Isda’s ‘novation protocol’ aims to tackle derivatives backlogs

The world's major derivatives dealers have signed up to the International Swaps and Derivatives Association’s long-awaited ‘Novation Protocol’, which seeks to facilitate the transfer of existing trades to third parties.

The new protocol is aimed at reducing the backlogs and uncertainty associated with the transfer of an exiting derivatives position to a third party. Until now, assignment trades have required the written consent of the remaining party before its counterparty could assign a trade to another dealer or institution. The new protocol simplifies this requirement to an electronic communication between the parties involved. The protocol will initially apply to credit and interest rate derivative trades, with a view to extending it to other derivative products in the future.

“This protocol addresses directly an area on which regulators and policy makers have focused their attention. It is a major step in achieving counterparty certainty,” said Jonathan Moulds, chairman of Isda and head of international markets at Bank of America.

New York-based Isda has sponsored a series of meetings this year, bringing together business, legal and operational staff from both buy- and sell-side institutions to address some of the mounting problems in derivatives confirmations, particularly in the fast growing credit derivatives market. The association has supported the development of automated confirmation solutions, such as Financial products Mark-up Language (FpML), the industry communications standard.

The backlog in derivatives confirmations has also raised alarm bells at the UK’s Financial Services Authority (FSA) and the New York Federal Reserve. The FSA send a letter to chief executives at the major investment banks in February, warning them about the scale of the problem. Meanwhile, the New York Fed will convene a meeting with 14 Wall Street banks, along with representatives from the Securities and Exchange Commission and the German, Swiss and UK financial regulators, on September 15 to discuss the problem.

The following banks and most of their various trading entities have so far signed up to the new protocol: Banca Caboto, Bank of America, Barclays Capital, Bear Stearns, BNP Paribas, Citigroup, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Nomura, Standard Chartered, Royal Bank of Scotland, UBS and Wachovia. Isda says it expects this list will grow in the coming months.