transactions to attract additional margin requirements. These incremental costs must be considered when seeking to optimise the all-in cost of maintaining FX exposures via redistribution of counterparty risk, clearing, novation etc. These methods can all be used in isolation, but the best outcome is achieved when applied together to optimise and minimise the all-in cost.
Although some of these properties are specific to the FX market, others are common across asset classes. In interest rate markets for example, mandates have driven the majority of trades into clearing and the instrument scope for SIMM and SA-CCR is the same – thus the optimisation characteristics differ from the FX market.
There are also differences specific to individual firms that can be highlighted, and are important to consider when seeking to actively manage risk to reduce the all-in cost of counterparty credit risk:

Summary – Significant complexity

The regulatory regime that governs counterparty credit risk contains multiple interdependent measures, applying to similar exposures, which must be considered in totality to avoid an undesirable outcome.
In reality, banks and firms are domiciled in different jurisdictions, have varying levels of portfolio complexity, and different funding costs. All these factors need to be managed concurrently when optimising counterparty credit risk and regulatory costs associated with OTC portfolios.
Complexity is high. To maximise the benefit of actively managing counterparty risk, firms need to apply their own individual preferences and drivers while simultaneously accounting for differences between UMR and SA-CCR, and bilateral and cleared exposures, for all the individual asset classes.
Given counterparties monitor risk in different ways, it is important to manage and optimise counterparty credit risk:

Explore our Counterparty Risk Optimisation Service and learn more about our SA-CCR solutions.

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