21 Jan 2009, Rob Davies, Risk magazine
In the buy-side community, email has been the traditional means of consenting to a novation. But in an effort to reduce operational risk, the Operations Management Group (OMG) - a collective of 16 dealers and industry bodies, including the International Swaps and Derivatives Association, the Managed Funds Association and the Securities Industry and Financial Markets Association - committed to managing all consents through electronic platforms.
In an October 31, 2008 letter to the Federal Reserve Bank of New York, the OMG outlined a 'soft' deadline of December 31 for buy-side firms to meet this target. Since the start of this year, dealers have been giving the names of buy-side firms that have failed to do so to their primary regulator.
But a 'hard' deadline of February 28 was also outlined by the OMG, after which "major dealers will only accept novation consent on eligible products submitted on electronic platforms and will not accept email".
With no room to manoeuvre, the stragglers among buy-side firms have been busily signing up with vendors who provide novation consent services, particularly in the early part of 2009.
"In the fourth quarter last year, there was a lot of talk on the issue and a few firms dabbling, but most were targeting the beginning of January to launch," said Jeff Gooch, global head of portfolio valuations and co-head of global trade processing at data provider Markit. The company's consent tool is a free add-on for clients already signed up to its trade processing platform. "We have probably done more business in the early weeks of 2009 than the whole of the fourth quarter."
Markit's competitors say the same. Frank de Maria, chief operating officer for Deriv/Serv, the Depository Trust and Clearing Corporation's trade matching and confirmation service, said more than 150 clients are using its consent platform, "which is a significantly bigger figure than we would have quoted at the start of January. Our sense is that all participants are working diligently to ensure they comply. I've been pleasantly surprised the uptake increased as quickly as it did in January, which makes the February deadline a lot more feasible than it looked in December."
With no room to manoeuvre, Mark Beeston, president of credit derivatives trade processing specialist T-Zero, believes firms failing to meet the February 28 deadline would be forced to comply soon afterwards out of necessity.
"My sense is that the majority of volume will already be electronically novated, and the majority of the residual volume will get done by the end of February," asserted Beeston. "Firms that have not put in place the necessary process, which is likely to be a single-digit percentage, will probably look to do that quickly in March. Otherwise they will find their books increasing in size significantly because they will not be able to lay off positions by novating them."
Assuming the February 28 deadline is met, the next stage for novations processing could be to scrap the current two-stage process of consent followed by confirmation.
"People recognise it is not a sensible process to be consenting to a trade electronically and then confirming it electronically," said Gooch. "Later this year I think the industry will look seriously at getting rid of the consent process and doing the confirm on the same day, which already happens for a large chunk of the interest rates market. Effectively, if you have done the confirm electronically, you've consented to the trade."
Deriv/Serv's de Maria said his company has been in discussions with the OMG for the past year on the same issue, and expects the industry to transition towards 'consent equals consent' after February 28.
"Even with the email process, the buy-side community has been vocal in stating that if it requests consent and that is granted, why should it then have to go through a separate confirmation process," he noted. "Although email is not controlled enough to facilitate that, the electronic process is and should be convertible to do that. But given the market conditions, there should be some flexibility for the industry to tackle one thing at a time."