JP Morgan and UBS compress forex books via start-up
NYC-based LMRKTS first broke cover two years ago; third bank participant is unknown
JP Morgan, UBS and a third dealer have completed a multilateral compression of foreign exchange derivatives via New York-based start-up, LMRKTS. Participants executed a layer of new trades to shift and net existing cashflows, streamlining portfolios in five different currencies: euro, sterling, Swiss franc, US dollar and yen.
It is the first public sighting of LMRKTS since Risk.net revealed its ambitions – along with those of fellow netting start-up NetOTC – in late 2013. The multilateral compression happened in the first week of October, following completion of a bilateral run in August.
"We designed the system with the help of the banks to provide the maximum amount of benefit with the least amount of new trades or disparities in pricing that often hold up other compression exercises," says Lucio Biase, founder of LMRKTS. "Submitted cashflows comprised two months of forex exposures and the process enabled the dealers to take their gross cashflows to net with efficiencies greater than 90%, so we were all pleased with the results."
"This has been a great example of being at the forefront by partnering with LMRKTS to bring a product to market quickly that collapses risk and drives efficiency of financial resources," says Dipak Chotai, global risk manager for forex, rates and credit with UBS in London.
The live multilateral run went smoothly, says Biase, with the new trades all confirmed in the space of an hour.
A rival service run by TriOptima became the second to complete a compression of forex trades in late October.
Compression has been a key part of the investment banking efficiency drive in the past two years, enabling dealers to reduce the size and complexity of their derivatives books, with accompanying benefits in terms of risk, leverage exposure and capital. It can be done in a variety of ways: in bilateral compression, two banks will analyse their books, tear up unnecessary trades and then replace them with a smaller number of transactions that achieve the same economic effect.
Multilateral compressions are harder to manage but offer potentially greater benefits. If Bank A has a net long position with Bank B, bilateral compression will remodel the book to make it leaner – but it can be no smaller than the net position between the two. If Bank A also has a net short position with Bank C, however, bringing the third bank into the analysis might allow greater reductions in trade numbers and notionals.
Until now, multilateral compression has been focused on interest rate swaps, with TriOptima the leader in the space. In the past year, clearing houses such as LCH.Clearnet have also begun offering the service.
The LMRKTS process seeks to achieve many of the same goals, but applies them to forex exposures and cashflows arising from forwards, options and cross-currency swaps. It also avoids terminating existing trades, because most banks lack systems that allow them to terminate forex trades en masse; instead, the service rearranges cashflow dates in an attempt to streamline the disparate cashflows in different currencies between the counterparties.
"Operationally, it's much nicer if I don't have to make 15 different back-and-forth payments with you in the next two months," says Biase. "And you also don't want to be long euros one day and short the next just because positions are rolling off the books. So, if I can consolidate those cashflows, I don't have as much hedging to do because I don't have as many open positions. And depending on the jurisdiction, I also get some relief on leverage because I am netting down exposure."
The first live forex compression took place between UBS and another European bank in August, before JP Morgan was added to the group for the first successful multilateral run.
LMRKTS switched its attention to forex compression after conducting test runs of a service that allows clearing house members to flatten exposure across different venues. This "intelligent switch" service should debut in the near future, says Biase.
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