Post-Trade Engine for the Credit Derivatives Market
Transforming Post-Trade Processing of OTC Credit Derivatives: The Evolution of DTCC’s Trade Information Warehouse
Credit derivatives emerged in the 1990s as an efficient way for banks and other investors to buy, sell and repackage the credit risk of an underlying entity – typically corporations or sovereign governments. By the early 2000s, credit derivatives became generally traded instruments and servicing them was an intensely manual process. Contracts were bilaterally negotiated, and their documentation often ran to 30 or 40 pages. Confirming and agreeing on contract terms necessitated weeks-long, line-by-line document reviews and sorting out the quarterly fees and contract termination payments was similarly time consuming.
The explosive growth of this market, lack of standardization and rising complexity of administering these contracts pushed the industry to seek ways to create operational efficiencies and reduce operational risk in their credit derivatives post-trade processes.
Launching a market utility
DTCC entered the post-trade processing ecosystem for credit default swaps in 2003, as the industry began to deal with increased volume and the need for standardization, centralization, and digitization. In collaboration with major dealers, DTCC introduced a payment reconciliation service focused on quarterly roll cashflows as well as an electronic confirmation system.
The logical next step was to create a system to record open credit default swap contracts and the related electronic processing of their lifecycle events and DTCC was the best-equipped agent to build such a system. Working closely with market participants, DTCC in 2006 rolled out the Trade Information Warehouse (TIW, or the Warehouse), the industry’s first infrastructure for record retention and asset servicing of credit default swaps worldwide. TIW provides a venue for market participants around the world to record the details of their agreed-upon contracts – known as “gold” records -- and process key events that occur over the trades’ lifetimes.
Although its activities are now generally considered business as usual, TIW has had a tremendous impact on the credit default swaps market, delivering huge cost savings, operational risk reduction and data transparency that were not possible before its establishment. During the global financial crisis in 2008 and 2009, TIW became an important source of information on the size and depth of the credit default swaps market. Today TIW continues to enhance the functioning of this important market.
Expanding capabilities with settlement
In 2007, DTCC worked with the industry to add another important feature that allows TIW to send messages of net settlement amounts for pairs of counterparties to CLS Bank (CLS) for settlement. Through this process, CLS, the industry vehicle for settling spot and forward FX contracts, includes credit default swap cashflows in counterparties’ net settlement amounts.
For trades that do not pass to CLS for settlement TIW provides its cashflow calculations directly to the counterparty firms so they may settle these calculated amounts outside TIW using the payment processing method of their choosing.
Credit event processing
The 2008 financial crisis resulted in a number of corporate mergers and defaults, each one constituting an event to be processed for the outstanding credit default swap positions on those entities. In October 2008, TIW processed its largest credit event to date, in terms of number of positions, with the Washington Mutual bankruptcy. And 2009 marked TIW’s biggest year for credit events, with 50 events processed in that 12-month period.
Other notable credit events include Greece’s sovereign default in 2012 and the Sears Roebuck bankruptcy, processed through TIW in January 2019.
Unique data source
In recent years a large volume of OTC credit derivatives has moved to central clearing, but many positions are still not cleared.
Both cleared and uncleared positions can be registered in and their lifecycle events processed by TIW, making TIW the unique, central source of data on credit default swaps worldwide. TIW leverages this market-wide data to produce public reports weekly on outstanding market positions and activity.
The credit derivative information reported to TIW includes data on trades from every jurisdiction, making it an invaluable resource to trading firms, regulators, academics and the public.
Transforming the platform
DTCC in 2016 launched a transformative initiative that will move TIW from a mainframe application to the cloud and establish a private permissioned distributed ledger network for credit default swap reports. This project allows DTCC to retire legacy platforms while leveraging distributed ledger technology (DLT) and cloud capabilities to increase efficiencies for clients. The functional build is complete and in-depth industry-wide testing with clients continues.