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The Magazine From OTC Space | News, Articles and Opinion on the Capital Markets

Shrinking The OTC Space l Weapons of Mass Destruction

Shortening the Blockchain l Front or Back Loading
Rocket • Edition 6 | Spring 2016 • | 1


LSE and Deutsche Boerse


The latest news is the potential merger between the London Stock
Exchange Group (LSEG) and Deutche Boerse (DB). There seems to
be strong opinion on-line on the likely success or failure of the idea,
The OTC Space plus the possibility that ICE will bid for LSEG too.
News, Articles and From a clearing perspective the combined LSEG+DB group would
Opinion on the have a dominant position in OTC products plus the long end of the exchange
Capital Markets traded rates curve. Both firms have the ability to cross-margin between OTC and
ETD, this would bring even more reasons for firms to clear at one venue.
A combination of ICE+LSEG would bring the ex-LIFFE business and the
short end of the ETD rates curve together, plus ICEs dominant position in CDS
To discuss the bespoke
marketing opportunities
My personal opinion is that having a pure European combination is necessary
available with The OTC Space, to compete with ICE and CME, much like Airbus and Boeing. The competition Having a pure
will keep both groups on their toes and bring benefits for customers. Whether the
with many options to enhance
your brand, products and UK referendum on EU membership would get in the way of completing this deal
European combination
services, contact:
Bill Hodgson
cannot be predicted. is necessary to compete
Owner and editor
Patrick Young at published a video using Twix as a
metaphor for the merger, likening the combination of the two cleared pools to two
with ICE and CME,
+44 (0) 77 1171 5311 sticks of Twix in a common wrapper, rather than one integrated chocolatey snack. much like Airbus
Samantha Hodgson
The video was great but his opinion I’m not sure about – it’s probably not possible
to measure the quantitative effect on Initial Margin and default fund without
and Boeing. The
Project Manager having permission from clearing members to access their data. competition will
+44 (0) 78 0788 5859
GSF Conference
keep both groups
Mariangel Gonzalez
Design and Layout
On another note I had the honour to moderate a panel on OTC derivatives at on their toes and
the Clearstream Global Securities Finance event in Luxembourg, in front of 650
people. We had a strong panel of experts from the industry and also interactive
bring benefits for
© The OTC Space 2016 engagement with the audience. customers.
Rocket • Edition 6 | Spring 2016 • | 2

The first audience vote asked “how familiar are you with the forthcoming rules
on margin for un-cleared OTC trades?” 25% answered “what rules?” with another
15% saying “not very”.
This isn’t too surprising in a room mainly populated by non-OTC people - but
by September they really need to know that the OTC market is going to begin
hoovering up assets to place as Initial Margin to cover the new margin requirements, Bill Hodgson has worked
and in March 2017 a bigger hoovering effect from the requirement for VM on all in the capital markets for
trades by almost everyone. more than 20 years on
With the requirement for non-rehypothecation, a large quantity of normally key pieces of the market
fungible assets will be locked up and somewhat immobile. Will this have an infrastructure. Contact Bill
effect on asset prices and liquidity? Will this reduce volumes of trades in the for consultancy, training,
bond market? We’ll begin to see the real outcomes from September and annually project and programme
thereafter. management.

Edition 6 E
This edition has some strong articles again, my thanks to all the contributors. We T @theotcspace
even have an article on distributed ledgers (or blockchains) which actually sets out W
the opportunities in banking, rather than hyping the impact. We like to hear from
readers so please contact us on with feedback on this
edition and ideas for the next one.

Bill Hodgson,
Owner and editor
October 2015
Rocket • Edition 6 | Spring 2016 • | 4

11 32 53


6 Contributors
8 Industry Events
Trading Technology
32 The Future of OTC Trading 49 Improved banking profitability hinges on IT
Regulation by James Parascandola transformation
by Peter Farley
11 Considerations for EMIR Category 2 entities: to front-
load or back-load? Clearing
53 Blockchain for traditional markets: hype, enhancement,
by Jaki Walsh disruption?
35 Indirect clearing: one set of rules for all?
by Peter Ten-Broeke by Sergei Mayorov
17 Selected regulatory deadlines
by Bill Hodgson 39 CCP Notionals Scoresheet 61 Why data harmonisation is key to efficient and effective
by Amir Khwaja Trade and Transaction Reporting
20 Anti-abuse legislation hits energy and commodity trading: by David Farmery
How REMIT and MAR are beginning to trigger a shift
by Aviv Handler Capital
64 Climbing the regulatory reporting mountain
40 Compressions shrinking the OTC Space by Marc Gratacos
26 European Open Access: The Reality by Diana Higgins
by Bill Hodgson

Legal Risk Management Management

29 ISDA Protocols: Turning rockets of remedy into weapons 44 Initial Margin on Uncleared OTC Derivative Trades: The 68 The Future of Diversity in Banking
of mass data destruction? ISDA Standard Initial Margin Model (“SIMM”) by Miranda Brawn
by Akber Datoo by Peter Sime
Rocket • Edition 6 | Spring 2016 • | 6

Contributors We would like to thank...

Miranda Brawn David Farmery

Investment banker and barrister Chief Operating Officer, Message Automation
Miranda has spent her career at some of the most prestigious global David spearheads the company’s business development efforts.
financial institutions, including JPMorgan Chase Bank, Deutsche He is also responsible for the company’s consulting activities,
Bank and Goldman Sachs International. Miranda’s primary role is plus finance, legal, and HR functions. Prior to joining Message
to manage the company’s legal risk across Europe for the derivatives, Automation in 2005, David had seventeen years in a variety
regulatory and securities financing business for an investment bank. of banking roles in the city, most recently as Chief Operating
She was voted by Brummel as one of the Top 30 most inspirational Officer of Nordea London Branch. David is a Chartered
women in the City and is featured in the CityAM Top 20 Women in Accountant and a qualified Corporate Treasurer.
the City Powerlist (Business and Finance category). BE Mogul has
named her one of the most influential and successful black business
people in Britain. She has also been elected a Fellow of the Royal Marc Gratacos
Society of Arts (RSA) in recognition of her outstanding contribution Founder, TradeHeader SL
to diversity and community work in Britain. Marc has been working in the f inancial industry since 2003
as a business analyst, consultant and trainer. As a consultant,
Akber Datoo he has been involved in a variety of projects in derivatives
Founding partner of D2 Legal Technology LLP operations and IT for organizations implementing electronic
Akber has a background as both a technologist and derivatives data standards.In 2011, Marc formed TradeHeader S.L,
lawyer. He advises on the management of legal contract data a consulting company focused on f inancial messaging
for risk management, RWA reduction, collateral optimisation/ standards, leveraging the expertise on FpML and OTC
management and insuring compliance with the increasingly derivatives but also covering other key standards in the
regulated environment such as Liquidity Reporting, Client Asset & industry such as FIX/FIXML and ISO 20022.
Client Money (CASS) and Recovery & Resolution Planning (RRP).

Peter Farley Aviv Handler

Senior Marketing Strategist, Capital Markets, Misys Managing Director, ETR Advisory
Peter focuses on the market dynamics and industry challenges that Aviv is a specialist in the regulation of the commodities, energy
drive IT investment priorities in the Capital Markets. He has an and financial markets and the managing director of ETR
extensive background as a financial journalist, market analyst and Advisory. He focuses on all streams of regulation including
industry commentator. He now delivers that insight to complement EMIR, REMIT, MiFiD II, CRD IV and MAR as well as
Misys product and marketing communication activities. applicable rules across the globe.
Rocket • Edition 6 | Spring 2016 • | 7

Diana Higgins James Parascandola
Credit risk management consultant Credit & OTC Derivaitves/Dodd-Frank/Clearing & Execution, NewOak/
Diana is a credit risk management consultant based in London with MF Global Holdings LLC
over 15 years experience in commodity trading. She has managed James has more than 10 years credit derivative trading
distress events and has also set up, transformed and closed down experience in buy & sell side roles and is presently an
credit risk departments in major European Energy firms. advisor to OTC derivative market participants assisting
firms in navigating the most complex and highly regulated
Samantha Hodgson environment in financial markets history. Prior to joining State
Project Manager, The OTC Space Street, James headed credit derivative trading and lead his
Having previously graduated with an Honours degree in firm’s effort to become a CDS clearing member at a leading
Psychology, Samantha joined The OTC Space team in 2014 to FCM and global broker-dealer. In addition to serving as the
assist with the project management of Comet 1, the first OTC firm’s lead OTC derivative representative, James spoke before
Space conference. She now continues to manage ongoing projects the CFTC in Washington, D.C. on matters pertaining to OTC
such as Rocket magazine, webinars, videos and conferences. derivative regulatory reform. In 2003/04, James was one of
Alongside projects she is responsible for managing The OTC four individuals who helped create and launch what is now
Space’s relationships with its sponsors and partners and acts as the most widely traded credit derivative index family globally;
chief administrative officer to the website. the CDX family of credit derivative indices, while he headed
investment grade index trading at Barclay’s Capital.
Amir Khwaja
Amir has more than twenty years experience in OTC Derivatives Peter Sime
and Technology. His prior positions include Director of Risk Senior Advisor at D2 Legal Technology LLP
Management and Financial Engineering at Calypso Technology Peter originally qualified as a mathematician and chartered
(2005-2012), CTO at SunGard Trading and Risk (2002-2005), accountant, before holding a variety of positions both within
CEO & Founder at Kronos Software (1998-2002). financial institutions and as industry regulator and advisor
– including the Association of Futures, Brokers and Dealers
Sergei Mayorov (AFBD) and the Serious Fraud Office. He subsequently spent
Strategy, Moscow Exchange ten years with Wachovia Bank as Head of Market, Credit and
Sergei is currently engaged in market structure analysis. In his Operation Risk, before moving to ISDA in 2011 as Head of
previous positions (then – with the Micex) he was in charge Risk and Capital where he led industry groups with the Basel
of government securities market and derivatives market, of Committee on forthcoming legislation including FRTB, BCBS
development of new products and market technologies. 239 and Basel III.
Rocket • Edition 6 | Spring 2016 • | 8

Peter ten Broeke Jaki Walsh
Attorney-at-law and Senior Legal Counsel, UniCredit Bank AG, Managing director, Derivati Consulting
London Branch With over 15 years of global experience in derivatives and project
Peter is a Dutch and English qualified derivatives lawyer with a management across investment banking, asset management
strong private practice and in-house background in Amsterdam and central clearing, Jaki has the unique benefit of having sell-
and London. He currently works in UniCredit Bank AG’s side, buy-side and service provider experience in the Derivatives
structured equity derivatives team and also has an advisory role market. Jaki can be relied upon to deliver what is promised, will
in the regulatory space. In that capacity he is directly involved manage expectations and does not believe in staying within a
in the implementation of EMIR within UniCredit Bank AG. ‘comfort zone’, rather “in getting my hands dirty to get the job
Prior to his current role, he worked in structured finance and done”. Prior to founding Derivati Consulting, Jaki was head of
securitisations at US law firm Cadwalader, Wickersham & Taft EMEA OTC Product at CME Group where she worked closely
LLP and, before that, at the Amsterdam and London offices of with buy and sell-side clients to support the successful launch of
Dutch law firms NautaDutilh and Loyens & Loeff. dealer-to-customer OTC clearing services.

Industry Events

Industry he New Year has brought with it the next round of annual to announce over the year will provide registered readers with a
Events with industry events across the globe, in addition to some new
events that may spark interest, and some topic specific
discount on registration between 10% and 20%.
To make use of the discounts that will be available to readers
Support courses to help develop understanding of specialist areas of throughout the year, it’s important to register. It’s free to do so,
From OTC the derivatives world. The OTC Space regularly releases ‘event
announcements’, to draw attention to events that will appeal to our
and provides us with valued information about who our readers
are, while your information is protected in accordance with UK
Space readers interests. A typical announcement will be developed to law. In addition, you will have access to all the ‘gated’ content that
provide a simplified snapshot, with an alphabetised list of speakers, is stored permanently on the website – these pieces are usually
a summary of the agenda (accurate on the date of publication), and the most valued pieces. You may also receive a copy of ‘Rocket’
information about the venue and registration. magazine, with expert articles and industry insight.
For more information
In the past there has occasionally been the opportunity to register at To register, visit
Samantha Hodgson
Project Manager, The OTC Space
a discounted rate using the details we provide in the announcements; We continue to agree new media partnerships throughout the this year media partners have been taking much more notice of the year, and search for events that our readers may be interested to
+44 (0) 78 0788 5859 number of OTC Space readers, and their experience in the industry. hear about. So far we will be announcing the following events, but
This means that so far 70% of the events we have currently partnered this list is by no means exclusive:
Rocket • Edition 6 | Spring 2016 • | 9

Industry Events

DerivOps North America 11-12 Apr Chicago No 15%

TradeTech 2016 12-13 Apr Paris Yes 15%
OTC Clearing & Risk Management for the Buy-Side 26-27 Apr London Yes 20%
CCP Clearing, Risk Management, Recovery and Resolution 5-6 May London No 10%
FATCA and the OECD CRS 12-13 May Dubai No 10%
Islamic Banking and Finance: Regulatory, Risk and Compliance 26-27 May London No 10%
5th Annual Collateral Management Forum 2-3 Jun Amsterdam No 10%
9th Annual International Derivatives Expo 7-8 Jun London No
Hedge Funds: Regulatory, Risk and Compliance 16-17 Jun London No 10%
ISLA 2016 21-23 Jun Vienna Yes
TSAM New York 23 Jun New York No 20%
Hedge Funds: Regulatory, Risk and Compliance 23-24 Jun New York No 10%
MiFID II: Regulatory, Risk and Compliance 28-29 Jul London No 10%
Advanced OTC Derivatives Documentation and Negotiation 12-13 Sep New York No 10%
Technology, Risk, Compliance and Innovation 13-14 Oct London No 10%
31st Annual FIA Futures and Options Expo 18-20 Oct Chicago No 10%
Advanced OTC Derivatives Documentation and Negotiation 24-25 Oct Miami No 10%
CCP Clearing, Risk Management, Recovery and Resolution 27-28 Oct Miami No 10%
Global Regulatory Compliance 7-8 Nov Peru No 10%
Global Regulatory Compliance 10-11 Nov Chile No 10%
Regulation Rocket • Edition 6 | Spring 2016 • | 11


Considerations for
EMIR Category 2
entities: to front-load
or back-load?
After a long and arduous road to the final EMIR
Interest Rate Swap (IRS) Regulatory Technical
Standards (RTS), the dates are set and front-loading
requirements remain.


ront-loading is a require-
ment that stipulates all
trades executed on or after
a pre-set date, that meet a
defined criteria (instrument,
currency and remaining maturity) on
obligation date, must be cleared.
These trades can either be:
l front-loaded i.e. all trades executed on or
after the effective date are immediately cleared or;
l back-loaded i.e. all trades executed on or after the effective date are
bilateral until the clearing obligation date and then those
trades are back-loaded into clearing – this could mean either
termination or execution of a new trade with new economic terms
or novation of the bilateral trade into clearing.
Regulation Rocket • Edition 6 | Spring 2016 • | 12

Background sion not to offer cleared pricing to clients for CME, as their internal
Frontloading was included at the outset of the regulatory process, cost increase without equivalence could not be absorbed. The agree-
in the level one EMIR text and therefore could not be completely ment between US and Europe does alleviate this issue however the
removed from the final implementation of the regulation. How- actual implementation of the agreed terms remains to be completed
ever after significant deliberation, the RTS has provided much on time and there are further considerations that remain to be dealt
needed compromise and clarity to the implementation. with on a case by case basis for Category 2 entities by May.
The complications to implementing the frontloading require-
ments were that in its initial form, frontloading was expected to be Final requirement
effective once a CCP had been ESMA authorised for a particular IRS
product set. Yet at this point in time, the product RTS were not in Category One – counterparties that are clearing members for at least
place and therefore the market had no clarity as to which entities or one of the classes of OTC derivatives set out in the Annex to this
underlying instrument, currencies and maturities would be subject Regulation, of at least one of the CCPs authorised or recognised
to the frontloading requirement or what the relevant timeline would before that date to clear at least one of those classes
be – a classic chicken and egg scenario! Front-loading is effective for all trades entered into or novated be-
In short, entities that eventually were classified as subject to the fore 21st February 2016 if the remaining maturity is greater than:
frontloading requirement in its original form would have been
faced with looking back to over a years worth of trading activity to l Basis Swaps: 50 years
ascertain trades that needed to comply and back-load into clear- l Interest Rate Swaps: 50 years
ing. Additionally, at the point of executing trades in this period, l Forward Rate Agreement: 3 years
brokers had no transparency as to whether the trades they were l Overnight Index Swaps: 3 years
pricing were going to be subject to the clearing obligation and thus
could not provide relevant accurate pricing. And for all trades entered into or novated after 21st February 2016
Hence additional criteria has been included in the final RTS to if the remaining maturity is greater than 6 months for all man-
specifically stipulate/restrict the front-loading requirement to be ef- dated classes.
fective only once the eligibility of entities and trades for the clear- Category Two – counterparties not belonging to Category 1 that
ing mandate are known. Although some thought the frontloading belong to a group whose aggregate month-end average of outstand-
requirement was inconsequential, it has in fact the ability to signifi- ing gross notional amount of non-centrally cleared derivatives for
cantly affect the market; an example of this is when there was a lack January, February and March 2016 is above €8bn and which are:
of equivalence for the US. The market impact as the Category one
front-loading date drew near was very meaningful, movements in a) financial counterparties
the basis between CME and LCH were substantial. Without equiva- b) alternative investment funds that are non-financial
lence, the Category 1 entities were facing having to make the deci- counterparties
Regulation Rocket • Edition 6 | Spring 2016 • | 13

NOTE: For the purposes of calculating the group aggregate need to notify ESMA who in turn have 30 days to produce an
month-end average of outstanding gross notional amount, all of opinion.
the group’s non-centrally cleared derivatives, including foreign ex- Firstly, in order to have clarity by the frontloading date, those
change forwards, swaps and currency swaps, shall be included. entities looking to use the exemption need to have already or im-
Where counterparties are alternative investment funds or undertak- mediately start the process. Secondly, given the many flavours of
ings for collective investment in transferable securities, the EUR 8 pension scheme and underlying investments, there is no guaran-
billion threshold shall apply individually at fund level tee that an exemption will be granted and if the entity is Category
2 without an exemption, front-loading will apply from May 2016.
Front-loading is effective for all for trades entered into or novated Even if the exemption is granted, it may not actually be that
before 21st May 2016 if the remaining maturity is greater than: useful. The likely driver for a pension scheme into clearing is go-
ing to be cost. Long term, the cost due to the fact that pension
l Basis Swaps: 50 years schemes are subject to the bilateral collateral requirements but
l Interest Rate Swaps: 50 years the short term cost implication are due to cleared versus bilater-
l Forward Rate Agreement: 3 years al pricing differences. Bilateral pricing will increasingly become
l Overnight Index Swaps: 3 years more punitive.

And for all trades entered into or novated after 21st May 2016 if Pricing
the remaining maturity is greater than 6 months for all mandated There are many factors to regulation that are incentivising clear-
classes. ing, including the bilateral collateral requirements and more so
the cost Basel / CRD capital requirements through Risk Weighted
What are the remaining impacts and considerations? Assets (RWA) and Leverage Ratio.
Exemption During the evolution of the Basel / CRD implementation,
Within the EMIR Clearing obligation there is an exemption for pen- there has been an expectation from the market to see a different
sion funds, currently until 2017, with the potential of a further 1 year cleared price versus bilateral price and due to the heavier burden
extension. However dependant on the type of pension scheme, this of capital and cost for bilateral trades, the cleared price is ex-
exemption can only be utilised if evidenced that the entities OTC pected to be the lower. That pricing differential certainly exists
derivative contracts that are “objectively measurable as reducing in- in the market, in fact there is even a pricing differential between
vestment risks directly relating to the financial solvency of pension CCPs. More and more buy-side entities are confirming that they
scheme arrangements”, or in some cases the exemption needs to be are increasingly seeing prices that are ‘encouraging’ them into
“granted by the relevant competent authority”. clearing and that their expectation is that the impact of the pric-
This process will take time, in the case of requesting exemption ing differences will only increase in the lead up to and after front-
from the relevant competent authority, the relevant authority then loading in May.
Regulation Rocket • Edition 6 | Spring 2016 • | 14

There are many firms that will go to market and block trade across multiple
accounts and allocate to the underlying account post execution. Within EMIR,
these accounts can (and are likely) to be spread across different category
classifications. To state the obvious, it is not possible to execute a block trade where
part is cleared and part remains bilateral.
This is will be exacerbated by the fact that there are banks advis- pleted in April, once the 3 month average notional period to trig-
ing that they will default to a cleared price for Category 2 clients and ger Category 2 has passed; however it is feasible that there will be
even potentially decline to execute bilaterally for certain Category 2 missing account representations for some time to come.
entities! For accounts where the category classification is not on record,
Once the higher price for bilateral/lower price for cleared is preva- the executing broker will have to make a judgement call, apply
lent in the market post front-loading, it is likely that Category 3 enti- an internal conservative assumption based on known due dili-
ties and pension funds will need to voluntarily clear ahead of their gence on the client account. This may not be the most favourable
respective obligation dates in order to preserve fund performance. outcome for the client, for example: in the case of a Category
At this point there will be no time for implementation and on- 3 client being quite close to the Category 2 trigger, they could
boarding projects or negotiation of terms with clearing members. find themselves conservatively assumed as Category 2 and lose
In fact clearing member capacity or appetite to take on additional access to bilateral execution from those brokers who will only
clients is already minimal. provide cleared pricing for Category 2 entities. It is important
Market participants should (and in most cases are) at least con- that clients are proactive with regard to notification of category
sider having all the plumbing in place, meaning clearing members, classification to their executing brokers, actually all counterpar-
documentation, technology etc., to be able to move swiftly into ties can specifically expect to have to provide disclosure as to the
clearing when faced with pricing that is more beneficial to clear. category of the principal to a trade at least at point of execution
and/or novation of historic trades.
In order to provide appropriate pricing and/or apply internal Execution
policy to clients, the executing brokers will need to identify the There are many firms that will go to market and block trade across
category classification for each client account. Now for the most multiple accounts and allocate to the underlying account post ex-
part banks will be reaching out to clients requesting notification of ecution. Within EMIR, these accounts can (and are likely) to be
their category classification but these processes can only be com- spread across different category classifications. To state the obvi-
Regulation Rocket • Edition 6 | Spring 2016 • | 15

ous, it is not possible to execute a block trade where part is cleared Post execution of a bilateral trade during the front-loading pe-
and part remains bilateral. riod, the trade logically should apply the bilateral valuation model
Therefore, a firm may either: however within 6 months the trade will have to be novated into
clearing or be terminated. An expectation and understanding of
a) have chosen to voluntarily clear all accounts that could be in- how this will be managed has to be clear and documented at point
cluded in a block trade (albeit if some accounts are Category 3 of execution – will the trade be terminated and a new execution
/ 4 or have an exemption or, required to reinstate the position with updated cleared econom-
b) have to split the block trade into separate blocks - cleared and ics? Or will the execution broker apply cleared economics during
bilateral which, by reducing the size of the trade, could also the frontloading period, based on the agreement that the trade will
impact the pricing received be novated into clearing by no later than 21st December 2016 oth-
erwise terminated?
For those banks that will continue to execute bilateral trades for Credit standing of available clearing members / executing
Category 2 entities post the front-loading effective date, all clear- brokers
ing eligible trade will have to be cleared by the Category 2 clearing With all of the considerations and complications relating to clearing
obligation date (December 2016). In order to ensure regulatory in general, not only front-loading and the withdrawal of major banks
compliance at the point of Category 2 clearing obligation, execut- from certain asset classes or the clearing business; the availability of
ing banks need assurance that in the event that the client fails to top tier / top rated / top capitalised major banks is reducing. These
novate the trade into clearing, the bilateral trade will be terminat- ‘top’ banks in turn are being more selective with regard to the clients
ed. This assurance comes in the form of an Additional Termina- and accounts that they offer services to.
tion Event (ATE) included in the bilateral ISDA. The ATE is not The large premier clients of these top banks are rightly confident
currently included in the exiting ISDA documentation, therefore that they will be able to retain the desired relationships and also ne-
Category 2 entities need to negotiate the inclusion of this ATE to gotiate favourable terms however this is less the case for medium to
ALL of their bilateral ISDA’s by May 2016 otherwise they will face small buy-side market participants. This second and third tier client
executing brokers declining to trade! base are facing either punitive terms with their preferred banks or in
worst case scenario, being unable to secure tier 1 relationships and
Valuation therefore forced to consider counterparties that would not normally
A bilateral trade and a cleared trade have very different valuation meet their preferred risk/creditworthiness criteria – tier 2 banks.
models, again major contributors to the model differences include The result could be medium to small buy-side market partici-
the bilateral collateral requirements and more so the cost Basel / pants being unable to compete against the larger entities for De-
CRD capital requirements through margin period of risk (MPOR), rivative mandates and either losing underlying clients completely
Risk Weighted Assets (RWA) and Leverage Ratio. or outsourcing the derivative part of mandates to the larger firms.
A partnership
invested in
the future

The collaboration of OTC Space and Strategic Exchanges, a partnership looking to share solutions and generate
new ideas from both sides of the Atlantic. Our goal is to assist financial firms gain a better understanding
around their own individual regulatory struggles by show-casing new, innovative and less onerous solutions
that will keep trading firms fully compliant and above all create new sources of alpha generation.
Regulation Rocket • Edition 6 | Spring 2016 • | 17

Selected regulatory deadlines

The chart shows selected regulatory activity and assumes a delay of one year for MiFID 2.

2015 2016 2017 2018 2019 2020

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 H1 H2 H1 H2
Trade Reporting
EMIR wL2 Validation 31 Oct 2015
DFA: SEC Mar 2016
EMIR Phase 3 Q3 2016?
SFT 2017

Clearing (EMIR)
Category 1 (1 CCP)
Category 2 ( > €8bn)
Category 3 ( < €8bn)
Category 4 (Others)

Bilateral Margin
Variation Margin
€3trn+ 1 Sep 2016
All 1 Mar 2016

Initial Margin
€3trn+ 1 Sep 2016
€2.25trn 1 Sep 2017
€1.5trn 1 Sep 2018
€0.75trn 1 Sep 2019
€8bn 1 Sep 2020
Regulation Rocket • Edition 6 | Spring 2016 • | 18

2015 2016 2017 2018 2019 2020

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 H1 H2 H1 H2

Trading on Platform 2 Jan 2018
Trade Reporting 2 Jan 2018
Open Access 2 Jan 2018


Reporting Phase 1 7 Oct 2015

Reporting Phase 2 7 Apr 2016

QIS End 2016
Implementation Mar 2018

BCBS 239 - Risk

Implementation G-SIBs early 2016
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Regulation Rocket • Edition 6 | Spring 2016 • | 20
Anti-abuse legislation hits energy and commodity trading:
How REMIT and MAR are beginning to trigger a shift
The last few years have seen many anti-abuse cases brought against traders, spanning LIBOR, insider
dealing and others. We have also seen some anti-abuse cases in commodities and energy, for example
the case where the CFTC and FERC investigated a North America based oil company in 2015 for gas
price index manipulation. However, many cases have not resulted in fines. Examples of this include
the alleged NBP price manipulation of 2012 and the “Chocfinger” case in 2010, neither of which
resulted in convictions.

Regulation Rocket • Edition 6 | Spring 2016 • | 21

n general, the commodities and energy sector have not tra- ic review of the commodities sector by the FCA2. This found
ditionally had the same internal monitoring technology in that in many (but not all) cases, the controls, technology and
place as financial counterparties, for many reasons, be they culture in the sector lagged the f inancial markets. The review
historic, cultural or otherwise. Outside of the big companies, stated that:
a smaller proportion of market participants will, for exam-
ple, have a dedicated surveillance system. See Figure 1. “Firms that did not fully recognise the risks of market abuse were
The sector is now seeing both an increase in regulation and more likely to employ inappropriate surveillance, in terms of the
scrutiny, from regulators and due to two sets of rules: choice of automated or manual systems, calibration of systems and
The Regulation of wholesale Energy Markets Integrity and frequency of monitoring. Overall, there was little order level moni-
Transparency (REMIT) came into force in 2011. This outlaws toring, making it difficult for firms to demonstrate effective moni-
market manipulation and the use of inside information, with sanc- toring for market manipulation, and we often found surveillance
tion legislation being put in place from June 2013 onwards. The being done on an inadequate or poorly targeted sample basis.”
final data reporting deadline is on 7th April 2016, after which regu-
lators will be able to monitor the market for possible manipulation. Elsewhere in Europe, the end of last year saw the first fines in RE-
The Market Abuse Regulation (MAR) will be familiar to most MIT. A small fine of 10,000 Euros in Estonia was dwarfed by a 25
in the financial markets. When it is implemented on 3rd July 2016, million Euro fine handed to Iberdrola for breaches of the REMIT
it will also include not only on-venue commodity derivatives but market manipulation rules. The market was sent a clear message
also off-venue trades and spot commodities that may influence that REMIT enforcement had begun.
their prices. Now that data is being collected by ACER, monitored and sent
to local regulators such as Ofgem and BNetZa, the sector is being
Increased scrutiny subject to ever closer scrutiny.
Regulators have recently made it known that the sector will be
subject to greater scrutiny than before. Last September, Ofgem REMIT – A brief recap
published an open letter1 on the application of REMIT, remind- REMIT has been enacted in order to specifically prohibit Mar-
ing market participants of the rules, and specifically pointing ket Abuse and the use of Inside Information in the gas and power
out that certain activities, such as “layering” are breaches of RE- markets in the EU. It applies to all physical and financial (deriva-
MIT and will be treated as such. The letter served as a reminder tives) trades, and also includes LNG where the supply is intended
that breaches of REMIT articles 3 and 5 (inside information for the EU network. REMIT is enforced by National Regulatory
and market manipulation) may result in criminal sanctions be- Authorities, who are local energy regulators such as Ofgem The
ing applied. Sanctions are also in place for breaches of the rest entire effort is coordinated on an EU wide basis by ACER, the
of REMIT. Agency for the Cooperation of Energy Regulators. REMIT can be
The end of the summer also saw the publication of a themat- considered to have four pillars:
Regulation Rocket • Edition 6 | Spring 2016 • | 22

formation in the context of REMIT includes information related

Figure 1: Surveillance overview to physical assets. For example a power station outage which has
not been published could be considered inside information.
Regulatory Scrutiny REMIT also prohibits actual and attempted market manipula-
tion, which can involve any activity that is considered “abusive”.
lTwo REMIT fines The act, and also guidance issued by ACER does list some very
l FCA Thematic review specific examples, which include techniques such as “marking the
l Data gathering has started
close” and “market cornering”. In many cases the types of abuse
are similar to the financial markets, although the physical side can
make it more complex to detect.
It is the data reporting element that is currently the focus of the
market. On-venue activity, that is activity arising from an Organ-
REMIT MAR ised Market Place (OMP), usually an exchange or a broker plat-
form, needed to be reported to ACER from 7th October 2015. Off
l All wholesale gas and power l Monitoring obligation venue OTC data needs to be reported from 7th April. This in-
l Regulators to soon begin l Cover all commodities cludes not only “stand alone” trades, but also long term contracts,
monitoring l Widens further with MiFID II such as Power Purchase Agreements, and trades such as second-
l “PPAT”s must monitor Financial regulators ary capacity trades. The second phase of REMIT has proven to
be difficult and will in all likelihood require significant “tweaking”,
PPAT = Persons professionally arranging transactions in much the same way that EMIR has. However, the fact that the
MAR = Market Abuse Regulation data is all being sent to the same database means that it will likely
FCA = UK Financial Conduct Authority become useful a lot sooner into its life than EMIR data.
REMIT = Regulation on Market Integrity and Transparency ACER collect the data and run monitoring software on it, but
they also send a copy of each country’s data to local regulators,
who run their own processes. We can thus expect cases to be
1) Inside Information brought against market participants based on the data (as opposed
2) Market Manipulation prohibition to suspicious transaction reports) within the coming months.
3) Market Participant registration
4) Data reporting Monitoring requirements under REMIT
The obligations of market participants to monitor their own ac-
It is forbidden to utilise inside information for trading activity ex- tivity under REMIT are outlined in Article 15 of the Act, where
cept in the case of some narrowly defined exemptions. Inside In- it is stated that “Professional Persons Arranging Transactions “
Regulation Rocket • Edition 6 | Spring 2016 • | 23

(PPATs) “shall establish and maintain effective arrangements and the European wholesale gas and power market. In theory, this will
procedures to identify breaches of Article 3 or 5”. permit them, and local regulators, to run monitoring processes
There is a great deal of discussion about who exactly a PPAT is. and software. The question is, how likely will such monitoring be
ACER’s guidance on REMIT states that: “These include at least trad- to find possible market abuse?
ing venues like energy exchanges and brokers.” In March 2015 ACER Those who have been involved in the data collection phases of
issued a document3 specifically examining the concept of a PPAT. REMIT will know that it has not been a straightforward exercise.
There it outlined several scenarios of companies which should have The second phase of off venue data collection has seen a great
the status. Some were instinctive – for example most OMPs would deal of confusion around how some of the data is to be collected.
be considered to be PPATs. Market Participants’ definitions are less The breadth of contract types across Europe means that it is un-
straight forward, especially when sleeving4 is involved. likely that all data will be sent in a 100% readable format. Some
A key point however is that not all market participants have an data types, such as for capacity and transportation trades, have
obligation to carry out internal monitoring under REMIT. Some a great deal of confusion around them, and this data is even less
have considered using this as a reason to spare some monitoring. likely to be useful.
However, many now consider this to be a bad idea, for several At a public workshop on 16th February ACER talked of a new
reasons including: set of schemas being planned for spring of 2017. This is likely to
be more than just a fine tuning and many are now talking of a third
l It is best practice to have monitoring in place, whether obli- phase of reporting. This also may support the argument that full
gated to or not. Most companies would prefer to have a good monitoring will be tough.
grasp on what their traders are up to. Despite all of this, it would be unwise to assume that no moni-
l The existence of effective monitoring is thought of by some to toring will be possible using the data. ACER have made the choice
be a good defence in the event that manipulation is taking place of pulling all sent data into one database, and in the end there is
in the organisation. only one set of schemas. This means the data is less subject to
l In the event of a manipulation, most would wish to know about incompatibility than say under EMIR, where even now, over two
it before a regulator, and take appropriate action. years after go live, there is a struggle to make sense of the data.
Now that regulators have most market data, monitoring is likely to The documentation and guidance provided by ACER has also
take place very soon. We can therefore expect interest in monitor- been copious when compared to EMIR. Many public workshops
ing due to REMIT to increase in the very near future. and roundtables have meant that the regulator does have a good
idea of what to expect. And ACER have been in the process of get-
When will REMIT data collection be effective and ting their surveillance system up and running for quite some time.
useful? In short therefore, while the data will not be perfect, it will cer-
From April 7th onwards (July 7th for “backloaded” contracts) tainly be possible for ACER and the other regulators to perform
ACER will be collecting data for the entire set of data covering some monitoring. Market participants would therefore be well ad-
Regulation Rocket • Edition 6 | Spring 2016 • | 24

vised to assume that they are “being watched” to some degree. tive monitoring is applied to “Professional Persons Arranging or
Executing Transactions” (PPAETs). MAR Article 3(28) defines a
MAR – How does it apply to the commodities PPAET as:
The Market Abuse Regulation(MAR) alongside MAD II will ap- “a person professionally engaged in the reception and transmis-
ply from the 3rd July 2016, and will cover several aspects of the sion of orders for, or in the execution of transactions in, financial
commodities markets. To summarise, MAR applies to the follow- instruments”
ing activity:
This definition is far wider than that under REMIT and the mar-
a) Derivatives activity on venues including regulated markets, ket generally is accepting that this is a requirement to monitor.
MTFs and eventually OTFs The introduction of MAR will therefore only increase the push to
b) Derivatives activity that could effect on-venue prices monitoring in the sector.
c) Spot commodity that could effect on-venue prices
The MiFID II/ MAR “Underlap”
There is a great deal of discussion and legislation around which MAR has always been scheduled to be implemented before MI-
commodity trades are considered to be “derivatives”, which is pri- FID II, which has caused an “underlap” of the rules. Since MAR
marily defined in MiFID Annex I Section C. The original ver- makes reference to some aspects of MIFID II and MIFIR, there
sion of MiFID has had guidance issued around its application, are some parts of MAR which will not apply until MiFID II is im-
in particular paragraphs 6 and 7, which define whether physical plemented. The delay of MiFID II will lengthen this period. The
forwards are considered to be derivatives. A detailed discussion impact on the commodities sector is several fold:
of this topic is beyond the scope of this article, but the outcome
is extremely important as to which activity will be in MAR in the Scope
first instance. MiFID II seeks to alter Annex I Section C, in several respects:
In addition to derivatives, the inclusion of spot commodities, will
widen the application of MAR to non derivatives in some cases. l Physical forwards executed on an OTF is added to the list of in
Many commodities companies are not currently “Investment scope derivatives (There is a “REMIT carve out” for some gas
Firms”, i.e. financial companies under MiFID. Never the less, the and power activity)
anti-abuse and some other measures of MAR will apply to all exe- l EU Emissions Allowances (EUA) will become derivatives un-
cuting transactions in the market. And these rules will be enforced der a new paragraph 11 of MiFID II Annex I Section C
by financial regulators, as opposed to energy regulators.
A key difference between MAR and REMIT is the monitor- Until MIFID II is implemented, these specific activities, i.e. activ-
ing obligation. Under MAR the requirement to carry out effec- ity on an OTF, and EUAs are not part of MAR.
Regulation Rocket • Edition 6 | Spring 2016 • | 25

Financial counterparties On the technological side, we can expect the “replay” facility to
MIFID II is likely to require many of those in commodities and turn into some basic reporting to begin with, later being replaced
energy to set up a regulated entity, under the “Ancillary Activity” by rules based surveillance engines and more advanced analytical
test contained in RTS 20 (which was “sent back” by the commis- capabilities. It does need to be borne in mind that the technol-
sion to ESMA on 17th March). Financial Counterparties have ogy which is used in financial markets is often not suited to com-
some obligations, which non-financial counterparties do not. modities markets, where not only does the physical element make
Those who are only “in” once MIFID II is here will also be af- monitoring quite different, but where legitimate reasons to enter
fected by the underlap. orders and transactions are often driven by different factors.

Monitoring and Surveillance in the commodities and The possible future state
energy trading sector To summarise, several drivers exist to push the interest in moni-
At the start of this article, we briefly stated that the monitoring fa- toring and surveillance in the sector:
cilities inside commodity and energy traders are not as mature as
financial services in general (with notable exceptions). What we l Scrutiny from regulators
can now see is that things are likely to change. l REMIT data being monitored by regulators
While the drivers are clearly coming, there is still a fear across l Monitoring requirements from MAR
the sector that they will be “oversold” surveillance systems, and
that “big compliance” in general is not always necessary. We can These as well as a general desire by the industry to be seen to be
therefore expect to see an incremental move to better monitoring “clean” and transparent, as well as following best practice is likely
and surveillance across energy and commodity companies. to drive interest in better monitoring over the coming years.
Many in the sector do not yet have the ability to “replay” what
took place at a particular moment, or why orders or trades were References:
placed. Most companies do not store orders for example. We are 1 See 09/20150814_
likely to see this being remedied as a first step. The availability of remit_open_letter_september_2015_0.pdf
order data from REMIT OMPs will make this easier. 2 See
We are then likely to see energy and commodity companies mov- 3 See
ing through different stages of maturity in their monitoring capabil- documentId=x158hc794xa
ity. This would be divided into “organisational” and “technological”. 4 A transaction whereby two counterparties that do not have credit with each
On the organisational side, we can expect both an expansion of other, ask a third party that has credit with both to be a middleman to facilitate
personal and possibly a fine tuning of the structure of the compli- a trade. This practice achieved some notoriety in 1998, when it emerged that the
ance organisation, so that a true independent oversight function is collapsed US power marketer Power Company of America had been regularly
formed. sleeving forward electricity deals. (Risk.Net)
Regulation Rocket • Edition 6 | Spring 2016 • | 26

European Open Access: The Reality

In the European market the relationships between exchanges and CCPs are currently driven by
commercial decisions, with MiFID 2, this is supposed to change.

n the market now are arrangements called “interoperabil-
ity” which means CCPs facing each other directly in this
model. See Figure 1.
Users of the exchange can individually choose which CCP
to clear their trades at, and the CCPs cooperate by holding
trades between each other representing the pass-through relation-
ship. Under MiFID 2, this isn’t true Open Access, even though it
gives CCP users a choice.
What the regulators envisage is the right for an exchange to
choose where it sends trades to be cleared, and for a clearing house
to choose which exchanges it clears for. In other words enabling a
many to many relationship to occur between CCPs and Exchang-
es, something which doesn’t really happen now. See Figure 2.
The regulators would like to see the opportunity for a CCP to
clear for multiple exchanges and provide margin offsets between
both sources of trades. MiFID 2 gives a CCP the right to request
access to any European exchange to clear business. See Figure 3.
Regulators would also like to see an exchange have the right
to request access to clear at any European CCP, giving users the
choice of clearing house.
Regulation Rocket • Edition 6 | Spring 2016 • | 27

Users Have the Power

Lets imagine the behaviour of the trading and clearing members of Figure 1: Interoperability
the exchanges and CCPs and pretend in Figure 3 they can choose Interoperability
which CCP to clear at. If they decided en-masse to route all their
business to one CCP, they would achieve maximum risk offsets
and lowest fees based on volume. But, given that a move by all us- Stock Exchange
ers to a single CCP in Europe is unlikely, they will continue to sup-
port more than one CCP in this scenario. This would mean each
time they trade, having to indicate which CCP the trade should be
routed to, and if their counterparty isn’t a member of their pre-
ferred CCP, not trading with them. Client
CM B CCP1 Margin CCP2 CM A
An Exchange (in Figure 3) will need to support two pools of A Flows
liquidity, one for each CCP, where pairs of firms trade with the
intention of clearing at a specific CCP. This has already occurred
on SEFs in the US, where the prices for OTC trades are quoted
specific to the CCP intended to clear the trade. Figure 2: Two Exchanges Accessing One CCP
The Right to Refuse Future 1
Built in to MiFID 2 are rights for the regulator of an exchange to
refuse an access request if:
London Frankfurt
l The link would fragment liquidity Stock Stock
l The link would adversely affect systemic risk Exchange Exchange
l The link would require the interoperability approach (above)
unless all parties consent
l If the request concerns exchange traded products (not OTC) Party A Party B
or the exchange has less than €1trn open interest, a 30 month
exemption can be granted by the European Commission,

A CCP can refuse an access request if: LCH.C

l Trade volumes would be too large to process, within the capac-
ity plan of the CCP
Regulation Rocket • Edition 6 | Spring 2016 • | 28

Figure 3: Two CCPs Clearing for One Exchange

Future 2


Party A LCH.C Party B Party A Eurex Party B

l The number and type of new Clients or Members would be What next?
too large for the CCP Given the number of obstacles to achieving a successful request,
l The CCP does not support the new products and the need for a substantial number of users to move as a herd
l The CCP’s costs are too substantial to support to achieve effective benefits, and that the regulators of a CCP or
the request Exchange can cite liquidity fragmentation as a reason to refuse, can
l The exchange is in a jurisdiction where the CCP cannot anyone see this having any major effect?
enforce its rules No-one anticipated the potential merger of the LSE Group and
l The link would fragment liquidity Deutsche Bourse, which would bring together two large pools of
l The link would adversely affect systemic risk cleared business, regardless of the Open Access regulation. Maybe
l The link would require the interoperability approach (above) in the long term the combined group would offer to clear business
unless all parties consent from any European Exchange and bring about consolidation of
clearing in Europe?
In either case a request for access can take between 3 and 6 months We won’t know any of this before 2018 when MiFID 2 might be-
to process, before either party has to respond. come effective, which itself is now subject to an uncertain delay.
Rocket • Edition 6 | Spring 2016 • | 29


ISDA Protocols: Turning rockets of remedy

into weapons of mass data destruction?
Since a first launch in 1998, ISDA Protocols have become the go-to solution to enable financial institutions and
their counterparties to respond to regulatory requirements and market events by amending affected contracts
without the need to trawl through and bilaterally renegotiate every single document.

n Rocket 4, the article “ISDA Revelation: the ISDA Mas- of a rocket was employed, with its sections from nose cone to
ter Agreement and Related Arrangements” summarised tail each mapped to one of the key constituents of the ISDA
the scope, benef its and protections the wider International toolset, that unite in providing its projectile power. The grow-
Swaps and Derivatives Association framework provides to ing array of protocols were given the supporting but crucial
OTC markets. In deference to our publisher, the metaphor role of stabilizing ‘Left Tail Fin’, rightly extolled as smoothing
Legal Rocket • Edition 6 | Spring 2016 • | 30

Figure: ISDA protocols

Protocol Client Reference Client

Adherence Data Data Onboarding
Monitoring and Data

Supplementary Management Agreements

Trade Execution;
Data Data
Management Collateral Management;
Questionnaires ? AMEND
Exhibit and Rules Regulatory Reporting;
Protocol Trade Other
Exhibits and Rules Linkage

the journey through regulatory compliance by taking the strain ble for interpreting. By the rules defined for a protocol, this pair-
out of re-documentation. match clarifies and establishes the scope, and potentially form,
However, there is a sense of growing unease and concern amongst of dated deemed changes to contractual terms. A simple enough
the rocket heads at D2 Legal Technology that all might not be well model - one that should not be too much trouble for a capable
on the launch pad. We need to look into the engineering blueprints rocket engineer….. but over recent years the blueprint has been
further to explain why…. growing in page number, and there’s more to get to grips with
than might meet the eye.
The Basic Protocol Blueprint
In the basic form of a protocol, firms that wish to partake re- Layering on Protocol Complexity: Paint by Numbers
quest to join the particular protocol ‘club’. After accepting the or Rocket Science?
request, ISDA include the name of the new member with their Whilst admittedly in response to increasingly intricate regula-
date of acceptance in one of the protocol-specific “adhering par- tion, over the years the complexities of protocols have increased
ties” webpages. Links are provided to adherence letters of each in respect of additional optionality that combines across parties in
member often outlining extra detail. Any two member parties matching, and more recently bilateral exchange of referential data
will have an implied match, which they themselves are responsi- and optionality choices by the completion of pre-defined ques-
Legal Rocket • Edition 6 | Spring 2016 • | 31

tionnaires. The decision trees and rules underlying protocols have with an auto-pilot, a fact that those who add their agreements
progressively increased in their complexity, and will continue to onto the payload and climb onboard for launch surely under-
do so, in terms of: scope (agreement applicability based on type, stand. However, what many are failing to understand and pro-
certain terms and facts); optionality matching (combination and vide for is the burden of regular maintenance and inspection
fallback logic); supplementary information required; form of bi- checks that are required to keep their mechanical integrity sure.
lateral exchange; multiplicities of underlying exhibits; and crea- As the battering forces of regulatory and financial risk grow ever
tion of new annexes and master agreements. stronger, such risk controls are more critical than ever. Without
As the industry waits for the complex ‘buy side’ addition(s) to taking action, the tail fin may just come free, sending their rocket
the “Resolution Stay” protocols1, and further anticipates the intro- spiraling out of control.
duction of the most ambitious protocol yet, to address the BCBS/ At D2 Legal Technology, we recognize that although the drivers
IOSCO2 Variation Margin (VM) requirements for non-centrally and risks may be shared across the industry - each firm is unique
cleared derivatives - it’s clear the trend for increased complexity is in its needs, capabilities and resources.
continuing. There is no ‘one size fits all’ solution - but our first-hand experi-
ence in the challenges presented with protocols has helped us to
A strategic approach: “Look before you launch” formulate a range of accelerators and analysis methods such that
Despite the belated introduction of systems and processes around we can effectively and efficiently: run current state analysis of how
legal contract data, most large financial firms are still failing3 to protocol data is stored, monitored and linked to agreements data
take into account the implications of protocols. Joining the club is management; tailor bespoke Target Operating Models; and rec-
easy…. but the outcome is not explicit or uniform, but rather variant ommend a plan of action to realize sophisticated and extensible
and embedded in online reports, rules, adherence letters, question- processes and systems.
naires, existing agreement details and various other content and ref-
erence data. As a result, critical legal data can be left in a highly un- References:
certain state. The climate of EMIR and Dodd-Frank has required 1 The ISDA Resolution Stay Jurisdictional Modular Protocol, which will enable
institutions to deal more intimately with protocol data, but remedia- parties to amend the terms of their agreements to recognize the contractual stays
tion activity has tended to be narrow and tactical. The risks demand determined by cross-border application of “special resolution regimes” applica-
a strategic approach - full time engineers who know how to make ble to certain financially significant companies when in distress
the blueprints work for them and keep the rocket sound. 2 Rules published by the Basel Committee on Banking Supervision (BCBS) and the
International Organization of Securities Commissions (BCBS/ISOCO)
Rocket to remedy, or weapon of mass data 3 A legal contract data survey conducted by D2 Legal Technology concluded that
destruction? over 85% of respondent firms failed to have robust processes/systems to be able
Our allegorical rockets built on the ISDA blueprint do not come to adequately manage their adherences to protocols.
Rocket • Edition 6 | Spring 2016 • | 32


The Future of OTC Trading

In order to look ahead, we must first take a look back and examine how OTC markets have evolved;
some of which was voluntarily undertaken, most of which was regulatory reform driven.
Trading Rocket • Edition 6 | Spring 2016 • | 33

he dealer has been at the epicenter of OTC de- So we can now visually witness bid/ask spreads widen 1000%
rivative trading for decades. And whilst the Volk- on the most liquid credit derivative instrument in the world on
er Rule and Dodd-Frank in North America and a SEF (as we did in August 2015) as opposed to seeing it on an
EMIR in Europe aimed at reigning in dealers’ pro- indicative run, market dynamics remain much the same. During
files in OTC and other institutional markets, if that times of heightened volatility, due to gross shortfalls of regula-
were the namesake regulations sole mission they tion in some areas and negligent market impairment in others,
have failed miserably. Let’s be clear, I’m writing liquidity on SEFs is retracted via wider bid/ask spreads and re-
this from a neutral perspective and market observer and am nei- duced notionals.
ther a proponent nor opponent of disintermediating dealers from
OTC derivative markets; I’m saying it simply hasn’t occurred as
regulation intended. Its true new participants have entered the Market dynamics and our state within the
FX and IRS space in liquidity providing roles but others, aspir-
ing new participants (BONY & STT) and legacy market makers
credit cycle will warrant changes that
(Nomura) have dropped out. New, ‘futurized’ products have been post 2008-Financial Crisis regulatory
introduced as well with most not gaining in popularity or traction.
So let’s be clear, tier 1 dealers controlled the market pre-2008 Fi-
reform has induced
nancial crisis and control the market today.
The biggest changes have occurred in execution venue and And during times of market stability, liquidity providers have
practice. Since the late 1990s, numerous attempts, most nota- refrained from offering large size and tight spreads particularly on
bly by the interdealer broker community were made to introduce platforms offering anonymity; a futures market infrastructure ca-
electronic execution medium into the traditional voice brokerage veat which the CFTC opted to not impose upon OTC markets.
model; which likely would have paved the way for buy-side in- The theme of regulation going too far and regulation not going
duction which likely is the reason they were never embraced until far enough is an incredibly important one and this theme is what’s
made mandatory. likely to drive the future of OTC derivative trading globally. But
Clearing too has reshaped infrastructure from an IT, human re- make no mistake, OTC derivative regulation as a function of mar-
source, capital, risk and cost perspective. In certain products such ket evolution has risen faster and grown more complex than the
as IRS, the competitive landscape has gotten more robust while United States National Debt.
in others like CDS, competition has been reduced. Costs have So we have bifurcation across markets. We have markets expe-
increased across the board, margining has become formalized for riencing liquidity impairment. We have new entrants attempting
cleared product and punitive for bilaterally executed product while to disintermediate the dealer. We have multiple SEFs. We have an
credit and counterpart risk has been reshaped and not reduced; OTC marketplace overlaid onto a futures market infrastructure.
another shortcoming of regulatory reform. We’ve reshaped counterpart risk but not reduced it when normal-
Trading Rocket • Edition 6 | Spring 2016 • | 34

izing for volume. We have legacy participants that have either ex- 5 years which is higher for certain products (CDS at 63%) than
ited markets, are in the process of exiting markets or are contem- others (IRS).
plating their exit. We have regulations in conflict (you must clear In conclusion, nothing has changed and everything has
said Dodd-Frank but we’ll make the cost of capital so expensive changed. Market dynamics and our state within the credit cycle
you can’t clear said Basel III). will warrant changes that post 2008-Financial Crisis regulatory
It sure sounds like a mess. But here’s where I think we’re headed. reform has induced. Impacting this significantly will be the up-
We’re beginning to see signs of regulator recognition that mul- coming Presidential election in the United States; which has a
tiple aspects of reform have impacted markets negatively. Af- strong stench of policy party allegiance with most Democratic
ter all, market participants were forced to consume, digest and contenders wanting to further ‘strengthen’ Dodd-Frank while
process what was two decades worth of reform in less than 2 Republicans want to address its impact in the form of signifi-
years. It’s true that there are compliance schedules for partici- cant revisions and/or unwind.
pants but at the end of the day between Basel II & III, the Volker Capital intelligence at the front office and treasury level will
Rule, EMIR and Dodd-Frank, it’s just too much for the market play an increasing role in guiding OTC markets as we move
to handle and globally coordinate at once. My conclusion, we’ll closer to Basel III implementation. And unless embraced by the
likely see revisions and reconsiderations to numerous aspects of dealer community, future-ized OTC product will largely remain
regulation which maintain market stability (at least in regulators just that. The hope for significant increases in market partici-
eye) but relax other covenants; most importantly to OTC mar- pation across new participant demographics will continue to be
kets and clearing would be applying common sense to leverage dim unless regulators and CCPs adopt OTC derivative margin
ratio requirements. requirements which resemble the futures market. There is one
In terms of electronic execution, RFQ or anonymous order thing I’m absolutely certain of – the impact of ‘regulatory re-
book requirements might go the way of the Dodo. These pro- form’ has been mostly able to hide behind uber-accomodative
visions have worked from a procedural perspective and nothing monetary policy.
more at a time in which there has been virtually zero market dis- We got a very small taste of how regulatory reformed institu-
tress, volatility or interest rate due to global monetary policy. As tional markets respond to volatility in August 2015 and it wasn’t
the FOMC is on the cusp of normalizing, and rates gradually in- pretty; and that was incredibly short-lived. We need common
crease along with the follow through effect to supply and demand sense regulation which strengthens our global financial infrastruc-
imbalances, a multiple pre-trade quote requirement will only hurt ture, not weakens or conflicts with itself. There are issues which
liquidity and times when it’s needed most. I expect we’ll see con- need to be addressed and remedied which have been borne out
solidation amongst execution venue disruptors and an increase of post-2008 Financial crisis and OTC derivative market reform
in hybrid solutions that pair traditional voice/messaging execu- which have been allowed to fester behind the sanctity of a zero
tion with electronic medium. Clearing is likely here to stay until a rate environment and if not addressed, we’ll have traded three sys-
member defaults which I’d assign a probability to within the next temically important defaults for forty.
Rocket • Edition 6 | Spring 2016 • | 35


Indirect clearing: one set

of rules for all?
More than three years after the entry into force of the European Market
Infrastructure Regulation (“EMIR”) and the regulatory technical
standards of 19 December 2012 with respect to, inter alia, indirect
clearing arrangements, indirect clearing is again at the centre of attention.


he reason for this is not just the fact that the first clear-
ing obligation of G4 interest rate swaps for Category 1
counterparties will now very soon be upon us, but also
because on 5 November 2015 ESMA published a con-
sultation paper on indirect clearing regulations, both
in the context of EMIR and MiFIR. Once clearing of OTC de-
rivatives through central counterparties (“CCPs”) will be a reality, have been prepared in the context of MiFIR. The deadline for
some market participants will only be able to clear their trades and responses on the consultation was 17 December 2015 and I will
access CCPs through an indirect clearing arrangement. It is for that therefore also provide a brief overview of the main positions ex-
reason that any indirect clearing set-up in the OTC space needs pressed by the responding main market associations on behalf of
to have the desired effect but also that any indirect clearing regula- their members.
tion works for exchange traded derivatives and does not negatively
impact on an already long standing practice of indirect clearing in Indirect clearing of OTC derivatives
that area. The concept of indirect clearing has been part of the level 1 text
In this article I will discuss the proposed regulation against the of EMIR since its inception. According to article 4(3) EMIR a
background of critical noises which have already been expressed counterparty to an OTC derivatives transaction of a class which
on several occasions in the past prior to this consultation by the has been made subject to mandatory clearing, will have to clear
market against the existing indirect clearing regulation in the con- such transaction as clearing member of a CCP or as client of a
text of EMIR and the draft regulatory technical standards which clearing member. In view of the capital and risk management re-
Clearing Rocket • Edition 6 | Spring 2016 • | 36

quirements to which clearing members of a CCP are subject (see address both the problems affecting the development of indirect
the EMIR conduct of business rules in articles 37(1), 37(3) and clearing arrangements for OTC derivatives and the problems raised
37(6) EMIR and the prudential requirements in articles 42, 43(3), in relation to indirect clearing arrangements for ETD, as the issues
45 and 48 EMIR), part of the market will necessarily have to clear encountered are essentially the same for ETD and OTC derivatives
either as client of a clearing member or through an indirect clear- (although some nuances exist between the two)’. This concern on
ing arrangement as client of a client of a clearing member. Such whether a uniform indirect clearing regulation will sufficient-
indirect clearing arrangement consists of contractual arrange- ly reflect the differences between different derivatives markets
ments between a CCP, a clearing member, the client of a clearing (OTC and ETD) has already been extensively highlighted by
member and the indirect client pursuant to which the client of a FIA Europe in the context of discussions on both the Discus-
clearing member can provide clearing services to the indirect cli- sion Paper MiFID II/MiFIR of 22 May 2014 (ESMA/2014/548)
ent. According to EMIR such indirect clearing arrangement may and the Consultation Paper MiFID II/ MiFIR of 19 December
not increase the counterparty credit risk of the indirect client 2014 (ESMA/2014/1570). This was also the reason for ESMA
and such arrangement needs to secure that the assets and posi- to exclude from the final draft regulatory technical standards for
tions of the indirect client are protected in a similar way as set MiFID II/MiFIR which it sent to the European Commission on
out in articles 39 and 48 EMIR in relation to the client of a clear- 28 September 2015, the draft regulatory technical standards for
ing member. After initial discussions in the market, shortly after indirect clearing arrangements for exchange traded derivatives
EMIR entered into force, on whether clearing members should as it wanted to make those subject to a consolidated consulta-
be under an obligation to offer indirect clearing arrangements tion procedure, together with the already existing regulatory
resulted in a general acceptance that this should not be the case, technical standards for indirect clearing under EMIR.
discussions now focus on how this equivalent level of protection
can be offered to indirect clients. Articles 39 and 48 EMIR and indirect clearing.
As indicated above, an indirect clearing arrangement with a clearing
Indirect clearing of exchange traded derivatives member should not increase counterparty credit risk and should
In the context of exchange traded derivatives the concept of in- ensure that the assets and positions of the counterparty benefit
direct clearing is already a well- established one and any further from protection with equivalent effect to that referred to in article
regulation on indirect clearing as required by article 30 MiFIR 39 (Segregation and portability) and article 48 (Default procedures) of
will to some extent have to respect the status quo and not un- EMIR. Essentially this means that an indirect client which for clear-
necessarily undermine that existing market. Also, it will have to ing its trades will be dependent on an indirect clearing arrangement,
respect and reflect the differences that exist between the markets may not end up in a worse position than a direct client would be and
of OTC derivatives and exchange traded derivatives. Or, as the an indirect clearing regulation should reflect that. What does this
5 November 2015 consultation paper states as the purpose of mean in practice?
the consultation: ‘to consult on the draft requirements that could Article 39(4) EMIR requires a clearing member to keep separate
Clearing Rocket • Edition 6 | Spring 2016 • | 37

records and accounts that enable it to distinguish both in accounts to make such ‘leapfrog’ payments. At the time the 19 December
held with the CCP and in its own accounts its assets and positions 2012 regulatory technical standards on, inter alia, indirect clear-
from the assets and positions held for the account of its clients at ing arrangements, were put in place ESMA may still have thought
the CCP level. Transferred to an indirect clearing arrangement this that EMIR would prevail over any ‘conflicting laws, regulation and
would mean that a client of a clearing member would have to offer administrative provisions of the Member States’ (see footnote 34 of
similar services to its clients (being the clearing member’s indirect the ESMA Consultation Paper, Draft Technical Standards for the
clients). From an accounts perspective this would mean that the di- Regulation on OTC Derivatives, CCPs and Trade Repositories, 25
rect client would equally have to offer its clients the choice between June 2012 | ESMA/2012/379), however the reality is often a dif-
omnibus client segregation and individual client segregation but ferent one and any indirect clearing regulation will have to take that
also that the CCP would have to create such arrangements in its reality into account. These concerns and others in relation to in-
accounts administration to enable the client to make a segregation direct clearing, have already been highlighted in the context of the
at the level of the CCP between its assets and positions and the as- EMIR Review in August 2015 but it should probably be assumed
sets and positions of its clients (i.e. indirect clients). This segrega- that a response from the regulator on these specific points will now
tion in the accounts structure at the level of the CCP, the clearing be covered in the context of this consolidated public consultation,
member and, in case of indirect clearing, the client seeks to ensure rather than in the report from the European Commission on the
that in the event of a default at the level of the clearing member, a EMIR Review.
client will be able to port its assets and positions to a replacement,
back-up clearing member within the porting window before any The consultation of 5 November 2015.
such positions get liquidated in the absence of portability. In an With the public consultation ESMA is looking to both (i) amend
indirect clearing structure this should equally be possible in case the existing regulatory technical standards of 19 December 2012
of a default at the level of the direct client. If upon liquidation of to the extent deemed necessary following the consultation and (ii)
the positions any balance remains due by the CCP to the direct adapt the existing draft RTS on indirect clearing arrangements un-
client, the CCP will return such balance to it if the CCP is famil- der MiFIR. In doing so the consultation paper closely follows the
iar with such client’s identity. In an indirect clearing scenario the topics which were already the subject of consultation in the context
CCP and/or clearing member will have to refund any such bal- of EMIR and MiFIR in 2014: (i) the structure and segregation of
ance to the indirect client, outside of a direct client’s insolvency by accounts; (ii) adequate default management procedures (including
way of a ‘leapfrog’ payment. However, such ‘leapfrog’ payments necessary ‘porting’ and ‘leapfrog’ payments); and (iii) how indirect
may prove to be very challenging and potentially not bankruptcy- clearing arrangements should be implemented for chains which go
proof if contested by a direct client’s trustee in bankruptcy. The beyond what is usual in the world of OTC derivatives. The latter
fact that these indirect clearing relationships will typically involve would be the case in scenarios where an indirect client offers clear-
many different jurisdictions and therefore many different insol- ing services to another indirect client which itself acts as direct cli-
vency regimes will considerably add to the challenge of being able ent for further indirect clients, not unusual in the exchange traded
Clearing Rocket • Edition 6 | Spring 2016 • | 38

derivatives space. Such chains could potentially be unlimited and er chains given the operational complexities and risks for longer,
the requirement to guarantee that they should not increase counter- cross-border chains. ISDA has again highlighted how local in-
party risk but, instead, provide equivalent levels of protection which solvency regulations may very well undermine the propagated
articles 39 and 48 EMIR provide to direct clients is obviously a chal- ‘leapfrog’ payments by a clearing member to an indirect client in
lenging one. a direct client’s insolvency and that it takes more to successfully
What would such indirect clearing arrangements mean for all establish such insolvency ring-fencing than a mere contractual
those parties involved in an indirect clearing chain? For CCPs that obligation. Equally, the proposed regulation for longer indirect
they will have access to all the information on assets and positions clearing chains would only realistically work if there is a proper
of each indirect client in the chain to make adequate margin calls. information stream throughout the clearing chain by all involved
For clearing members to establish adequate procedures of default parties in the chain. However, in the absence of clear contractual
management covering both the possibilities of porting of trades obligations at each level between the relevant parties involved it is
as well as liquidation of positions in the absence of portability. In questionable how this would ever work.
this context the consultation paper however refers for the first time What is new in the market feedback is that it is unclear what it
to an ‘obligations of means’ rather than an ‘obligation of results’. means in the context of porting and leapfrog payments that parties
For a direct client this means that it needs to provide the clearing have an ‘obligation of means’ instead of an ‘obligation of results’.
member with all the necessary information for it to properly iden- What does it require for such obligation to be met?
tify and monitor any risks that come with indirect clearing. These
obligations of a direct client equally apply to indirect clients where Conclusion.
they clear for underlying indirect clients as if they were a direct cli- It is clear that establishing a regulation for indirect clearing that
ent themselves. What becomes very clear though is that the longer works for the markets it seeks to regulate - the market for ex-
the indirect clearing chain is, the more important it will be that change traded derivatives and the market for OTC derivatives
there is an adequate flow of information, right through and up the - is much more challenging than anticipated. It is disappoint-
clearing chain, with all involved parties being fully aware of their ing to see that where most of the topics which come up when
responsibilities. discussing the concept of indirect clearing have already been
highlighted by the market on previous occasions, the current
Market feedback on the consultation. draft RTS does not seem to have taken any of those issues at
Both ISDA and FIA Europe have responded to the consultation heart. With the clearing obligation now only months away from
and their feedback very much reflects feedback that they have ex- us the need for the regulator to take these concerns seriously has
pressed on previous occasions. In the context of exchange traded never been bigger. One central question which should be at the
derivatives FIA Europe has repeated its concern for the impact forefront is whether it makes any sense to have one single set of
of any regulation on the existing, well established, market and rules for indirect clearing to serve markets which are different to
has promoted a limitation of the proposed regulations to short- start with.
Clearing Rocket • Edition 6 | Spring 2016 • | 39

With special thanks to:

CCP Notionals ince September the biggest change in
cleared business has been a reduction
whilst preserving the risk profile are having a big im-
pact. You could argue that the regulators are meas-

Scoresheet at CME and LCH.Clearnet of a com-

bined total of ~$5.6trn. Capital rules
are directly driven by the total notional
uring the wrong thing, as notional isn’t a measure of
the risk of a trade or portfolio, just one input to the
risk profile. Perhaps this is also behind the reduc-
amount of business held and hence tion of $664bn at JSCC and $26bn at ICE Clear, also
services to compress a portfolio, reducing notional OTC business.

19 February 2016 (In millions of USD) 11 September 2015 (In millions of USD) CHANGE (Sep-Feb) (In millions of USD)
ASX 243,402 ASX 188,599 ASX 0 0 54,803
Asigna / Mexder 14,469 Asigna / Mexder 324 Asigna / Mexder 0 0 14,145
CME (ETD) 15,419,713 CME (ETD) 17,554,828 CME (ETD) 0 0 -2,135,115
CME (OTC) 56,452 19,392,918 CME (OTC) 54,362 22,440,315 CME (OTC) 2,090 0 -3,047,397
Comder 87,199 Comder 44,306 Comder 0 42,893 0
Eurex 161,510 Eurex 116,762 Eurex 0 0 44,748
Eurex (ETD) 539,296 Eurex (ETD) 517,911 Eurex (ETD) 0 0 21,385
HKEX 2,337 HKEX 622 HKEX 0 0 1,715
ICE Clear Credit 885,224 ICE Clear Credit 886,951 ICE Clear Credit -1,727 0 0
ICE Clear 564,871 ICE Clear 591,261 ICE Clear Europe -26,390 0 0
Europe Europe
ICE Fut US -3 0 0
ICE Fut US 0 ICE Fut US 3
JSCC 250 0 664,784
JSCC 11,869 9,628,751 JSCC 11,619 8,963,967
KRX 0 0 -6,034
KRX 290,361 KRX 296,395
LCH CDSClear 2,276 0 0
LCH CDSClear 27,153 LCH CDSClear 24,877
LCH ForexClear 0 -6,103 0
LCH ForexClear 83,229 LCH ForexClear 89,332
LCH SwapClear 0 0 -14,076
LCH SwapClear 17,199 LCH SwapClear 31,275
LCH SwapClear 137,335,845 LCH SwapClear 0 0 -2,643,496
LCH SwapClear 139,979,341
Ltd Ltd Ltd
Nasdaq OMX 83,814 Nasdaq OMX 73,687 Nasdaq OMX 0 0 10,127
SGX 166 120,113 SGX 266 124,572 SGX 0 -100 -4,459
Sub-total 1,545,568 170,594 183,249,729 Sub-total 1,569,073 133,904 190,288,600 Sub-total -23,505 36,690 -7,038,871
Global Total 184,965,891 Global Total 191,991,576 Global Total -7,025,685
Rocket • Edition 6 | Spring 2016 • | 40


Compressions Shrinking
the OTC Space
New regulatory measures start to deliver benefits as efforts to reduce
outstanding derivatives have achieved brilliant results in the last 18 months.
By June 2015, the derivatives market had shrank to USD 553 trillion from its
peak of USD 711 trillion in the first half of 2014. Aggregate compressions
over the same period was of USD 265 trillion, three times as much as in the
previous 18-months.

n the last two years, compressions have evolved into more
complex products and various market players have joined
forces to collaborate in post-trade risk management cycles.
The result is the emergence of interesting methodologies that
have proved effective in reducing the volumes of derivatives
that were so blamed for contributing to the credit crisis.
Portfolio compression is nothing more than a technique to elimi-
nate a number of deals from a portfolio while ensuring that profits
and price risk remain the same, or almost the same. Compressions
are measured in notional value terms, equivalent to the number of
units times the deal price, through all the life of the derivative. Buys
and sells, both add up.

Double, Double Troil and Trouble

Figure 1 shows how the aggregate value of global derivatives has
increased after the regulatory implementations in 2012, partly be-
cause more OTC derivatives have to be cleared. This means that the
company enters into a transaction with another company, and then
Capital Rocket • Edition 6 | Spring 2016 • | 41

Clearing OTCs may reduce the risk of losing money in case one of the companies
default, but adds operational risk to the financial system from five directions
as more operational support is required when considering the companies’ and
the clearing house perspectives
both entities strike the trade through to the clearer. As a result, the this service and design new types of compressions. Furthermore;
number of OTC transactions doubles when the deals are cleared. EMIR, Dodd Frank and FinFrag include mandatory actions related
This is one of the side-kicks of regulation. Clearing OTCs may re- to compressions.
duce the risk of losing money in case one of the companies default, The interest rates swaps (IRS) with central counterparties
but adds operational risk to the financial system from five directions dominate the compressions landscape. Figures 2 and 3 show
as more operational support is required when considering the com- how in 2012 these instruments were 86% of the global compres-
panies’ and the clearing house perspectives: sions. In 2015, IRS were an overwhelming 98% of the total. Fur-
ther details on these statistics can be found in the BIS Quarterly
l When company A does the deal with company B; Review from December 2015. The forex market is still active; in
l When company A novates the deal to the clearinghouse; the fourth quarter of 2015, Trioptima launched new products to
l When company B novates the deal to the clearinghouse; compress FX Forwards and FX Swaps.
l When the clearinghouse views the transaction with company
A from its own perspective; Adaptation and Collaboration Efforts Evolving into
l When the clearinghouse views the transaction with company More Complex Compressions
B from its own perspective. Compressions are adapting quickly to the needs of the markets.
The first compressions in the early 2000s were “Bilateral”, mean-
The good news is that compressions have made their way into the ing that two companies show each other their portfolios and agree
priorities of large and medium financial institutions to manage their to terminate a set of transactions with no need of arranger or cen-
regulatory risk. Compressions in the second half of 2013 were of 22 tral counterparty. A similar term “Duo” refers to compressions
Trillion USD, and jumped to 116 Trillion USD in the first half of between two parties, in this case one of them can be a central
2014. The most recent statistic shows that compressions eliminated counterparty. Then in 2003, TriOptima developed a tool to ex-
107 Trillion USD notional value in the first half of 2015. ecute “Multilateral” compressions where more than two players
In Rocket 5, we examined how the Leverage Ratio in Basel III can submit their portfolios to a central arranger capable of finding op-
be improved using compressions even if no capital is injected. This portunities to eliminate transactions across participants.
benefit alone has been the main driver behind the steep increase In 2014 and 2015, different service providers and participants
in compressions, which in turn has motivated new vendors to offer have joined efforts and started to offer complementary services.
Capital Rocket • Edition 6 | Spring 2016 • | 42

Figure 1: OTC Derivatives Shrinking as Compressions Rise

Notional values - USD in Trillions

120 Global compressions Global derivatives 800

Global compressions

Global derivatives

60 400


0 0
2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015
1.H 2.H 1.H 2.H 1.H 2.H 1.H 2.H 1.H 2.H 1.H 2.H 1.H 2.H 1.H
Source: BIS Statistics, Trioptima, TriReduce. Dec 2015

Central clearers such as CME and LCH SwapClear, in associa- member which means that less collateral needs to be paid or re-
tion with Trioptima, have adapted compressions techniques to re- ceived by a single member when market prices move.
duce the number of cleared deals held by its clearing members. Swap Execution Facilities or “SEFs” such as Bloomberg,
For example, “Unilateral” or “Solo” compressions are cycles by Tradeweb and truEx have developed services by which they match
which the clearing house sits in the middle, compressing with each a sometimes large set of trades that offset existing cleared transac-
participant to reduce their open positions, and therefore reducing tions. The clearing house receives the group of trades. As a result,
their margining requirements. From a participant’s perspective, the the client’s net position to the clearing house is reduced, and in turn
compression happens only with the clearinghouse and the partici- less collateral is required. The client may want to execute a few new
pant cannot see what actions are taken by other participants. The trades to get its overall portfolio back to the original position. This
clearing house benefits by having to warehouse less “line items” or additional step is called “Compaction”.
trades. More important, the clearing house reduces its risk to coun- “Blended-rate” in IRS compressions enable a participant to re-
terparties by shrinking concentration of margins with any single place a group of buys and sells with one transaction that has equiva-
Capital Rocket • Edition 6 | Spring 2016 • | 43

Figure 2: Compressions by Instrument Type Figure 3: Compressions by Instrument Type

Full year 2012 First half of 2015

98% IRS, CCPs

86% IRS, CCPs
1% IRS, Others
10% IRS, Others
0% CDS
4% CDS
1% Other
0% Other

Source: BIS Statistics, Trioptima, TriReduce. Dec 2015

lent economic value. The new transaction would have the net no- ners and CapitaLabs announced they compressed €800 billion
tional value of all the buys and sells. The rate of the new deal is the notional Swaptions. These instruments have a more complex risk
weighted average rate of the original transactions to ensure that the profile than the vanilla IRS, given their asymmetry. Having had 10
final cash flows are the same as before the compression. banks including JPMorgan participating in BGC’s cycles shows
In early 2015, “Rebalancing” appeared as a technique by which how portfolio compressions continue to prove useful in reducing
and arranger can find offsetting transactions between two clearing risk in OTC Derivatives.
houses and their members. The principle is the same as with other
compressions. A member enters into new transactions with a clear- Sources:
ing house, and strikes offsetting deals with another clearing house. 1 Portfolio Compression, Techniques to Manage EMIR and other Regulatory and
Another member enters into offsetting transactions with the clearing Trading Risks, by Diana Higgins, Risk Books, 2015. 20% discount for The OTC
houses so that the clearing houses keep their original net position. Space readers on
The final result is the elimination of a number of deals with all the 2 BIS Quarterly Review December 2015. Extract by Andreas Schrimpf in pages 24-
participants in the cycle and the clearing houses ending up holding 25. Bank of International Settlements (BIS)
portfolios with less line items, and with the same economic value qt1512.pdf
and open position as before the rebalancing cycle. 3 The Impact on Compressions on the Interest Rate Derivatives Market, Research
Last, but not least in the Fourth Quarter of 2015, BGC Part- note by ISDA, July 2015.
Risk Management Rocket • Edition 6 | Spring 2016 • | 44

Risk Management

Initial Margin on
Uncleared OTC
Derivative Trades:
The ISDA Standard
Initial Margin
Model (“SIMM”)
Following the Financial Crisis the Financial
Stability Board (“FSB”) of the G20 nations
at its Pittsburgh Summit in 2009 determined
that one key component of its response
was to force certain standardised Over the
Counter (“OTC”) derivatives into Central
Counter Parties (“CCP’s”) or “clearing”.
Risk Management Rocket • Edition 6 | Spring 2016 • | 45

ne part of this strategy is to impose stringent margin re- current industry thinking and a framework under which IM can
quirements on non-standard OTC trades which remain be calculated and agreed. A further objective of this initiative
outside clearing. These proposals cover both Variation is to reduce disputes though the transparency of the model ap-
Margin (“VM”) and Initial Margin (“IM”). VM set- proach. The model is called the ISDA SIMM (Standard Initial
tles profits and losses incurred between counterparties Margin Model).
to date, with IM seeking to provide a cushion for potential future The concept of an IM model is not new. The London Interna-
losses. tional Financial Futures Exchange introduced SPAN6 margining
The Working Group on Margin Requirements1 (“WGMR”) (niftily known as Liffe-Span) in 1990 following its use in Chicago.
consulted widely and received a great deal of industry feedback The idea is simply to look at an aggregate portfolio, apply shocks to
culminating in a final policy framework published in March 20152. the underlying risk factors and find out the maximum loss through
A Quantitative Impact Study (“QIS”) was also undertaken; high- some aggregation process. Key to this is the notion of a “margin
lighting that the effect on the industry will be very significant. period of risk”, which is the period which needs to be covered by
Although starting on 1 September 2016, the proposals are to be IM to allow the portfolio to be liquidated or the risks immunised.
phased in, and will not be implemented in full until 1 September Clearly a model for OTC derivatives will be much more complex
2020. Nevertheless, according to ISDA3 roughly 95% of “clear- than one for exchange traded instruments. By definition, OTC de-
able” Interest Rate Derivatives are currently cleared4. rivatives are non-standardised and illiquid and therefore harder to
The proposals raise many questions, key amongst these are: hedge or immunise.

l Which IM requirements will apply to uncleared OTC The ISDA SIMM

derivatives? This is certainly not a “one size fits all” approach. There are a num-
l How can the IM calculations be agreed by parties to the ber of choices and so counterparties will need to check carefully,
contract? Large dealers have proprietary models whose and agree, a number of details. The OTC “world” is divided into
details they do not wish to disclose. five risks7, six risk classes8, four product classes9 and two different
l How do these work across different jurisdictions given the fact ways of handling equity risk factors. The key to the risk aggregation
that the rules are different across jurisdictions? methodology is to estimate the correlations between various inputs.
l What collateral will be acceptable to post as IM? There are literally hundreds of these. The correlation matrix of risk
sensitivities across different time buckets contains 120 factors, 18 of
Initial Margin Model which are zero and one is negative. So the correlation between 11
To help provide answers to these issues ISDA initiated a WGMR year and 15 year buckets is 18% whereas between 11 year and 16 year
Implementation Program to facilitate the implementation of the buckets is zero.
margin rules across jurisdictions5. These are currently in draft No doubt a great deal of hard work has gone into calculating
form and may be subject to change. They do, however, set out these correlations, and will continue to be invested. Those of us
Risk Management Rocket • Edition 6 | Spring 2016 • | 46

The concept of an IM model is not new. The London International Financial Futures
Exchange introduced SPAN margining in 1990 following its use in Chicago. The idea
is simply to look at an aggregate portfolio, apply shocks to the underlying risk
factors and find out the maximum loss through some aggregation process
who have spent several decades in the markets know two things. ogy at this time may well be commendable. However, given the
Firstly historic correlation is easy to calculate but of limited rel- timescale and widespread use of an existing methodology, is it a
evance, whereas future correlations are highly relevant but not bridge too far?
measurable. Secondly, correlations are highly stable until they be-
come unstable. Shocks are sudden, violent and unpredictable. The Liquidity
fact that these inputs are hard to predict does most certainly not One of the criteria for determining the eligibility of a derivative
mean that it should not be attempted, simply that the limitations to meet the clearing mandate is the liquidity of instruments and
of the modelling approach should be fully understood. the ability of a CCP to hedge or immunise in case of default. A
large portfolio of liquid 20 year “on-the run” interest rate deriva-
Methodology tives may well meet this test. However, in a year the portfolio may
In October 2015 ISDA announced that it had appointed ICE Bench- become 19 year residual maturity, off-the-run and illiquid – what
mark Administration Ltd to build and operate the crowdsourced happens then? Either a CCP may be able to “put” the portfolio
utility for the SIMM. It is interesting that the methodology cho- back to market participants causing tremendous disruption, a risk
sen is not one of those widely used. Value at Risk (“VaR”) usually impossible to measure and capitalise, or there will be a “Hotel
comes in three flavours: Parametric (also known as variance-co- California” model (remember the Eagles?) meaning that once a
variance), Historic Simulation and Monte-Carlo Simulation. The derivative is in clearing it can never get out. In the latter case CCP’s
method most widely used is Historic Simulation10. Regulators are must be capitalised and have the risk management capabilities to
moving from VaR to Expected Shortfall. VaR gives a probability of manage large illiquid portfolios, with a potentially large require-
losses not exceeding a certain amount to within a given confidence ment for collateral.
limit. However, it gives no information whatever about the likely
losses when the specified amount is exceeded. Expected Short- Risk Weights
fall attempts to remedy this by predicting the loss distribution in The approach of determining risk weights prescriptively is bold,
the tails (outside the specified amounts). It is also interesting that but one followed by the Securities and Futures Authority many
the draft ISDA SIMM document annotates the term ISDA SIMM years ago. Volatilities, like correlations, are easy to measure his-
with a note stating “patent pending”. Patenting a new methodol- torically but unmeasurable (other than from market pricing) for
Risk Management Rocket • Edition 6 | Spring 2016 • | 47

Model approval may be restricted to certain instruments, risks and data

sets. Thus two firms facing each other would need to check the full details of each
other’s approvals before IM could be agreed. The types of collateral acceptable with
models approved by different regulators may differ
the future. The British Pound is currently categorised as “regular Model approval may be restricted to certain instruments, risks
volatility”. Imagine how a Brexit could change that. The point is and data sets. Thus two firms facing each other would need to
that, if parameters are to be centrally measured and maintained, check the full details of each other’s approvals before IM could be
recalculation needs to be frequent and accurate. The fact alone agreed. The types of collateral acceptable with models approved
that this is a Herculean task again does not mean that it should not by different regulators may differ (see below). Hence two firms
be attempted. There is also the question of ownership of the data facing each other have a great deal of details to check. The ben-
and who will underwrite losses arising from errors or omissions. efits of an industry model are derived from the efficiencies of be-
ing applicable to all and not needing to be tweaked in respect of
Model Approval each counterparty relationship. Clearly the specific nuances of a
Obtaining, and maintaining model approval for the calculation of party’s model approval are problematic in this regard.
IM is non-trivial. There are a number of issues including:
The current WGMR proposals require firms to apply to each Dispute Resolution
jurisdiction in which they operate for approval. There is no con- The rules for the calculation of Counterparty Credit Risk (“CRR”)
cept of “Home/Host” whereby models approved by the Home involve significant add-ons in respect of unresolved disputes in-
regulator would automatically be accepted by Host regulators. cluding those relating to collateral. It is therefore extremely impor-
This would make the process potentially much longer, complex tant that, in the face of all of the issues outlined above, collateral
and expensive as different jurisdictions apply differing standards, disputes can be quickly resolved. One aim of the ISDA SIMM,
data requirements and languages. A common ISDA SIMM ap- which is to be highly praised, is a significant reduction in disputes
proach should certainly make this process much easier. However through the use of (more) transparent models. Institutions who
the challenges of obtaining model approval should not be un- do not use the ISDA SIMM my find it hard, if not impossible to
derestimated. Regulators advise that, when considering a model, agree collateral calls on a daily basis.
only 30% of the process addresses the model. The remaining 70%
is based on systems and control, management, supervision and Collateral
other firm-specific issues. The ISDA SIMM approach should cer- It has long been recognised that the imposition of margin require-
tainly reduce the 70% part, but will certainly not eliminate it. ments on uncleared OTC derivatives will create a very significant
Risk Management Rocket • Edition 6 | Spring 2016 • | 48

mentation aspect of the margin reform regulation implemen-

tation and it will be certainly interesting to observe how firms
Crowdfunding manage this.
Crowdsourcing is a term coined in 2005 which refers to the Conclusion
gathering of data or solutions to problems through the use of
This is an area fraught with difficulty. Although the intention of
a typically large online community. In this context, it is being
the FSB is hard to argue against, its implementation shows that
utilised to ensure a consistent implementation of risk weights
and correlation parameters and their sensitivities to changes in the devil really is in the detail. Firms, not limited to banks, face
input values in the ISDA SIMM. The utility accepts data from an array of hurdles and some will inevitably require outside ex-
participants, analyses them and produces consensus results, which pert assistance. These include model approval, data sources, risk
are then provided back to users. This use of consensus results is categorisation and legal documentation management together
clearly preferable to firms using their own internal determination with building the remainder of the 70% of the model approval
of risk buckets and weightings and the involvement of a large not covered by the ISDA SIMM itself. The problems of adapting
community is designed to provide stable results. to a new methodology should also not be underestimated.
The ISDA SIMM is a welcome initiative and one which clearly
has a long way to run. In view of the WGMR implementation
requirement for “acceptable” collateral. In order to mitigate the timetable, this should be at the forefront of the industry’s mind. If
ensuing collateral shock the WGMR has, quite rightly, attempted it is not, it may already be too late.
to widen the classes of collateral which are acceptable to cover
IM. One consequence of this is a proposal that individual juris- References:
dictions set their own lists of acceptable collateral. After all, if 1 A group formed in 2011 by the BCBS, IOSCO and other interested parties
covered mortgage bonds are liquid in certain Nordic countries, 2 BCBS publication d317
why should the Nordic regulators not accept these? No reason at 3 The International Swaps and Derivatives Association Inc.
all other than, a firm running a centralised collateral management 4 ISDA Derivatives Market Analysis: Interest Rate Derivatives, 21 January 2016
unit (by far the most efficient way to manage collateral) may face 5 Draft ISDA SIMM Methodology V 3.8 documents published 12 January 2016
real challenges. Collateral considered acceptable in one jurisdic- 6 Standard Portfolio Analysis of Risk
tion may well not be considered as acceptable in another. 7 Delta risk, Vega risk, Curvature risk, Inter-curve basis risk and Concentration
The consequence is that we may move from a world of Black risk
and White, where each piece of collateral is either acceptable or 8 Interest Rate, Credit (Qualifying, Credit (Non-Qualifying), Equity, Commodity
not acceptable, to a world which might be characterised as “Fifty and Foreign Exchange (“FX”).
Shades of Collateral”. Clearly a legal documentation nightmare. 9 Interest Rates and FX, Credit, Equity and Commodity
There is already such a major dependency on the legal docu- 10 See Amir Khwaja of Clarus Financial Technology November 2015
Rocket • Edition 6 | Spring 2016 • | 49


Improved banking
hinges on IT
The pressure for change in the way the
capital markets operate is building relentlessly
and the only way in which investment banks
and other key players can remain successful
will be to completely transform current
business models.

his will mean an overhaul of archaic technology infra-
structures and outdated working practises and the transi-
tion to an agile enterprise architecture that is scalable and
robust enough to meet today’s problems and tomorrow’s
Margins are under extreme pressure as costs continue to rise
and revenues are restrained by more risk-averse investors. In ad-
dition, the pressures on capital allocation ratchet ever-higher as
regulators demand weightier safety buffers to protect against the
impact of potentially more extreme (if unlikely) negative mar-
ket outcomes.
Technology Rocket • Edition 6 | Spring 2016 • | 50

The message is clear, IT is not just important; it is critical to the future wellbeing
and effectiveness of any financial institution. But even more pertinent is where
that IT spend is directed.
Although appearing to be robust, stable and effective in delivering Whether it is the imminence of the Blockchain, the arrival of the
millions of secure transactions at ever-increasing speeds between Cloud or the embracement of analytics, it is clear that not only will
ever-wider geographies, the cracks in capital markets IT capabilities more need to be done with less, but it will have to be done smarter,
are not only starting to show but are widening. The significance of faster and more accurately.
the recent dismal round of earnings reports from nearly all the ma- At the heart of this transformation will be more sophisticated use
jor banks, with little optimism about immediate prospects, has not of data that delivers more relevant information, more quickly, to
been lost on industry leaders. vastly improve the quality of decisions by those who need to make
It was no coincidence that as J.P. Morgan announced their re- them - or Intelligent Use of Intelligence. This will mean a complete
sults last month they declared that not only “We are a technology restructuring of the vertical, often asset-class based, silo structures
company,” but at a time when it is cutting costs in nearly every that currently dominate banks’ IT architectures, into horizontal
other area of operations it said it is increasing its 2016 IT spend capabilities that are able to leverage data and pricing across asset
to $9.4 billion. classes to deliver comprehensive views of risks and outcomes to
Refocusing IT Budget Deployment At the same time as banks improve their front office capabilities
More importantly, J.P. Morgan is re-focussing where it spends that to gain what are often only marginal (and sometimes temporary)
technology budget, with the amount directed towards innovative edges over competitors, they also have to overhaul cumbersome and
investment and technologies rising to 40% of the total from 30%. It costly back office functions. These are too often still heavily bur-
knows that as an IT company (or even a bank) it needs to allocate dened by the errors and exceptions that are an unfortunate natural
funds to where they can have the biggest impact on efficiency and by-product of manual processes.
competitiveness. This costly drive towards greater straight-through processing
The message is clear, IT is not just important; it is critical to (STP) and automation is also opening the door to long-resisted col-
the future wellbeing and effectiveness of any financial institu- laborations with competitors over sharing resources such as post-
tion. But even more pertinent is where that IT spend is directed. trade utilities. Current pilot projects are likely to be only the first
It will not be good enough to just maintain the status quo, but steps in this direction.
rather identify how existing resources can be made more robust But whichever route is chosen, it is clear that more collaboration
and responsive, while simultaneously building new capabilities and the use of shared resources will be essential if the industry is to
to meet new challenges. put an end to the burden of cost duplication.
Technology Rocket • Edition 6 | Spring 2016 • | 51

Figure: Transition to an agile enterprise is challenging

Effective transformation is thwarted by current fragmented architecture

Fragmented “best-of-breed” siloed architecture on site Transformed, agile enterprise architecture in the cloud

Rates FX/MM Bond Credit Equity Enterprise-wide connectivity

FO workflow Cross-asset front office workflows

Data analytics and visualisation

Pre-trade compliance

Enterprise-wide analytics

Enterprise-wide data
Enterprise-wide risk framework
Real-time trading risk l Long time to first benefits
Scenario analysis
l High risk untangling and Cross-asset
Pricing and sensitivities decoupling Post-trade processing
Market data
l High cost of execution
Static data
Post-trade workflow
Collateral management Cloud-enabled

Early Adopters latency all bear testimony to industry innovation.

That’s not to say there hasn’t been investment in new technol- But Wall Street is not what it once was and the current blood-
ogy. The capital markets have always had a reputation for early letting shows no signs of abating, as more banks published dismal
adoption given the importance to competitiveness of speed, agil- results for 2015, with fixed-income trading in particular continuing
ity and the demand to process vast volumes of data in minimal to be hit hard. For example Morgan Stanley cut 25% of fixed in-
timeframes. The evolution of algo and quant trading, the refine- come headcount, while similar stories accompanied results across
ment of risk management techniques and commitments to low the globe as Barclays, HSBC, Credit Suisse, Standard Chartered and
Technology Rocket • Edition 6 | Spring 2016 • | 52

others all seek to cut more costs as losses mounted. Next Steps
RBS, once the world’s biggest bank by assets, is already a shadow Not every bank will represent, or develop, an ecosystem that reflects
of its former self having slashed risk-weighted assets by more than the entire market. Therefore there are likely to be only a few truly
75% to under £250 billion and shut down most of its global network global and universal players, supported by more specialist (local or
to the point where some 90% of its business is now generated in the regional) banks, albeit who adhere to global standards.
UK and Ireland. It is pretty much back to where it started in terms The industry needs to look outside and consider how smart-
of size, footprint and business model when Fred Goodwin took over phones and the digitalisation of individual lives have changed cus-
as CEO in 2001. tomer expectations. Banking services need to be accessible every-
where, at any time and on any device. Only new technologies such
The Need for Technology Transformation as HTML5, Java, in-memory databases, real-time analytics engines,
There are some who have seen the light, UBS CIO Oliver Bussmann super elastic compute grids and cloud-enabled componentised soft-
for one. He wrote recently, “I am very positive, because I believe ware architecture can fulfil those new higher standards, while giving
technology will play a fundamental role in changing the dynamics. the bank opportunities to grow.
It will disrupt outdated practices, provide opportunities for new This can be achieved more easily with open architectures, de-
players and above all dramatically enrich the services offered to cli- signed to leverage commoditised hardware and supported by the
ents. For a long time the industry has needed this shake-up and Cloud for lower costs and greater flexibility. The added benefit of
some institutions may fall behind, but UBS is taking a leading role infinite scalability delivers the ability to respond with the resources
in helping to transform the banking sector.” when needed. The added connectivity to any system or service
He added, “It is critical to balance the speed needed to drive com- means the requirement to hard programme hundreds of standard
petitive advantage against the importance of protecting clients’ as- industry interfaces becomes obsolete.
sets and complying with a much stricter regulatory landscape.” Digitalisation is everywhere. How banks choose to adopt or em-
The regulatory landscape is also becoming tougher and any new brace it will be up to them. These are just some thoughts on where
developments must therefore be both integrated and scalable. Con- the industry needs to aspire to be and how it could enable the bank
sequently IT systems need to have the flexibility and agility to re- of tomorrow. Imagine no more hard coded interfaces that take
spond to new demands from financial authorities. months to deliver, or risk calculations and big data analysed in a
Another factor to consider is that all banks do not need to follow fraction of a second. No duplication, agility to respond and the re-
the same path. More importantly, the industry needs to avoid the duced costs and lower TCO that result. That’s not just the future
costly trap it has already found itself in through the duplication of of banking technology, it’s available now. It will be interesting to see
technology investment. Instead, more collaborative models need to how many financial institutions agree and respond to the challenges
evolve where resources are shared and IT capabilities are delivered with significant change to their IT investment priorities and busi-
from cloud-based structures on an as-needed basis. ness cultures to make it happen.
Technology Rocket • Edition 6 | Spring 2016 • | 53

Blockchain for traditional markets: hype,

enhancement, disruption?
Blockchain is one of the hottest topics in financial industry nowadays. 2015 was the year of high
expectations about how blockchain could proliferate beyond bitcoins, 2016 has been emerging
as a year of expectations that at least some of the ideas expressed before would transform from
PowerPoint files into proofs-of-concept, prototypes and (who knows?) even killer apps.
Technology Rocket • Edition 6 | Spring 2016 • | 54

nterest in blockchain seems to be inspired primarily by an- has come from it’s implementation for bitcoins, is successful to
ticipated benefits (from those who may say that understand some degree.
them) and by concerns that blockchain could, as hoped by Historically, blockchain is a distributed ledger realized as an en-
others, revolutionize (disrupt) existing market structures or, as crypted chain of transaction blocks (hence blockchain) verified in
recently attributed by Dan DeFrancesco, by FOMO (Fear of the course of ‘permissionless proof-of-work’ or mining.
Missing Out). More generally, such public blockchains pave the way to P2P
This brief note is organized as a collection of several straightfor- ecosystems, i.e.:
ward statements open to criticism, and is one more attempt to guess
how blockchain might be disruptive for ‘traditional markets’. l systems without intermediaries like brokers, custodians and
central authorities;
1. Breaking down ‘traditional markets’ l self-sufficient systems with rules and procedures embedded
‘Traditional markets’ here are existing markets for public instru- into and with no (or little) references to external provisions.
ments and with ‘central authorities’ – primarily, exchanges’2 for
trading, CCPs for clearing, CSDs for settlement. By contrast, At the same time, public blockchains are not as P2P as may appear
‘non-traditional markets’ are existing or potential markets for at first glance. Users (‘peers’) interact with each other not directly
‘private’ instruments – public equity, other securities not traded but via some system designed and developed by somebody compa-
on public markets, loans, etc. rable, by it’s overall influence, to central authorities (but with no,
Non-traditional markets are likely the most probable area or at least with less, responsibility).
where bitcoin-style ecosystems could be developed and the only
financial space where blockchain prototypes have been already 2.2. Private blockchains
announced – Nasdaq Linq for public equity, Symbiont ‘smart se- For reasons mentioned briefly below, the advantages of making cen-
curities’ (initially intended for corporate debt, syndicated loans, tral authorities completely redundant are not absolutely obvious. So,
securitized instruments and private equity), Overstock for pri- the idea has come to somehow merge central authorities with block-
vate bonds and Digital Assets for ‘capital investment’ of Pivit®3. chains, thus creating ‘private blockchains’ where ‘blockchain’ is trun-
The border line between ‘traditional’ and ‘non-traditional’ mar- cated to ‘just another kind of distributed database’ allowing ‘data in-
kets is not impenetrable, e.g. when central authorities provide non- frastructure without physical presence’ (quote from Preston Byrne).
core (or ‘other’ as in Table 1) services like the above-mentioned Private blockchains differ from public blockchains mainly in that:
Nasdaq Linq.
l private blockchains are explicitly organized by some central
2. Breaking down ‘blockchains’ authority (with explicit rules and responsibilities);
2.1. Public blockchains l users of a private blockchain are not ‘peer’ to the central
Everything (or almost everything) that is known about blockchain authority, the latter may have exclusive rights of rulemaking,
Technology Rocket • Edition 6 | Spring 2016 • | 55

In extreme cases, central authorities may withhold stakes, leaving itself as

a sole verifying body (‘fully private networks’). Actually, why not – if central
authority is trusted enough to be ‘super-peer’, then why is it not valid for running and
verifying a ledger?
or access to full (e.g. non-anonymized) data, or doing some l data enrichment, e.g. for creation of auto-executable ‘smart
procedures (e.g. default management), etc.; contracts’.
l consensus about block validity in private blockchains is achieved
usually (though, maybe not necessarily) via ‘permissioned 2.3. Hybrid blockchains
proof-of-stake’ when ‘stakes’ are determined by (or under There also may be a ‘hybrid’ intended e.g. for smoother interop-
the rules of ) the central authority. Such ‘forging’ instead of erability between central authorities by providing common dis-
burdensome mining may decrease costs and significantly tributed ledgers and/or integrating their ledgers (e.g. as ‘side-
improve speed and other performance metrics. chains’).
Similar to public blockchains, hybrid ones are basically P2P for
In extreme cases, central authorities may withhold stakes, leaving central authorities (but with radically less top-tier peers), similar
itself as a sole verifying body (‘fully private networks’). Actually, to private blockchains they (1) may rely on mutual trust between
why not – if central authority is trusted enough to be ‘super-peer’, top-tier peers and may not require permissionless mining (in this
then why is it not valid for running and verifying a ledger? sense they may be called ‘consortium blockchains’), and (2) may
Private blockchains are deemed to inherit the benefits of public also include second-tier users (members of central authorities).
ones (though the final answer to the question ‘how are these benefits
possible in the absence of permissionless mining’ seems yet to be 3. Breaking down ‘disruption’
given), first of all: Traditional markets (in the general sense) may be disrupted across
two layers:
l data integrity:
− uniformity: each user or subscriber will get the same golden l ‘P2P disruption’, i.e. full or substantial disintermediation when
source of data; central authorities are substituted with P2P interactions;
− resilience and prevention of data loss or damage; l ‘non-P2P disruption’ when centralized models remain as
− immutability; principle, but business processes within central authorities
l origination from transactions, traceability and potentials for change radically. This may be harmful or even crucial for
individualization (coloring) of basically fungible instruments incumbent institutions who will not able to address new
(‘tokens’); challenges.
Technology Rocket • Edition 6 | Spring 2016 • | 56

It is sure that public blockchains have been neither intended, nor designed
for purposes of external use, especially in traditional markets – problems
of latency, anonymity, settlement finality, etc. are often named as something to be
addressed to make native blockchains viable here.
4. Mapping blockchain models to disruption layers chains over centralized models is that there is no ‘single point of
4.1.Public blockchains and P2P disruption failure’ (e.g. see in Euroclear/Oliver Wyman ‘Utopia’). But even
By definition, the only blockchain model which might cause P2P if this is true, it also may mean no single (or none at all) point of
disruption is the public blockchain if it appears to be achievable in claim if something goes wrong since blockchain, like any other
traditional markets. But, as seems to be recognized more and more, technology, is hardly 100% bulletproof. So, one more example of
this is not very likely to happen. value-adding by central authorities is that they arrange dispute
To support this skepticism, some general observations and procedures and take responsibility - up to wasting their capital.
(anti-) cases are provided below (see Table 1). Secondly, modern financial markets are not very consistent with
a P2P framework (e.g. legal monopoly for CSDs).
4.1.1.Some general observations in favor of centralized services Thirdly, it is sure that public blockchains have been neither in-
First of all, not all centralized services, which are to be made due to tended, nor designed for purposes of external use, especially in
P2P disruption, are really bad and/or outdated. As has been stated traditional markets – problems of latency, anonymity, settlement
in the recent DTCC white paper, the benefits of such services for finality, etc. are often named as something to be addressed to make
most modern financial markets ‘present a high bar that distributed native blockchains viable here.
ledger technology must improve upon’. There is still substantial
value-adding in centralized services, e.g.: 4.1.2.(Anti-) Case 1: Trading
Distributed ledger here may mean an order book, a list of trans-
l specialization of dedicated institutions improves quality of actions (executed orders), or even a list of settled transactions if
services and reduces operational costs and risks; trading is to be merged with settlement (see Table 1) verified for
l liquidity concentration, netting, etc. contribute to larger cost compliance with some rules of order submission and matching.
and risk reductions through economies of scale and scope; Since such a concept is deemed to be not quite consistent with
l central authorities are important (self-) regulatory bodies permissionless mining (e.g. for latency reasons), solutions to walk
responsible for market ruling and surveillance. away are proposed (like permissioned proof-of-stake) which may
actually mean change to non-public blockchains.
It is sometimes said that one of the advantages of public block- But even if distributed ledger is implemented into trading, it
Technology Rocket • Edition 6 | Spring 2016 • | 57

An inspiring idea is to merge settlement with trading to achieve ‘instant settlement’.

However, implications of this idea should be thoroughly assessed. To mitigate credit
and systemic risk, exposures are to be properly collateralized at the moment
when the trade is made (not after - because trade happens simultaneously with
settlement) or even at the moment when the order is submitted.
would not automatically push out exchanges from traditional Anyway, blockchain-driven settlement (if and when achieved)
markets because order and trade processing are not the only doesn’t immediately imply that there will be no space for CSDs
value-adding centralized services. Exchanges are also involved anymore. Asset transfers (settlement in it’s practical sense) are not
in listing and contract design, liquidity promotion (e.g. via mar- the only activity of CSDs who also get a legal monopoly for record
ket-makers), (self-)regulation and so on. Further unnecessity of keeping and notary services. To hand over P2P interactions to them
these activities seems to be far from being proved, so who will be may presume substantial rethinking of legal framework in general.
responsible for them in P2P trading (if and when it happens) is
also far from being clear. 4.1.4. (Anti-) Case 3: CCP clearing
Clearing is, probably, the most disputable area for P2P disrup-
4.1.3. (Anti-) Case 2: Settlement tion. Distributed ledger here may mean a list of obligations ready
Distributed ledger here may mean a list of settled transactions for settlement verified, as in the case of blockchain for settlement
verified for availability of necessary assets to prevent their ‘double (see Table 1), for availability of necessary assets. If availability
spending’ (in bitcoin terminology). To make this concept work- is confirmed, this list is to be forwarded to the CSD for execu-
able, finality supported by blockchain should be upgraded to the tion, else embedded default management procedures have to be
legally required level of certainty. invoked to reshape the list of obligations for it’s final integrity.
An inspiring idea is to merge settlement with trading to achieve ‘in- If such a concept is implemented, CCPs are foreseen to be re-
stant settlement’. However, implications of this idea should be thor- placed with ‘decentralized clearing networks’ (quote from Mas-
oughly assessed. To mitigate credit and systemic risk, exposures are simo Morini and Robert Sams).
to be properly collateralized at the moment when the trade is made This way of development, though theoretically thinkable, leaves
(not after - because trade happens simultaneously with settlement) open some important questions about clearing without a CCP, e.g.:
or even at the moment when the order is submitted. In other words,
instant settlement requires real-time risk management including pre- l How to achieve multilateral netting and make it legally
order validation that is not the common model now, except in the binding?
Russian market (Moex) where it is a paradigmal approach. l Is embedded risk and default management , with all potential
Technology Rocket • Edition 6 | Spring 2016 • | 58

risks and actions preliminary assessed and coded, a viable and So, hype, enhancement, or disruption?
realistic model? The general answer seems to be that blockchains in traditional
markets may be all of these:
Not a rare point of view is that blockchains, if and when imple-
mented into centralized clearing, would not disintermediate it but, l as a way to P2P ecosystems with no space for central
instead, lead to some ‘non-disruptive’ enhancements. authorities, public blockchains are, if not a hype, not very
realistic in the world as we know it (another question is how
4.2. Private/hybrid blockchains and non-P2P disruption long such a world will continue to exist);
Non-public blockchains could bring significant enhancements to l if certain conditions are met, non-public blockchains might
traditional markets without undermining niche for central authori- bring significant enhancements to traditional markets;
ties in general. To make this happen it is necessary (1) to identify l however, even if such enhancements are likely to leave intact
and prove use cases where the idea of distributed ledger would be the principal role of central authorities, this doesn’t give a
more attractive than current business practices, and (2) to make lifetime guarantee for any particular incumbent institution and
sure that blockchain technologies (e.g. permissioned verification, may be pretty disruptive to those who will fail to implement
sidechains) are valid and helpful for such cases. new technologies if they appear to be successful.
Though all major central authorities have disclosed their inten-
tions to explore applicability of blockchains to their core day-to- At least one good thing about blockchain is already known – it
day activities, no particular use case seems to be revealed at the has already provoked revision of customary business processes
moment with a high degree of confidence. to better adjust them to rapidly evolving competitive and techno-
Without prejudging possible future outcomes, some high-level logical environments. What will the results of this revision be and
guesses are presented in Table 1 where blockchains are broken will blockchain be the technology to lay behind changes are other
into different models (as described above) and each of them is questions for further elaborations.
assessed for applicability to, separately, trading, clearing, settle-
ment and other (non-core) activities of central authorities.
Basic assumptions for such guesses are as follows: References:
1 Views expressed in the notes are the author’s opinion and should not be perceived
l use cases for private blockchains might take place where there as an official position of the Moscow Exchange.
exists (1) a sufficient level of trust to central authorities and (2) 2 ‘Exchanges’ are taken here in a broad sense covering any ‘organized’ marketplaces
the interest of central authorities to provide users with golden or trading venues.
sources of data thorough blockchain-based distributed ledgers; 3 Though no specific features of blockchain design in these prototypes have been
l use cases for hybrid blockchains might take place where publicly disclosed, some indirect indications vote for relating them more to
there is room for interoperability between central authorities. ‘private’ blockchains rather than to ‘public’ ones.
Technology Rocket • Edition 6 | Spring 2016 • | 59

Table 1: Potential use cases for blockchains in traditional markets

This is a non-exhaustive list open to discussion and criticism

Blockchain model
Blockchain model Distributed database (ledger) P2P ecosystem (similar to bitcoins)
Central authority Yes No
Consensus about block validity Centrally induced (permissioned proof-of-stake, etc.) Permissionless proof-of work
Blockchain model Private Hybrid Public
Order and trades processing Maybe if latency Interactions between • Theoretically thinkable if latency
problems are exchanges: problems are resolved
resolved • Common order book • In practice hardly possible since

exchanges perform other value-

• Little (or no) responsibility for business continuity

adding centralized services (listing

Interactions between exchanges, CSDs and

and contract design, rulemaking,
surveillance, liquidity promotion,

CCPs: instant settlement

Confirmations, matching, etc. Maybe, including Interactions between CCPs: Maybe if done between members

• Problematic resolution of disputes

for non-members • Cross-margining
Netting, compression Maybe, including • Other clearing links • Theoretically thinkable e.g. as pre-
for non-members programmed ‘decentralized clearing
• In practice hardly possible to pre-
program any future risk

Margining Maybe, including

Default management Maybe for selected
procedures (e.g.
closing-out, default
actions, haircutting)
arranged as e.g.
‘smart contracts’
Technology Rocket • Edition 6 | Spring 2016 • | 60

Table 1: Potential use cases for blockchains in traditional markets (continued)

Blockchain model
Blockchain model Distributed database (ledger) P2P ecosystem (similar to bitcoins)
Central authority Yes No
Consensus about block validity Centrally induced (permissioned proof-of-stake, etc.) Permissionless proof-of work
Blockchain model Private Hybrid Public
Collateral management Maybe Interactions between CCPs
and CSDs
Asset transfers Maybe Interactions between CSDs/ Problems of finality and identification
ISCDs: of counterparties
• Settlement links
Interactions between CSDs
and central banks:

• repos for RTGS for with

instant DVP
Interactions between
CSDs, issuers, registrars,
Notary services Maybe custodians Not in line with legal monopoly of
Corporate actions (votings, income Maybe
transfers, splits and conversions,
etc.) and depositary receipts
Market data Maybe e.g. for E.g. Interactions between exchanges:
uniform reference • Consolidated tape
data • Common stop lists
Trade reporting Maybe Interactions between TRs, exchanges and Maybe if it appears to be legally binding

IT and related services for non- Maybe (prototypes Maybe
centralized markets (private have been already
securities, etc.) unveiled)
Between TRs, exchanges and CCPs Maybe (trade reports processing)
Technology Rocket • Edition 6 | Spring 2016 • | 61

Why data harmonisation is key to efficient and

effective Trade and Transaction Reporting
David Farmery from Message Automation discusses the need for a harmonised data platform at the heart of any
strategic Trade and Transaction Reporting solution.

any financial institutions are struggling to main- weeks through rules configuration only. Testing of new
tain efficient and effective trade and transaction re- functionality is against a comprehensive data set already
porting solutions, as the waves of regulation keep held in a single database, containing full economic details
crashing in. With major changes to EMIR; and new of all trades across asset classes. (And regression testing is
requirements from SFTR and MiFID2 all due to automated)
add to the storm over the next one to two years those institutions
without robust and flexible reporting solutions will inevitably con- Effective would look like this:
tinue to suffer.
Although perhaps stating the obvious, firstly maybe we should l The solution should enable operations and compliance staff
define our view of ‘efficient’ and ‘effective’. to see the full history of a trade, who is reported to and why.
Efficient would look like this: Importantly they should also be able to see why a trade was
not reported to any particular jurisdiction to enable clarity
l A very high percentage of trades go from entry into source for themselves, auditors and regulators.
systems through to the TR or ARM with no manual l Where required data is not available from source systems,
intervention or keying of additional data. the solution should provide an automated, audited method
l The number of breaks or issues reported back from the TR for adding that data to the trade record in a controlled
or ARM is very small and the solution includes workflow fashion.
to enable these to be managed and rectified with minimal l The solution should enable flexible end-user views of the
manual intervention. overall trade data ‘sliced and diced’ as required. For example:
l Changes from the regulator, or the addition of new all trades reported to DTCC under EMIR, all trades not
jurisdictions/regulations can be implemented in a very few reported as the responsibility was with the counterparty.
Technology Rocket • Edition 6 | Spring 2016 • | 62

Figure: Solution diagram

In-house EMIR
systems External LEI UTI insideTRACK
look-ups, USI
determination, Configurable
generation, UPI Regime end-user
etc dashboards
Vendor System Dodd Frank
futureLANDSCAPE Canadian
Harmonised Database of trade
Data Format
Vendor System messages and
e.g. GMI responses

Other Reference TR Reconciliation
Data Others

l The ability to easily reconcile TR trades and positions back punitive manpower overheads and regulatory issues.
to original source systems (i.e. books and records, not merely The success story covered in the attached case study could only
to the reporting engine where the population might already be have been achieved via the implementation of a genuine central-
incorrect.) ised, harmonised data model and database. In conversation some-
times this is greeted with scepticism, but this does not need to be
What should be clear from the above is that solutions which draw a three-year gazillion dollar project, it really doesn’t. Ensuring this
only the relevant data and then report separately from each source contains all the economic details of every trade serves to ‘future
system are neither efficient nor effective. As a result many financial proof ’ against the next regulatory hurricane twisting in, so the me-
institutions are now bearing the pain and cost of this in the form of dium term benefits are very substantial.
Technology Rocket • Edition 6 | Spring 2016 • | 63

Case Study:
How a major International Bank reaped benefits from a strategic trade reporting solution
The Project Automation said. “The bank already had an that MA would deliver a solution to handle the
The Banks’s initial requirement from Message incumbent supplier for Dodd Frank reporting, but new Canadian reporting requirements as part of a
Automation was for an EMIR trade reporting solution they were not happy with the results, from either the strategic, multi jurisdiction, system. Working closely
in very short timescales. This first engagement with speed of response or the costs involved. With the as a team with the MA staff, the bank has been able
them proved so successful that they quickly decided EMIR deadlines looming, they invited us to propose to meet all subsequent reporting deadlines despite
to expand the solution to include Canadian Trade an alternative to their existing Dodd Frank reporting the very tight timescales involved.
Reporting. Subsequent to this they also switched their supplier. In a competitive pitch, which kicked off in As well as reporting trades, it was equally
existing Dodd Frank reporting system over to the MA late November 2013, we conducted a demo that important for the bank to be able to prove that it has
platform. impressed both the business users and the IT team. done so completely and accurately by reconciling
The inherent agility of the MA offering has enabled The following week we ran some sample data positions reported at multiple TRs back to its source
the bank to expand usage of the solution to support through the solution which was then successfully systems. For this the bank decided to replace an in
the changing regulatory requirements across multiple submitted to DTCC. Within just one month contracts house solution with the MA TR position verification
jurisdictions, as and when, they arise. For example, were signed and despite a very tight deadline, the solution which is live for the Canadian jurisdiction and
the bank is now using the MA platform to support a bank went live for EMIR reporting by 12th February is being rolled out for other jurisdictions.”
new regulatory requirement for the reporting of bond 2014 for Rates, Credits, FX and Equities derivatives.”
trades (not derivatives). Significant Benefits
A Long Term partnership As a result of using the MA suite of solutions and
Key Business Drivers David continued. “The success of this first despite increasing regulation, the bank has been able
l Significant cost reduction engagement is developing into a long term and to manage operating costs across the board, and the
l Increased efficiency fruitful partnership. The next step of the relationship relationship continues to go from strength to strength.
l Increased compliance levels – first time was to implement a Canadian reporting solution and The Bank now views MA as the default provider for
then MA took over the entire Dodd Frank reporting all regulatory reporting requirements and is looking
The Project system enabling the bank to de-commission the closely at adding MiFID 2 reporting to the MA
David Farmery, Chief Operating Officer at Message original vendor solution. They had the confidence platform.
Technology Rocket • Edition 6 | Spring 2016 • | 64

Climbing the regulatory

reporting mountain
In recent years, there has been an important increase in
automation, especially in the post-trade side of OTC
derivatives products.

usiness processes such as confirmation and reporting,
which were highly manual, are now electronic. Regu-
latory reporting rules already require some degree of
real-time reporting. Trades are being cleared in Central
Counterparty Clearing houses and recorded in trade re-
positories. All of this increases the importance of connectivity be-
tween all these firms in the derivatives market.
For example, when a firm needs to communicate to multi-
ple regulators, the fact that all of them share the same electronic
data standard makes it easier for firms’ systems to be able to send
data consistently to the different regulators. However, the current
regulatory environment is not moving towards the use of a single
data format for trade reporting. Looking at the current regulatory
standards support, regulators require different formats to com-
For more information:
Visit the Rocket Resources page
for links and more information at
Technology Rocket • Edition 6 | Spring 2016 • | 65

ability in formats supported by regulators but this behavior also

Table 1: Data standards officially supported by regulators extends to other daily operations such as reporting to trade re-
FIX/ ISO positories, trade confirmation, negotiation, trading, and payment
Regulation FpML
FIXML 20022 activities. Firms need to be able to process different data inputs
CFTC Part 20 and are required to produce multiple output formats.
CFTC Part 43 (Transparency) At a more granular level, one of the main issues firms are fac-
US CFTC Part 45 (Recordkeeping) ing is data quality. For example in some trading systems informa-
CFTC Clearing tion is implicitly defined, not all information is contained within
SEC SBSR the system, so it is difficult to extract a complete representation
ESMA EMIR of the trade data. Also, reference data may come from different
ESMA MiFID II sources so there are no unique codes for some of the values be-
Europe ing used in the messages. In these scenarios data validation be-
comes critical. Validation engines that control both the structure
BoE Sterling Money Market Data Collection
and the content of the messages become an essential component
of the internal data messaging toolkit. The sooner validation is
JFSA applied the better in order to avoid data issues in downstream
MAS systems or at external interfaces.
ASIC At transport level, firms use different mechanisms too. A firm
Canada CSA may be using multiple transport mechanisms to send different
Ontario OSC message formats at the same time. Transport mechanisms being
Russia used in financial firms may include FTP/SFTP, AMQP, SWIFT-
Net, amongst others.
ply with different jurisdictions. Formats include open standards If we take all multiple combinations of data and all transport
such as FpML, FIX/FIXML, and ISO 20022. Trade Repositories level mechanisms available in the financial industry, the conclu-
are also using multiple standards and proprietary data formats for sion is that interoperability is very difficult. Thus reducing inte-
trade submission. Some examples of regulatory supported stand- gration costs requires standardization both at data level but also
ards for OTC derivatives are included in Table 1. at transport level.

The problem The solution

There is no single standard that dominates the financial market- The solution that we, at TradeHeader, offer for this problem com-
place so organizations use multiple financial standards. There is bines a set of data converters and validation tools supporting a
also significant use of proprietary formats. Table 1 shows the vari- mixture of proprietary formats and open standards such as FpML,
Technology Rocket • Edition 6 | Spring 2016 • | 66

facilitates the creation of independent components such as valida-

Figure 1: Architecture overview tion tools for different standards, different XQuery components for
data conversion, Java components such as, for example, the Quick-
Financial institution FIX-j open source FIX engine, and more. The activation of these
components when applicable is described within a set of config-
uration files defining what it is called “Contexts”. Contexts are in
FpML / FIX / FIXML / ISO 20022 / CSV / JSON, ...
charge of routing the messages to the appropriate modules within
Camel depending on client and/or format. They may be defined in
HTTP SFTP AMQP JMS XML, Java, or Spring.
The integration framework ‘Apache Camel’ already supports sev-
eral important cloud services. Cloud services can be integrated in
TradeHeader’s Messaging Transformation Apache Camel using the same concepts as we’d use for integration
of HTTP, FTP, JMS, JDBC, and all other Camel components. That
Routing Conversion Validation is the biggest advantage of this integration framework and facilitates
a very flexible deployment. TradeHeader’s Messaging Transforma-
FpML / FIX / FIXML / ISO 20022 ... tion may be deployed in-house or in the cloud depending on cus-
tomer needs.
Most financial organizations have invested in specific transport
mechanisms and data formats. If new regulatory requirements ap-
pear, TradeHeader’s Messaging Transformation (TMT) will take
Trade Repository / Regulator care of transforming the existing firms’ data formats using the same
transport mechanism and send it to the regulator. As an example, an
FIX/FIXML, and ISO 20022, together with an open framework asset manager in the US was using SFTP for transport and CSV as
called Apache Camel that facilitates mes- its format for trade record keeping and it wanted to submit to a new
sage routing with off-the-shelf standard transport level connectivity Swap Data Repository (SDR). The SDR was using AMQP as trans-
such as HTTP, SFTP, AMQP, JMS, JBI, SCA, MINA, or CXF, as port and FpML as their trade format. Using TradeHeader’s busi-
well as pluggable components. ness analysis together with the Messaging Transformation (TMT),
The converters efficiently transform data from/to different stand- the asset manager didn’t have to change its existing format. It had to
ards. For firms, this reduces the costs of understanding and main- install the TMT solution in an in-house server. However it was able
taining these formats. to keep using CSV over SFTP by sending it to the TMT server and
An overview of the architecture is available. See Figure 1. TMT took care of routing, transforming, validating, and sending
Apache Camel provides a modularized solution. The framework the messages to the SDR in the appropriate format. This was a con-
Technology Rocket • Edition 6 | Spring 2016 • | 67

and having to produce and consume them. TradeHeader conversion

Figure 2: Message Transformation modules are developed as complete transformation tools so there is
no need for the financial institutions to work in data transformation.
Financial institution In the current environment, in which regulatory requirements
data formats are changing frequently, TradeHeader’s Messaging
Transformation (TMT) provides a flexible solution in which code
Apache Camel doesn’t need to be recompiled if the data input and/or output for-
Routing mat changes. Routing, Conversion, and Validation may need to
be updated if a new version needs to be supported. However, this
should be transparent for the existing users. The context files take
XML CVS, JSON care of the appropriate version to be used for a specific customer,
where to validate it, and which standard version should be used in
the output. One important value that TMT brings to customers is
Validation Format / Config that it takes care of messaging maintenance.
As a summary, the advantages of this approach include:

XQuery / Config XQuery l Flexibility at both data and transport levels.

Transform Validation Transform l No need for new data standards expertise since
TradeHeader’s converters already give you the data format
Routing Context l No version maintenance since TradeHeader’s converters will
take care of that for you.
l Modularized approach
l Highly customizable
Trade Repository / Regulator l Can be deployed in-house or in the cloud
l Security and reliability
siderable cost saving for the asset manager. It didn’t have to invest in
a new transport mechanism or data format. Expertise in complex financial products and data standards is
See Figure 2 for an example of TradeHeader’s Messaging Trans- scarce. In this current environment, where even regulators are ask-
formation (TMT) using the Apache Camel architecture. ing firms to report trades in multiple formats, tools that allow you
Our approach is to facilitate data conversion as much as possible. to standardize data and transport level interfaces become critical in
Firms find it difficult to work with different standards and formats order to reduce firms’ integration costs.
Rocket • Edition 6 | Spring 2016 • | 68


The Future of Diversity

in Banking
Diversity is key to the future of the banking industry.
Diversity includes an attitude of open-mindedness,
and a willingness to value the contributions of
employees regardless of their background and lifestyle.
There should be training to encourage openness
towards different ideas and diversity in thought. This
also means a specific focus on gender, race, disability,
age and social mobility etc.

lmost a third of board directors at FTSE100 banks are However, the report also warned that although many banks had
women, compared to just over a quarter of FTSE 100 launched notable diversity-boosted initiatives, the perception of the
companies overall. A report released in November 2015 sector being bias towards white, male employees still existed and
praised the banking industry for its efforts to improve there had been limits to how people were held accountable for their
diversity but cautions that there is still more to do. In approach to diversity. Anthony Browne, Chief Executive of the BBA,
particular, the British Banker’s Association (BBA) paper highlights remarked that the report was a positive sign that “the days of the old
that 31 per cent of board directors at FTSE 100 banks are women, boys’ club in banking are numbered”, but also added: “Work still
compared to 26 per cent for FTSE 100 companies overall. needs to be done to increase the number of female senior managers
The business case is not just a financial one but also being able and address the problem of the corporate pipeline. Diversity is more
to provide a better service to the global customer base and instil a likely to be achieved if there are internal consequences for not trying
corporate culture that welcomes new ideas. Optimisation of diver- to improve it. Our industry intends to lead, not to follow.”
sity provides the best commercial impact so that banks are more Race diversity still appears to be the elephant in the room and
adaptable to new situations and opportunities. is nearly 20 years behind gender. According to the Spencer Stuart
Management Rocket • Edition 6 | Spring 2016 • | 69

Board Index 2015 report, racial diversity in UK boardrooms are at The ‘Miranda Brawn Diversity Leadership Scholarship’ provides the next generation
of BAME leaders with greater access to educational and career opportunities via
1998 levels of gender equality, with less than 2 per cent of British
funding, work experience and mentoring. The aims are to help to increase race
directors from FTSE 150 from a Black, Asian and Minority Ethnic
diversity and equality within Britain’s workforce. The Bank of England has a similar
(BAME) background. This is a big problem because it is depriving initiative to help increase race diversity in Banking.
British business of creativity, innovation, insight, experience, all of
which could be making British companies a lot more money. For more information visit:
What else can be done to bring more diversity and
business success to the banking sector?
Exercise more action and less talk. The danger with talking about Innovation, disruption and cutting-edge business thinking is the
your commitment to diversity is that talking about it can feel the result of different perspectives coming together in a constructive
same as doing it, you feel good about it, but nothing actually creative manner to get to a far better place. Hiring practices need to
changes as a result, or at least not at a pace which is satisfactory. be improved and other sectors such as law are considering (i) CV-
Talking about diversity may in fact make things worse: recent blind policy for job interviews; (ii) “unconscious bias” training;
studies indicate that diversity initiatives seem to do little to convince and (iii) beginning with the end in mind. When this is achieved,
women and ethnic minorities that companies will treat them more you are helping yourself, your organisation, the industry and in-
fairly, while making white men believe that they themselves are being spiring a different mix of people to believe that one day they too
treated unfairly. There should be an increased engagement of male could be sitting in a bank. The results are that you do better busi-
diversity champions so they feel part of the diversity initiative. The ness and make a lot more money.
best route is to go ahead and act rather than to keep talking about It has become clear that diversity makes good business sense.
what you are going to do. Communication through demonstration The McKinsey & Company report ‘Why Diversity Matters’ was
is the best form of showing your commitment to diversity. launched in January 2015. Results showed that gender-diverse
It’s 2016. Your board director list on your company website, your companies were 15% more likely to outperform and for ethnically
boardroom picture in your annual report, your media coverage can- diverse companies this was 35%. It is also paramount in demon-
not, and should not, depict your board line-up as all white men. This strating that fair representation and equal access are necessary for
is an issue everywhere and the solution is simple. Change it. When the Banking sector. It needs to reflect the diversity of people and
you know you cannot release that all-white-male board to the press, culture in order to achieve greater success.
you have to change the composition of your board. Do not appoint Leaders need to get behind the business case for a more diverse
one female or ethnic minority director to your board – appoint sever- and inclusive working environment for everyone. Diversity and In-
al. The optimum number of ‘different’ directors for a board is three or clusion should not be about cherry-picking one group for success.
more, because then there are enough of you to be seen and treated as It is about removing the barriers to success for everyone to enable
the norm, you will feel supported and more able to contribute freely. a successful banking industry in the future.