Central Settlement Service for OTC Credit Derivatives Market Achieves 95% Average Netting Factor
With many eyes in the industry now looking for ways to reduce risk in the large and growing over-the-counter (OTC) credit derivatives market, DTCC is delivering one solution through its central settlement service.
Over the past three quarterly payment cycles, the service – provided by DTCC in collaboration with CLS Bank International – has reduced 1.62 million gross payments valued at US$72.5 billion (£36.5 billion) gross to 823 net payments valued at US$3.5 billion (£1.8 billion), achieving an average 95% netting factor.
Seventeen dealers now participate in the central settlement service, compared with 14 when the service was launched in late 2007. They represent the vast majority of the dealer volume in the global OTC derivatives market. The service will be opened to buyside clients starting in 2009.
In the most recent quarterly settlement cycle, on June 20, the 17 participating dealers had 66 bilateral settlement relationships among themselves. Since that time, the number of bilateral relationships has climbed to 107. By comparison, when the settlement service was launched, the 14 participating dealers had 19 bilateral relationships. The sharp increase in bilateral relationships in less than seven months has contributed substantially to the volume growth of the service and demonstrates the industry’s progress in meeting its commitments regarding centralized settlement.
“By replacing manually generated bilateral payments with automated, netted payments processed through our Trade Information Warehouse, DTCC has addressed a significant area of risk that concerns our customers and their regulators,” said Frank De Maria, DTCC managing director and COO of DTCC Deriv/SERV LLC. “Our vision has been to simplify and streamline the payment process for bilateral contracts as well as create a global centralized repository for OTC derivatives contracts that automates recordkeeping and enhances trading parties’ ability to track their contractual obligations.”
On a quarterly roll
Based on the schedule of periodic coupon payments for OTC credit derivatives, payment activity volume for these contracts spikes on the quarterly settlement dates, also known as the quarterly rolls, which occur on March 20, June 20, September 20 and December 20 of each year.
DTCC, working with CLS Bank, also performs payment netting and central settlement for OTC credit derivatives on a daily basis but, because of the high volumes, focuses its central settlement reporting on the quarterly roll results.
Results of the central settlement service’s three quarterly rolls for 2008 are summarized below:
- June 20: 880,000 gross settlement obligations worth US$40 billion (£20.1 billion) were consolidated into 500 net settlements valued at US$2 billion (£1 billion); 17 dealers participated.
- March 20: 400,000 gross payments worth approximately US$18 billion (£9.1 billion) were netted down to 200 payments worth about US$1.2 billion (£604 million); 15 dealers participated.
- December 20: 340,000 gross payments worth about US$14.5 billion (£7.3 billion) were netted to 123 payments valued at approximately US$288 million (£145 million); 14 dealers participated.
The Federal Reserve Bank of New York, as well as U.S. Treasury Secretary Henry M. Paulson, Jr., this year have cited the need for further enhancements to the post-trade processing infrastructure for OTC derivatives to reduce operational risks in this market.
“To support long-term growth, the processing infrastructure must be capable of processing transactions efficiently through periods of sustained high volume and market volatility,” the New York Fed said in a statement issued in March. Among the commitments industry participants have made to enhance this infrastructure, the New York Fed noted, is the implementation of centralized settlement.
“We have made substantial progress in addressing customer needs and regulators’ concerns about reducing risk in the credit default swap market,” De Maria said. @