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Creditex, Markit To Launch CDS Compression Platform
July 3, 2008
Creditex Group and Markit Group announced yesterday that they will introduce a platform for the credit derivatives market that is designed to improve multilateral portfolio compression, or “tear-ups.”
The platform, scheduled to launch in the third quarter, will reduce operational risk and improve the use of regulatory capital, say the companies, and will be available for the U.S. and European credit default swaps (CDS) markets. Interdealer brokerage and credit derivatives processor Creditex and Markit, a leading provider of data and valuations services for over-the-counter derivatives, will manage the service jointly.
Developed in response to a June 11 request for proposals (RFP) from the International Swaps & Derivatives Association--on behalf of 13 major CDS dealers--the new platform will use compression to terminate existing trades and replace them with a much smaller number of transactions. The process results in portfolios that have the same risk profile but less capital exposure.
CDS, accounting for about $62 trillion in notional amount outstanding, represent the fastest-growing sector of the OTC derivatives market. But as trading volumes have surged so has operational risk from confirmation backlogs and trade breaks. In March, the President’s Working Group on Financial Markets recommended improving the processing of OTC derivatives, which prompted trade groups and infrastructures such as ISDA and the Depository Trust & Clearing Corp to ramp up efforts to advance automation.
ISDA says that discussions about portfolio compression began in early May, when it formed a working group to find an efficient way to implement the process. Following the issuance of its RFP, the trade group established a committee of representatives from the 13 institutions to select vendors to build the service. “Portfolio compression, as well as efforts to hardwire the settlement mechanics into the credit derivatives definitions, will continue to be an area of focus for ISDA throughout 2008,” said Robert Pickel, CEO and executive director of ISDA, in a statement.
According to Creditex and Markit, their compression platform delivers significantly better results than current tear-up procedures, which do not generate replacement trades and are done with a limited number of counterparties. Because more trades can be processed through the new service, firms can reduce the gross notional amount outstanding of CDS on their books by at least 50 percent.
Mazy Dar, chief strategy officer of New York-based Creditex, said that reducing the gross notional amount will allow banks to lower their regulatory capital requirements. By having their internal units--the flow desk, proprietary trading desk, convertible bond desk and prime brokerage group--use the service, firms will increased the universe of trades available for processing, which leads to larger compression ratios.
“We are pleased to be part of a collaborative effort with Markit and major industry participants to strengthen the CDS market infrastructure,” said Creditex CEO Sunil Hirani. “We believe this foundational effort will bring immediate and longer-term benefits to the CDS market as highlighted and called for by market participants and regulators.”
Kevin Gould, EVP and head of data products and analytics at Markit, added, “This initiative will significantly reduce operational risk within the CDS market and the solution leverages the individual strengths of both Creditex and Markit.” According to Gould, Creditex will be responsible for aggregating the necessary data from broker-dealers while London- and New York-based Markit will operate the algorithms necessary for portfolio compression and check the results against the counterparty limits of each firm.
