Compression in a CCP
triReduce CCP Compression Service
triReduce not only extends the operational efficiency of clearing OTC derivatives but also reduces the potential for systemic risk by compressing trades cleared through a Central Counterparty (CCP). The CFTC final rules for CCPs indicate that portfolio compression should be one of the services offered to members.
As demonstrated by the ongoing compression cycles executed with LCH.Clearnet SwapClear members for their cleared interest rate swaps, compressing within the CCP provides significant benefits without disrupting normal operations. The graph below shows the results of the collaboration between TriOptima and LCH SwapClear. These regular compression cycles contribute to maintaining stable notional outstandings in LCH despite overall growth in market activity.
LCH and TriOptima collaborate
Source: LCH.Clearnet Limited SwapClear Service. For more information on SwapClear volumes, click here.
SwapClear supports periodic multilateral compression activity, to reduce the volume of outstanding trades. The charts that show the effect of compression assume that all trades removed by this process would still be live today.
Minimizing trades in the CCP is a focus of both client and regulatory interest as more and more transactions are directed into clearing. New regulations address portfolio compression for bilateral as well as cleared swaps. A CCP that offers compression has a competitive advantage in attracting and keeping its members. It also reduces the potential for systemic risk that the concentration of trades in a clearinghouse can generate and minimizes the operational disruption of a Default Management process.
How triReduce works for cleared trades
Many institutions regularly participate in triReduce cycles around the globe for their interest rate portfolios. The process in the CCP is similar but more streamlined since trades are already matched and reconciled.
In the cleared trade environment, participants identify and submit cleared OTC trades against their original counterparties that they would like to eliminate from their books. They submit those trades with mark-to-market and risk information and define their individual market risk tolerances.
An unwind proposal is then generated and delivered to the participants and the CCP. The proposal identifies trades that can be compressed at each institution’s own mid mark-to-market values while still respecting the market risk parameters set by each institution. All participants verify the proposal. Once the unwind proposal is accepted by all parties, the CCP calculates the margin impact and where necessary asks for additional margin cover. Once satisfied, the CCP declears the terminated trades and processes the deletions. All participants then eliminate the trades from their books; and those trades cease to incur costs and risk.
Managing risk in a world of increasing complexity
As the new OTC derivatives regulatory landscape continues to develop, the need for risk mitigation will increase. Eliminating trades in the CCP reduces the operational cost and risk of maintaining trade records on the members’ books, and also simplifies the default management process should the need arise. Most importantly, as part of a prudent default risk management strategy, CCPs typically conduct periodic tests of their default procedures. These tests simulate a default scenario including hedging and valuation exercises. The fewer the trades in the CCP, the less time and resources will be needed to devote to these risk management activities.
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