The bankruptcy filing by storied U.S. retailer Sears Roebuck on October 15, 2018, garnered plenty of headlines and months of news coverage. But, thanks to DTCC's Trade Information Warehouse (TIW), the $1.267-billion gross payout on counterparties' default insurance on Sears' debt, which TIW netted down to less than 20% of that total, caused not a ripple in the markets.
The TIW has undertaken the seamless, efficient processing of credit events like this one since its creation more than 10 years ago, delivering tremendous efficiency and risk-mitigation benefits to the market.
Sears stands out for being one of TIW's largest credit events, in terms of number of positions processed -- Washington Mutual's default in 2008 still ranks as the largest -- but it was unremarkable in every other way.
"The fact that we routinely manage the payment calculation and, in some cases, payment settlement of tens of thousands of positions for bankruptcies like Sears' without causing any market disruption means TIW is operating the way it should, streamlining processes that used to be extremely cumbersome for market participants to handle," said Marcus Denne, Executive Director, TIW Product Management.
Bookkeeper for the Industry
Buyers and sellers of credit protection on corporate and sovereign debt used to confirm their trades on paper, using 30- to 40-page credit derivative contracts that necessitated weeks-long, line-by-line document reviews. Sorting out quarterly contract payments was similarly time consuming, causing backlogs and contributing to the operational riskiness of these contracts.
Working with the industry, DTCC in 2003 introduced a payment reconciliation service focused on quarterly roll cash flows among the largest participants in the marketplace.
Recognizing the need for standardization, the industry began to use common formats and language in their over-the-counter (OTC) derivatives contracts through ISDA -- which allowed DTCC also in 2003 to introduce an electronic confirmation system.
"Across single name swaps, indices and tranches, the Sears event touched every kind of contract in the TIW. The sheer magnitude of it was extraordinary." – Alan Bendel, Director, TIW Product Management
The logical next step in this evolution was the creation of a registration system – TIW's warehouse function -- for open credit derivatives and the related electronic processing of the lifecycle events, both planned and potential.
"We built the TIW to enable parties to track the status of their trades from the day of confirmation all the way through contract maturity," said Denne. "We incorporated DTCC’s confirm reconciliation services and added payment calculation, settlement, and event processing."
As the record-keeper for the world's credit derivatives market, the TIW provides a venue for parties to register the details of their agreed-upon contracts – known as "gold" records -- and process key milestones that occur over their lifetimes. These milestones include payment calculations, successor events such as reorganizations or renames of corporate entities, and credit events such as bankruptcies, restructurings and insolvencies.
Today, virtually all OTC credit derivatives in the institutional marketplace are registered in the TIW, enabling the efficient industry-wide resolution of default insurance contracts when bankruptcies occur.
The TIW has processed 195 unique credit events since its inception. The Sears event was noteworthy in the number of default protection positions it processed, making it larger than all other credit events combined over the previous 12 months.
Of the total positions, the preponderance were in Credit Default Swap Index (CDX) contracts, with a small number of CDX Swaptions, as well as some Credit Default Index Tranches (CDT) and single-name Credit Default Swaps (CDS).
"Across single name swaps, indices and tranches, the Sears event touched every kind of contract in the TIW,” said Alan Bendel, Director, TIW Product Management. “The sheer magnitude of it was extraordinary."
The TIW processed the event following publication of the ISDA-led January 17th auction results, which yielded a recovery amount on Sears’ debt of 79.875 cents on the dollar. The TIW calculated a gross bilateral cash flow of $1.2 billion. With netting, the bilateral cash flow dropped to $202 million.
TIW and Settlement
TIW also offers a central settlement service through CLS Bank. In 2007, following TIW's launch the year before, DTCC worked with the industry to establish an arrangement under which the TIW can send net settlement amounts for pairs of counterparties to CLS for settlement. In this system, CLS Bank, the industry vehicle for settling spot and forward FX contracts, includes credit derivative cash flows in counterparties' net settlement amounts, significantly reducing firms' operational inefficiencies.
"The Warehouse moves a tremendous amount of cash between counterparties, but we're able to lower their settlement risk through bilateral netting -- something firms could not do on their own," said Bendel. "That massive reduction in risk happens seamlessly through CLS Bank. In the case of Sears, the risk of settling rebates or recoveries was completely removed for firms that utilized the settlement service provided by TIW. The fact that we plug into CLS directly on behalf of our participants provides great value to the market."
For trades that do not pass to CLS for settlement – which include trades cleared through a central counterparty (CCP) as well as some bilateral uncleared transactions -- the TIW provides its cash flow calculations directly to the counterparty firms so they may settle these amounts outside the Warehouse using the payment processing of their choosing. This procedure further reduces any breaks that could occur between two counterparties that agree to use the TIW record as their golden source for position and calculation information yet utilize their own settlement method.
Market Value of TIW Data
In the wake of the 2008 financial crisis, regulators and market participants alike have promoted CCP clearing of OTC derivatives trades. However, a large number of positions still are not cleared or are cleared at multiple CCPs.
By having a record of cleared and uncleared positions, the TIW plays a unique role in the market as the central source of data on credit derivatives. The Warehouse leverages this data to produce public reports on a weekly basis on outstanding market positions and activity. The reports identify the volume of weekly activity that is risk-related and not for other purposes such as compression.
"To know the size of the market for a given reference entity, you need to include cleared and uncleared trades, and only the Warehouse can bring all this information together," said Denne. "Our data delivers a depth and breadth of information to trading firms, regulators, academics and the public that is not available anywhere else."
From the processing of credit events like Sears', to quarterly contract payment calculations, to weekly and historical data reports on positions registered in the Warehouse, the TIW provides critical utility functions that have dramatically increased transparency, provided operational efficiencies and cost reductions and reduced operational risk in the credit derivatives marketplace.