Q&A on Deriv/SERV: 2007 Review, 2008 Preview
Janet Wynn
The past year for DTCC Deriv/SERV was marked by strong growth on multiple fronts, including enhanced functionality and expanded capabilities across its family of services. The Trade Information Warehouse, which had its first anniversary in November, built a large database of credit derivatives contracts, launched its payment calculation and credit event processing services, and began rolling out central settlement.
Deriv/SERV’s matching and confirmation service experienced significant take-up for interest rates and equity derivatives while continuing to expand the menu of products and lifecycle events it accommodates. Deriv/SERV in September signed its 1,000th customer, reinforcing its position as the largest provider of post-trade processing services in the over-the-counter (OTC) derivatives industry, serving customers in more than 30 countries.
@dtcc spoke with Janet Wynn, DTCC managing director and general manager, DTCC Deriv/SERV, and Peter Axilrod, DTCC managing director, Business Development, about 2007 achievements and objectives for 2008.
It’s been another busy year at Deriv/SERV. What were its most significant accomplishments in 2007?
Wynn: Building out the functionality of the Trade Information Warehouse was arguably the most important achievement this year. The Warehouse went into production in November 2006, but this is the year we began the calculation of payments between counterparties, which will be used in central settlement.
We also put in place the ability to mark and track credit events, an important feature that further mitigates operational risk for the industry. Now, should a credit event be declared, market participants have an automated, centralized and seamless system that can support the auction process.
Completion of backloading of dealers’ legacy trades into the Warehouse was another important accomplishment, one in which industry members played a major role. Dealers took on the demanding and time-consuming task of re-documenting all their past credit derivative transactions and entering them into our system. Buyside firms have started backloading their legacy contracts.
In one year, in addition to all the new credit derivatives transactions that come into the Warehouse through the front door, we’ve stored the vast majority of outstanding, pre-2006 credit contracts. The Warehouse inventory now numbers over 2.5 million contracts. This size gives the industry a comprehensive, robust global repository of the most up-to-date data for credit derivatives transactions, which will in turn make the downstream processing of these contracts much more efficient, cost effective and certain.
In partnership with CLS Bank International, we are making steady progress in bringing the Warehouse’s central settlement function online with an initial group of dealer firms settling a series of payment transactions. As we head into 2008, we expect to see rapid growth in the number of participants and of payments being settled through the Warehouse.
For matching and confirmation, Deriv/SERV is widely recognized as the industry standard in the OTC credit derivatives market. How are you working with customers to increase their usage of the service for equity and interest rate products?
Peter Axilrod
Axilrod: We have succeeded in building a multi-product platform, establishing Deriv/SERV as the only post-trade service used by virtually all major global derivatives dealers to electronically match and confirm OTC credit, interest rate and equity derivatives. Deriv/SERV supported all three of these products before 2007, and we are now gaining significant market participant take-up in rates and equities, where we are seeing triple-digit volume growth.
For equities, we expanded the service to accommodate the complete geographic scope of index, swaps and variance swaps products for which there are ISDA® [International Swaps and Derivatives Association] master confirmation agreements [MCAs]. We’ve reached out to all customers about activating their use of this service and facilitated dialogue between the buyside and the sellside to sign or prepare to sign the MCAs. We’ve built a full-functioning interest rate platform, supporting all post-trade events, including assignments, terminations and amendments. And in 2007 we added CDS [credit default swaps], on loans as well as CDS residential and commercial mortgage-backed securities to the menu of credit products we support.
What were Deriv/SERV’s biggest challenges this year?
Wynn: We grew in every possible direction. We added 260 customers since the end of 2006, recently surpassing the 1,000- customer mark. By the summer, our average daily volumes more than doubled, and at times tripled, what they were at the start of 2007. We also doubled the number of customers using our payment reconciliation service to more than 140. And we added a great deal more functionality in all three product lines.
Our staff worked tirelessly to accommodate this growth while also collaborating with the industry to build out the Warehouse and other Deriv/SERV enhancements.
What is the significance of providing central settlement capability in the Warehouse?
Axilrod: Centralized settlement is important because it removes all uncertainty from the process. You know for sure what is going to be settled and what isn’t, even the day before it takes place. It eliminates unapplied cash. It enables you to streamline a whole chunk of your infrastructure by reducing Nostro breaks and Nostro reconciliations – the discrepancies between what parties expect to pay to or receive from each other.
With central settlement, market participants can “trade and forget.” Legally confirmed, or gold, transactions flow into the Warehouse, payments on these contracts can be calculated, counterparties can sign off on them and they can proceed to be bilaterally netted and settled.
How will central settlement affect payment reconciliation?
Axilrod: Deriv/SERV’s payment reconciliation service is complementary to central settlement. Not only does “pay rec” help a number of our member firms prepare for central settlement, it also continues to provide an avenue for the small population of trades that aren’t gold, or can’t be calculated in the Warehouse, to be reconciled in an automated fashion.
One of our priorities in the coming year is to extend the payment reconciliation service to rates and equities.
In September, Deriv/SERV passed the 1,000-customer milestone. What are the major challenges in servicing the needs of such a large, diverse and geographically dispersed client base?
Wynn: As we’ve noted, our customer base has not only grown but also evolved since we launched the service in 2003. We’ve gone from dealers to hedge funds to traditional asset managers. We’ve even seen pension funds, a couple of trusts and foundations come in.
Traditional asset managers present servicing complexities that are different from other customers. Most of these managers engage the custodian population – and in most cases multiple custodians – as well as third-party service providers. It means a less direct relationship than Deriv/SERV has with dealers and hedge funds. We’re working with these parties and expect to continue collaborating closely with them in 2008 to make the service easily accessible to that market segment.
What are you doing to educate custodians about Deriv/SERV and get them on board the service?
Wynn: We’ve provided some reports that show only the accounts they’re allowed to see. In the past, our services were like one window into an account. Now we can parse the account in ways that are useful to a variety of service providers.
We’ve also begun conversations with the major audit firms about how they can use the Warehouse information going forward in their audits, which would reduce all customers’ need for paper reports to support their audits.
While Deriv/SERV is global, its presence is strongest in Europe and North America. What are you doing to increase visibility and penetration in the Asian markets?
Wynn: We’ve established a representative office in Hong Kong to give us an on-the-ground presence in the region. We’ve also linked our Relationship Management teams in London with Asia, and they’ve been meeting with dealer clients in the Asian markets to discuss what we must do to activate the specific services that market participants need in those locations.
In addition, we continue to reach out to Asia’s OTC derivatives community by exhibiting at the ISDA regional sessions in Singapore, Hong Kong, Sydney and Tokyo.
Deriv/SERV’s online training and webinars help educate and communicate with a global customer base. What have you been doing on that front?
Wynn: We have significantly boosted our training capacity this year, running several webinars per month, some running weekly, covering a range of issues related to our core matching and confirmation service for all products, the Warehouse, payment reconciliation and assignment processing. This year, about 1,200 participants worldwide have logged on to our webinars.
We’ve also added self-paced e-learning courses that are accessible anytime, anywhere, to enhance the flexibility of our customer training. These courses provide an overview of our services and walk participants through the steps needed to establish connections to the Warehouse.
Next year, we anticipate adding other courses, including spot-training sessions and podcasts on key areas of complexity, such as assignments.
[For more information on Deriv/SERV webinars and e-learning sessions, visit www.dtcc.com/products/derivserv/webinars.php.]
The surge in volume in the credit derivatives market last summer resurrected concerns that the industry’s infrastructure and processing capacity are not yet sufficiently robust. What lessons can market participants take from the summer market experience?
Wynn: It’s a testament to the dealer and buyside communities that they were able to manage effectively the unprecedented volume surge in OTC credit derivatives trading last summer, given all the other efforts they have taken on this year – particularly Warehouse backloading and testing all the new Warehouse functionality. Automation surely played a major role in the industry’s ability to avoid serious operational stresses to the market.
A lesson we can take from last summer is the importance of end-to-end straight-through processing. These volume surges can reveal any gaps in the processing chain and help identify areas where the industry can standardize business processes.
What are your priorities for next year?
Axilrod: One priority is to enhance and bolster the functionality of our core platform. When Deriv/SERV was launched four years ago, the market was very different. It was a much smaller business with a much smaller set of counterparties. In the first half of 2008, an important focus for Deriv/SERV will be streamlining the access and the workflow for all of our processes so we can continue to accommodate the incredible volume of transactions and the number of customers using our service.
We will also work on aligning all the capabilities of our matching and confirmation service so that any feature functionality for credit is also available for interest rates and equities. In addition to building out our payment reconciliation service to include those products, we are looking at expanding the Warehouse capability to include equities and interest rates.
We are also enhancing Deriv/SERV’s interface with the buyside, recognizing that these market players come in many sizes and are supported by custodians and other third-party service providers.
How are you working with the industry to achieve these objectives?
Wynn: We’ve continued to meet regularly with senior members of the dealer community and the buyside to set our priorities and approach towards our collective goals. Industry members, as well as other service providers, have been highly collaborative and have played a critical role in ensuring we continue to offer robust services for all constituencies in the marketplace. @