The continued pressure of leverage ratios, G-SIB rules and constrained operational resources have driven banks to look for increasingly sophisticated compression solutions.
Low Touch Compression is the next evolution in the compression process delivering improved usability, user transparency and full automation together with API technology. Banks can now have a highly efficient compression process that can be run daily with all instruments supported by the CCP co-mingled in a single run, enabling further process consolidation and allowing banks to optimize the resource levels required to support the processes.
NatWest Markets is pleased to be one of the first dealers to adopt low touch compression. The ability to compress different rates products simultaneously freed up operational resource, while the new LTC capabilities avoided several hours of processing time and system dependencies.
Ian Turner, Head of Flow Portfolio Optimisation, NatWest Markets.
Increasing balance sheet pressures, primarily from the leverage ratio and the implementation of rules governing global systemically important banks, drove banks to explore all the available options to mitigate the balance sheet impact. The most effective tool is compression.
With the relentless growth in OTC trading volumes over the last decade, banks demanded innovation and an increasing frequency of compression cycles as they looked to manage their escalating balance sheet costs, whilst operating against the backdrop of growing resource constraints and systems limitations. Moreover, the growing sophistication of compression techniques was placing an additional burden on banks as the importance of data accuracy became paramount.
Increasing balance sheet pressures and growing resource constraints have seen banks increasingly turn to compression as an effective means of mitigating costs and risks. As a result, it’s important that compression services evolve to meet the needs of clients today.
We’re pleased to compress co-mingled swaps for our customers via our new Low Touch Compression approach which not only minimizes the time spent by clients, but also provides superior data checks so they can compress in confidence.
Global Head of Sales and Relationship Management, triReduce.
The project set out to achieve several design goals:
The system required intelligence, so it could accept data submitted in any order, determine what was sent and decide what to do with it. The data needed to be rigorously validated and have a rule-based exception process, with the system providing comprehensive and timely feedback to the end user.
To provide a fully automated process a new system architecture was required. It had to react to asynchronous events, interpret the event and determine the action to be performed. To do this, the workflow was modelled in a state machine which operates seamlessly with a UI or via an API.
The simplest mechanism to deliver process automation is SFTP, but this is limited and not suitable for interactive applications and providing feedback on data submission. It is essentially a limited mechanism with the file naming convention providing the only clue as to what to do with the file.
A more advanced solution was required, which needed to:
Be straight forward to implement for clients
Provide a format that allowed for structured data transmission
Be suitable for interactive applications
Be an established industry standard with libraries available for most programming languages
Use HTTPS to reduce the dependency on opening ports in firewalls
Low Touch Compression Process - Applies to Cleared Rates
Internet standard REST (Representational State Transfer) was chosen as the API technology which is the de facto internet standard.
Standard libraries are available in most programming languages and REST uses HTTPS as does normal web traffic. Additionally, documentation is interactive reducing deployment time for clients.
Data integrity is a key prerequisite in providing a successful compression service.
The initial checks determine if the trades are correctly booked. All errors are quantified and the pre-set rules (fixed by the customer) govern the actions that can be performed on the trade, enabling the process to be fully automated. A typical example is an incorrectly applied fixing.
100M 12Y Rec Fixed @0.523. Next floating cashflow due 07-Oct-2019.
Fixed on 3-Apr-19 @ -0.23.
Trade is processed in FER:
A 9bp error on a 6-month fixing on a 100million notional trade equates to a ~50k cash break.
Errors highlighted by the compression process can either be rectified before they become settlement issues (which would reduce the P&L impact and increase the operational costs) or, if the error is below the pre-determined error threshold the automated process will continue. Either way, the threshold will determine the course of action.
Next, the MTM and risk undergoes a reasonableness test, for example trades could be valued using the previous days curves. Errors are identified, and the trades excluded.
The Low Touch Compression re-engineering provided an ideal opportunity to expand the framework and allow for all instruments supported by a CCP for multilateral compression exercise to be included in a single compression cycle. Inflation and basis swaps can now be co-mingled with IRS, FRA and OIS all with the same integrity checks and robust controls.
The lightweight data requirements for LTC minimizes the client development effort required to include new additional instruments and functionality.
Compression has evolved from a basic operational task, undertaken by a handful of banks to help reduce line items in their books, to a necessity reducing capital costs for most institutions actively trading OTC derivatives.
The increasing demands of managing financial institutions balance sheet costs has placed significant operational pressures on the organizations running numerous disparate processes. Low Touch Compression, with state-of-the-art automation and technology, and full co-mingling of all instruments supported by the CCPs, reduces expensive errors and significantly increases the efficiency of a bank’s post-trade processes.
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