Clearing, Compression and Customization

We at ISDA have worked hard on building the infrastructure of the OTC derivatives market. At times, it might seem we take credit for what others have done. But the funny thing about ISDA is that thousands of people think of themselves as part of the Association. One of our Board members said he counted 200 people in his firm alone who were active in ISDA committees, working groups and projects. We count all who work in the industry as part of ISDA. We represent them and like to publicize progress, regardless of which entity actually did the work – as long as it makes our markets safer and more efficient.

In that spirit, we turn to LCH SwapClear. Their focus for over 10 years has been inter-dealer clearing across many currencies, and they are actively reaching out to the buy-side to expand clearing as well as to incorporate new products. It’s a fact, not sufficiently recognized in our view, that SwapClear has cleared over 50% of the interest rate swap market. During the Lehman default in 2008, SwapClear assigned over $8 trillion of Lehman interest rate swaps and returned over half of the initial margin that was posted.

SwapClear has quietly worked at another project – compression. In this effort they work closely with TriOptima, which has a long track record of compressing cleared and non-cleared swaps. This past week, they were able to cancel nearly $26 trillion of contracts. Since this program started, SwapClear has torn up $89 trillion of contracts. TriOptima has compressed a total of $158 trillion, including $74 trillion of uncleared trades since 2003. Compression will work even better as more dealers join SwapClear and participate in the compression process. It is a great way to ensure volumes at clearinghouses do not grow excessively large.

We at ISDA will work with SwapClear, Tri-Optima and our members to promote compression. We believe it has great potential to do much more.

What else can we find out from the trades in SwapClear? They recently analyzed nearly one million trades in their clearinghouse and identified the number of instances there were five or more trades that had 10 identical terms. It sounds like a lot of terms but it’s not. Currency, start date, end date, fixed rate, index (e.g., Libor), index tenor (e.g., 3-month), day count, business day convention, holidays and roll date. Seems like a pretty standardized trade to us. Yet we were surprised to learn that less than 9% of SwapClear’s trades met this definition of standardized.

To date, SwapClear has done primarily dealer trades and dealers typically write “standardized” trades with one another. What the analysis tells us is two things. First, there just aren’t that many six-year sterling or dollar or euro swaps written in any day. If we think there might be 20 full-year maturities in the 17 currencies, that amounts to 340 possibilities alone and SwapClear clears probably around 2,000 trades a day. You do the math. Second, it seems dealers fine tune some of the terms they negotiate with other dealers. Fine tuning transactions is, of course, one of the great strengths of the OTC derivatives market. And keep in mind, these trades are all cleared, so it is not fine tuning for the sake of fine tuning.

Another interesting fact stands out in the SwapClear analysis. Over half of SwapClear’s trades are unique. So much for trading like futures.

We thought our readers would find this data interesting. We hope regulators do as well.

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