Additionally, the regulators called for the International Swaps and Derivatives Association’s cash settlement protocol – introduced in 2005 – to be written into standardised credit derivatives trade documentation. These proposals were echoed by the FSF, which also appealed for market participants to automate trade novations.
The industry is responding to the recommendations. In a letter sent to the Federal Reserve Bank of New York on March 27, the Operations Management Group (OMG) – a collective of 18 dealers formed in December 2007 to address the issue of confirmations backlogs in OTC markets – submitted its latest set of operational goals. Several major buy-side firms, including Alliance Bernstein, Blue Mountain Capital Management and Citadel Investment, are represented on the OMG.
In the Fed letter, the OMG stated its main aims for the credit derivatives market were to ensure consistent use of electronic confirmation platforms for eligible trades, to deliver a market implementation plan by May and to work with Isda on a plan for credit event management. By July, another stated aim is for submission, matching and accuracy targets to be met by major dealers and buy-side institutions in the OMG; while by September, most major dealers are expected to be live electronically with each other for central settlement. At some stage in 2008, novation requests will only be submitted through electronic platforms, as opposed to email.
The OMG will work with industry bodies Isda, the Managed Funds Association and the Securities Industry and Financial Markets Association for the May market implementation plan.
In terms of electronically eligible matching trades, major dealers and buy-side institutions will commit to submitting 90% of trades within one day after trade, with 92% of trades matched within five days. The OMG also pledged that 90% of trades would be submitted accurately without amendment.
For central settlement-eligible trades, major dealers will commit to submission of all those trades on the day of trading and confirmation within two business days. Meanwhile, the OMG says the request by regulators to incorporate the cash settlement protocol into standardised documentation will require “participants to agree in advance to a mechanism to address these and other issues that may arise”.
As it stands, the protocol is based on an auction mechanism for the settlement of credit derivatives contracts. To date, Isda has organised nine such auctions. In the Fed letter, the OMG said the key issues have been identified, and the process towards standardising the protocol has already begun with the dealers that have been closely involved in developing the auction process. At Isda’s annual general meeting, held in Vienna in April, representatives of the OMG admitted the timeframe to implement the new measures was ambitious.
“These are aggressive targets and will be a stretch for the industry, but we have seen a major commitment from dealers and the buy-side community to attain them,” said Oliver Stuart, global head of credit operations and co-head of global fixed-income documentation at Morgan Stanley.