Guide to OTC Trading

Lifecycle of an OTC trade


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LEARNING UNIT 2 | OTC TRADINGWorkflow, Regulation and Solutions

Lifecycle of an OTC tradeINTRO First, lets have a 1st approach to the lifecycle of an OTC trade by having a look into the standard trading of a share on a spot (or cash) market as opposed to derivatives trading.https://www.youtube.com/watch?v=mEnCKNIb0Bs&index=1&list=PLNea5CpV4u8mE1H-Di9dmebWtFc1UbQdy

Now, moving on the lifecycle of an OTC derivative trade, we will focus on the trade of an Interest Rate Swap (IRS) as swaps are the most traded OTC derivative in the world.

For a review of swap basics visit these two links:http://www.slideshare.net/RubnGarcaNavarro/financial-derivatives-55545674?qid=ccc962bd-c524-40c7-b5a6-0aa808e84267&v=&b=&from_search=9 Slides 30, 31, 32, 33, 34http://www.investopedia.com/articles/optioninvestor/07/swaps.asp


ROAD MAP OF THIS PRESENTATIONPLAYERS DEFINITIONPLAYERS DESCRIPTIONREGULATORY REPORTING, ACRONYMS AND IDSTRADE TYPES BY EXAMPLESTRADE LIFECYCLE AND WORKFLOW TRADE EVENTSINTRO TO MARKETWIRE & VCONMain sources:http://www.cftc.gov/index.htmhttps://riskfocus.com/https://www.clarusft.com/http://www.marketsreformwiki.com/

Other sources:http://global-emarkets.com/http://www.dtcc.com/http://www.investopedia.com/https://en.wikipedia.org/

Lifecycle of an OTC tradeLink:https://riskfocus.com/infographic-the-u-s-derivatives-trade-reporting-ecosystem/

PLAYERS DEFINITION

Lifecycle of an OTC tradePLAYERS DESCRIPTION: SEF

1.The role of Swap Execution Facilities (SEF) in derivatives trade execution, Be the principal execution venue of all swaps in US.A SEF is defined as a regulated facility, trading system or platformin which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility.Responsibility to report real time data and creation data of swaps executed on a SEF to a Swap Data Repository (SDR) of its choice, both CPs must also report to the same SDR.

Links:https://riskfocus.com/role-of-swap-execution-facilities-sef-in-derivatives-trade-execution-clearing-reporting-part-1/https://riskfocus.com/the-role-of-swap-execution-facilities-sefs-in-derivatives-trade-execution-clearing-and-reporting-part-2/https://riskfocus.com/the-role-of-swap-execution-facilities-sefs-in-derivatives-trade-execution-clearing-and-reporting-part-3/https://riskfocus.com/the-role-of-swap-execution-facilities-sefs-in-derivatives-trade-execution-clearing-and-reporting-part-4/


http://www.cftc.gov/IndustryOversight/TradingOrganizations/index.htmThese SEFs are usually owned by:Either classic US market intermediaries that joined SEF ranks with brokers, swapdealers and interdealers as Icap, Tullett Prebon, BGC, Tradition, GFI.Or fintechs, old and new, like Bloomberg, Reuters and 360T, Tradeweb, Dealerweb. SEF in the world: 68% of $ denominated IRSs are traded on United States SEFs | 53% of world swaps for $, , Yen, GBP

https://www.clarusft.com/what-is-left-off-sef/https://www.clarusft.com/2015-sef-market-share-statistics/PLAYERS DESCRIPTION: more colour on SEFs

There are 27 SEFs registered lately. See IRS pie for market share,

Lifecycle of an OTC tradePLAYERS DESCRIPTION: SDR

2. The role of Swap Data Repositories (SDR) in derivatives trade execution,

Be the mandatory reporting and reportkeeping body for all swaps.Since all of the steps are done electronically, the trade processing and data comms SEF|SDR occur nearly instantaneously.The SEF can choose which SDR to report its trades. Most popular SDRs are the DTCC, CME and Bloomberg SDR.Two stages in reporting, the creation of the swap and the continuation of the swap over its existence until its final termination or expiration.

Links:http://www.cftc.gov/IndustryOversight/DataRepositories/index.htm http://www.dtcc.com/derivatives-services/global-trade-repository

Lifecycle of an OTC tradePLAYERS DESCRIPTION: DCO, Uncleared Swaps3. The role of Derivatives Clearing Organization (DCO) in derivatives trade execution,

Be the mandatory submission body for clearing of all swaps.

PRIOR to be accepted a swap deal:Is UnclearedHas to be reported to a SDR by both the SEF and the Reporting Counterparty.Receives an Alpha USI and the Reporting Counterparty ID (RCP)|Known also as LEI.Links:http://www.cftc.gov/IndustryOversight/ClearingOrganizations/index.htmhttp://www.marketsreformwiki.com/mktreformwiki/index.php/Mandatory_Clearing_Regulation

Lifecycle of an OTC tradePLAYERS DESCRIPTION: DCO, Cleared Swaps

3. The role of Derivatives Clearing Organization (DCO) in derivatives trade execution,WHEN ACCEPTED several things happen simultaneously (see blue lines):

Is ClearedSEF submits an Exit message for the Alpha USI (the original trade ID).DCO creates & communicates new USIs (Beta, Gamma) to the relevant CPs.DCO sends the creation data for the cleared transactions to a SDR of its choice using the Alpha USI as the Prior USI.

Links:http://www.cftc.gov/IndustryOversight/ClearingOrganizations/index.htmhttp://www.marketsreformwiki.com/mktreformwiki/index.php/Mandatory_Clearing_Regulationhttp://progressive.powerstream.net/008/00102/cmeg_es/CMEClearPort/multiscreen.html


RECENTLY we got two different status coexisting in US for OTC clearing, plain CCPs and DCO.The main gap being DCO got harder requirements than CCPs in terms of (credit) risk management & financial resources.Promoting entity duplication for clearers within US framework as CCP AND as DCO (See case of JSCC in DCO chart).

NOW an US|EU agreement has been reached to get common ground,http://ec.europa.eu/finance/financial-markets/docs/derivatives/20160210-eu-cftc-joint-statement_en.pdfhttp://www.shearman.com/~/media/Files/NewsInsights/Publications/2016/02/EUUS-Agreement-On-Regulation-Of-Central-Counterparties-FIAFR-021616.pdf

PLAYERS DESCRIPTION: DCO vs. CCP

DF and EMIR regulate OTC clearing in US and EU.In US the CFTC stablished the DCO as the main player to clear OTC trades vs. In the rest of the world the figure was the CCP.Most popular global CCPs are LCH, CME and JSCC (See CCP chart).

Lifecycle of an OTC tradeREGULATORY REPORTING

US with DF and the CFTC set up a regulation framework that defined the appropriate channels to trade OTC derivatives.Specifically on swaps stablished that they were to be:TRADED PRIMARILY THRU SEFTHEN SUBMITTED FOR CLEARING TO DCOAND FINALLY MANDATORY REPORTING AND REPORTKEEPING INTO SDRBeing US markets the lion share of global trading these rules have become principal to every market player and to the financial industry as a whole.Some exceptions are allowed but the bulk of OTC swap trading is subject to these laws.

Links:http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htmhttp://www.cftc.gov/PressRoom/PressReleases/pr7343-16http://www.cftc.gov/PressRoom/PressReleases/pr7342-16

Lifecycle of an OTC tradeRegulatory Acronyms and FpML

Links:http://www.fpml.org/http://www.fpml.org/fpml_focus/regulatory-reporting/http://www2.isda.org/functional-areas/technology-infrastructure/data-and-reporting/identifiers/

FpML stands for Financial products Markup Language and for OTC derivatives:Its the open source XML standard for electronic dealing and processing.Enbodies the industry protocol for sharing information on|and dealing in dervs & structured products.Provides the standard data content and structure to exchange derivatives transactions electronically.The main users of FpML are dealers, asset managers, hedgefunds, service providers, fintechs.Widely used both in execution, clearing and regulatory reporting to CFTC (Dodd-Frank), SEC (DF) and ESMA (EMIR, MiFID II, MIFIR).Guide to some of those acronyms, and how FpML and other standards relate to them,http://global-emarkets.com/acronyms.html

Lifecycle of an OTC tradeREGULATORY IDENTIFIERS

International regulators and supervisory bodies have called globally for the adoption of unique identifiers to improve derivatives data reporting, the three main are:Unique Swap Identifier (USI)|Unique Trade Identifier (UTI)Allows to uniquely identify a trade or contract for regulatory reporting. That stays unique throughout the life of a trade.USI is the CFTC term for UTI used more globally.Legal Entity Identifier (LEI) is an unique identifier associated with a single corporate entity that identifies that entity in the financial market. Although no common entity ID convention exists today a range of regulatory initiatives, as the 20-character alphanumeric code, are driving the creation of a universal LEI standard.Unique Product Identifier (UPI) is used to uniquelyidentifyaproduct and has sufficient specificity to be usedfor reporting to global financial regulators.The classification of products is provided via the ISDA OTC taxonomies.


TRADE TYPES BY EXAMPLES: Simple, With two or more Legs and StructuresSIMPLEThese trades involve the use of just one derivative instrument. For instance, 50 million euros on a 3 month forward on eurocurrency.Another trade would be a Feb 2022 1.10 Call relating Euro/GBP on 25 million of dollars. With TWO or MORE LEGSThis trade involves the use of several derivative instruments of the same kind. Lets think on option strategies like a bull call spread on the eurocurrency. Here we have two legs, buying the Sep20 1.05 Call & selling the Sep20 1.20 Call. On a long call butterfly we would have 3 legs again of the same derivative instruments (options).STRUCTURESInvolve the use of several derivative instruments of different kinds. For instance, a guarranted fund that delivers in 2 years either the invested capital or the 60% of the rise of the SP500. In this case we might buy a 2yr Forward on the SP500 together with the buy of a 2yr Put at closest strike to present SP500 levels, thus, using forwards and options.

Links:http://www.theoptionsguide.com/bull-call-spread.aspxhttp://www.optionseducation.org/strategies_advanced_concepts/strategies/long_call_butterfly.html


TRADE LIFECYCLE AND WORKFLOW


TRADE LIFECYCLE AND WORKFLOW: Acknowledgement and Trade Confirmation

What? Both are important processes aimed to reduce the risk of the traders P&L.Sending trade Confirmations to the counterparty.Receiving trade Confirmations from the counterparty.Trade or Contract Matching.Trade Affirmation.The counterparty acknowledges the trade details. Before that, some amendments|updates might arise on the price or quantity of the trade, impacting the traders P&L book. This agreement on trade details can be achieved through:How?


TRADE LIFECYCLE AND WORKFLOW: Trade MatchingTRADE MATCHINGgenerally applies to mandatory electronic matching of trade details.Both parties are required to input details to a central matching facility.Matching results (i.e. matched, unmatched) are provided by the trade matching facility to both parties.Examples include:Omgeo Central Trade Manager (CTM).TRAX (Internationally traded debt & securities).Depository Trust & Clearing Corporation (DTCC).National Securities Clearing Corporations Trade Matching Service (NSCC).


TRADE LIFECYCLE AND WORKFLOW: Trade AffirmationTRADE AFFIRMATIONrelates to the electronic matching & processing of trade details typically between Securities Institutions and Institutional Clients (being both subscribers of this service).

The Institutional Client agrees (AFFIRMS) or disagrees (REJECTS) and the response is sent back to the Securities house. When affirmed by both parties Its usual that the Hub generates and sends automatically Confirmations to both counterparties with the affirmed trade details.Examples include:Omgeos Oasys Global system.FIX (Global)Oasys Domestic - (US)DTC ID (Institutional Delivery) (US)

Lifecycle of an OTC tradeTRADE EVENTS: IntroIn the Booking & Record Keeping of Trade Events each Institution face 3 Conditioning Factors,Its Record Keeping and Booking SystemsFor example, as in Murex there are just 7 actions and It is thru those actions that the institution has to reflect a bigger number of trade events, each trade event can be articulated in several valid ways. The institution procedure to articulate and name, lets say, a novation in Murex has to be taken into account. Thus, a novation for Bank A which is a Murex user is done thru two actions, a new trade and a cancellation.Its Procedures & TerminologyThe Regulatory Reporting RequirementsAt the end of the day, from the regulator point of view, it is not so important how Banks articulate their booking internally. Trade events are to be reported as defined and indicated by the authorities in terms of frequencies, formats, fields and so on.Using Murex, Star, Kondor or WallStreet matters when it comes to How to reflect trade events thru its lifecycle.

Lifecycle of an OTC tradeAllocationAmendmentBackloadCompression (ie, TriOptima)Corporate ActionCredit Event (also succession)Exercise ( Full | Partial )ExitIncreaseModificationNovation (F|P)Position cancel or ErrorTermination (F|P)Trade or New TradeUnwind (F|P)

TRADE EVENTS: OverviewBrief terminology on OTC trade events reported to Global Trade Repositories (GTR),A SDR is a GTR specilized in swap trade reporting under US jurisdiction.Here a DTCC link showing in pages,18 to 22 Complete Table with compatibilities between Business Events | Lifecycle Events

24 to 29 Models of reporting depending on:Trades being: Bi-lateral | thru SEFReporting being: Independent| DelegatedLink:http://www.trioptima.com/services/triReduce.html

http://www.dtcc.com/~/media/Files/Downloads/Data-and-Repository-Services/GTR/GTR-Europe/DTCC-GTR-OTC-Lite.pdf?la=en

Lifecycle of an OTC tradeTRADE EVENTS: Main Post Trade EventsTrade events rules set by Regulators focus specially in the full reporting of three fields:Counterparties, Notionals and Expiries. Both initial values and later changes.NOVATION (Full|Partial) Its the act of replacing one Counterparty in a contract with another.http://www.investopedia.com/terms/n/novation.asp | http://www.isda.org/publications/pdf/2004ISDANovDefinitionsUG.pdf

INCREASE|DECREASEIts an early termination by means of changing its Maturity. From that moment, both counterparties will cease to make the previously agreed-upon payments.EXERCISE (F|P)

UNWIND (F|P)

COMPRESSIONTo implement the Right of the holder of an option to buy (in the case of a call) or sell (in the case of a put) the underlying of a contract. Usual also in credit events.A process of terminating a swap by marking it to market and calculating its value in order to determine which counterparty has a positive terminal value that would be paid by the one whose terminal value is negative.TriOptima allows to reduce the size of OTC derivatives notional exposure|number of items in a Portfolio vs. each Counterparty in order to improve risk management.Implies modifying the Notional of an existing contract.TERMINATION (F|P)

Lifecycle of an OTC tradeMarkitWire is the most widespread OTC trade and postrade solution in the financial markets,How it works?Intro to MarketWire (32 min. video) http://cdn.markit.wallst.com/MarkitServVideo/Content/MarkitWire/Equity/MWEQ05.htmlWho owns it?Intro to Markit: History, shareholders, acquisition

More Markit solutionsINTRO TO MARKETWIRE & VCONVCON is Bloomberg platform widely used for trading and clearing of cash and derivatives.Connects buy and sell side firms to multiple CCPs, specially in IRS|CDS.Allows trade matching, generation of confirmations and sending of trades to clear on CCPs.Standing for Voice Confirmation its workflow shows trade status (affirmed, rejected, cleared, pending).Interacts with MarkitWire/MarkitServ http://www.idcg.com/pdfs/idcg_news/VCON.pdfhttps://en.wikipedia.org/wiki/Markithttp://www.markit.com/product/markitserv


End of presentation,

Thank you.

Fonetic Trading Unit

LEARNING UNIT 2 | OTC TRADINGWorkflow, Regulation and Solutions

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Economy & Finance

Guide to OTC Trading