Operational risk fears as OTC clearing gathers steam

Despite the industry’s best efforts, it will be impossible to avoid operational problems as the over-the-counter derivatives market transitions to central clearing, banks have warned at an industry event in New York.

“I have said this to regulators – I appreciate the buy side are saying it – there are going to be glitches, and no matter what people try, that will happen. It’s important to note,” said Ray Kahn, global head of OTC derivatives clearing at Barclays.

The first phase of mandatory clearing took effect in the US on March 11, with some reported technology issues around middleware – the services that connect trading counterparties to their futures commission merchants (FCMs) and link up FCMs with clearing houses. In some cases, the various participants were classifying clients or products in different ways, making it difficult to pass trades from hand to hand along the chain. This was a particular issue for clients that were onboarded close to the deadline.

“Because of the rush-to-the-door mentality that even some of the category 1 firms had, there were trade configurations or executing dealer-to-product mappings that hadn’t yet been done in real life and that uncovered a few static data issues, whether those were in the middleware chain, the FCM or the clearing house,” said Dave Olsen, global head of futures and options, OTC derivatives and securities clearing at JP Morgan.

These may not be teething problems. Some participants worry that the multiple layers of the cleared OTC market – which will also encompass swap execution facilities (Sefs), swap data repositories and central credit-checking hubs – will be a source of operational risk for years to come.

“Once we get two years down the road, any given trade could involve a Sef, a credit hub, middleware, FCMs, a clearing house, and the executing broker. For each one of those there is a data flow and if there is a glitch it could be momentarily catastrophic – a glitch with your middleware means things aren’t going to get passed down to your FCM or to the clearing house and then how does that get cleared? It’s overwhelming,” said Amy Caruso, director at Babson Capital Management.

Market participants at the conference raised other problems that occurred around the March 11 deadline, including a lack of preparation from bank trading desks that slowed down the clearing process. In particular, fingers pointed at European execution desks rather than their US counterparts.

“Some delays also come when you are dealing with a non-US desk,” said Bruce Mark, managing director for operations at MKP Capital Management. “If it doesn’t get cleared by the time Europe goes home, the folks in New York at certain banks haven’t been able to finish the trade and send it through to clearing… We don’t want to be chasing loose ends at the end of the day. Once we affirm the details it should go to clearing.”

Separately, clearing house representatives looked ahead to June 10, when category 2 firms are required to start clearing. Some participants have estimated that anywhere up to 2,000 hedge funds and asset managers will be caught – a huge step up from the 40 or so category 1 firms. Peter Barsoom, chief operating officer for Ice, offered a lower estimate – but still warned that it may be difficult to get all of them ready in time.

“The category 2 population is somewhere in the region of 250 – give or take 50 on either side. We looked at the number of firms that have already set up accounts at the clearing house. It is a paltry sum compared to that 250. Alarmingly so,” he said.


This article was first published on Risk


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