Existing services such as TriOptima's TriReduce work by analysing an entire portfolio of trades and cancelling - tearing up - trades that offset each other. (TriOptima was also one of 11 companies that bid to provide the Isda service.) The new service, operated by interdealer broker Creditex and data provider Markit, works by cancelling all trades on the same underlying name and tenor, and replacing them with two trades that reproduce the same payoff and risk profile.
Kevin Gould, Markit's head of data products and analytics, says this gives it a significant advantage: "Existing tear-up services actually change the risk profile slightly, so many trades have not been submitted for this reason... or the institutions have needed to monitor the process closely. It is very easy to offset index trades, but on single-name trades you do not have standardised coupons, you could have different coupons on the same notional. So if you have two offsetting trades with the same name and duration, but one with a 200bp coupon and the other with a 100bp coupon, you have an annuity risk."
But, TriOptima's co-founder and chief executive Brian Meese argued, this problem is not really serious. "That's not our view. Whether the compression cycle changes the risk profile is up to the institution, and most of them choose not to. You don't need the ability to create new trades, although it might increase the efficiency."
Also, he said, visions of reducing entire portfolios to a pair of trades are over-optimistic. "Banks won't send in all their portfolio anyway, as some of the trades may be back-to-back with prime brokers." Counterparty risk limits will also reduce the degree of compression and produce a less-efficient solution.
The claimed levels of efficiency give the Creditex-Markit plan no clear advantage. Gould says that in trials with portfolios of single-name deals, his service has achieved compression rates of "up to 50%, 60%, 70%". The service will focus on single-name deals, as straightforward tear-up services can deal much more easily with more standardised index deals, he says.
But, Meese points out, "we are removing 95% of index trades and 72% of single-name trades already... it is possible that our single-name business could be affected [by the new service] but we will have to see".
The week on Risk.net, November 17–24, 2017Receive this by email