With the credit derivatives market more than doubling annually, reaching $26 trillion in notional outstanding as of June last year, regulators on both sides of the Atlantic have rightly been concerned about the industry's ability to keep up with the processing and tracking of deals. Stern warnings from supervisors - notably the UK Financial Services Authority and the Federal Reserve Bank of New York - led to a concerted effort, starting in 2005, to automate as much of the processing as possible.
Major in-house system development and a growing range of third-party solutions have helped reduce the backlog in confirmations. However, there was still one piece missing. Over-the-counter derivatives often have life cycles of five years or more, and counterparties need to continuously track and reconcile events such as assignments, amendments, terminations and notional adjustments. Automatically confirming an OTC trade is one thing; efficiently managing it through its life cycle is another. What was required was a centralised registry of all OTC trades, and infrastructure to support the automation of post-trade processes. Step forward the Depository Trust and Clearing Corporation (DTCC) and its Trade Information Warehouse.
New York-based DTCC was already playing a major role in the credit derivatives market with its Deriv/Serv automated affirmation and confirmation platform. Identifying the need for a depository and asset management service for the OTC derivatives markets similar to those that it operates for US and other international securities, it began drawing up plans for the Trade Information Warehouse a year ago. Working closely with a group of 17 top dealers, the DTCC designed a platform that would fill many of the gaps in the OTC trade-processing world.
"Today, we duplicate effort repeatedly across functions - basically agreeing trade facts in trade checkout processes, confirmation processes, pre-settlement tie-outs, post-settlement fail management and portfolio reconciliations," says Jeff Gooch, managing director of fixed-income operations at Morgan Stanley. "The Trade Information Warehouse should mean we agree a trade once, and that all other processes flow from this agreed set of facts. This starts to bring many of the operational efficiencies of the cleared listed products to the OTC environment. I think people have yet to really understand how significant this is."
Some people on the buy side do understand. Although it is the sell side that has been under pressure from the regulators to do something about the processing of credit derivatives, the buy side has an equal, if different, interest in improving the situation. "For us, it is more important to get a centralised clearing mechanism up and running, and we think the Trade Information Warehouse is the first step in moving towards a clearing system analogous to an exchange, where margining occurs on a daily basis," says Jim Keller, managing director at Pimco, a leading fixed-income asset manager based in Newport Beach, New York. "If we can mimic the futures exchanges in terms of absolutely minimising credit risk, I think that's hugely important."
In financial IT, there is many a slip between having a good idea and its implementation. The list of projects that have failed in the journey from drawing board to live production is long, and given the dynamic nature of today's markets, there is a widely held view that industry platforms are better left to commercial organisations that understand real business pressures. The not-for-profit DTCC has overturned this assumption, bringing the Trade Information Warehouse in on time and budget in an aggressive schedule from a February announcement to a November launch date.
Brad Bailey, senior analyst at Boston-based financial services research organisation Aite Group, says: "Perhaps the most impressive thing about the Trade Information Warehouse is that it was able, very close to schedule, to be implemented and initiated. It has been a major undertaking."
The major dealers are already back-loading five years' worth of credit derivatives trades into the warehouse - a process that is likely to take until mid-2007. Once these are added, along with all current trades that can be fed from automated confirmation services such as the DTCC's Deriv/Serv, the benefits will start to unfold. Terminations, assignments and other events will be automated, and balance-sheet information, collateral management and payments should be more accurate. Once credit derivatives are embedded, the DTCC plans to add other asset classes, including equities, interest rate and foreign exchange products.
"We developed the warehouse in close collaboration with leading dealers and buy-side firms over an aggressive 10-month time frame," says Bill Hodgson, vice-president of DTCC business development, who led development from London. "This has been cross-border collaboration - from developing business requirements and designing an operating model, to setting processing standards and testing. We anticipate that a wide range of industry service providers will be connecting to the warehouse and offering complementary services."