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Examples: In 1973, stock certificates were virtually replaced by electronic blips on computer screens, with the launch of its subsidiary for online operations, the Depository Trust Company. In 1985, it began processing purchases, redemptions and exchanges of mutual fund transactions as well as settling the transactions electronically through the Fund-Serv platform. In 2003, DTCC began automating the affirmation and confirmation of transactions in over-the-counter derivatives such as credit default swaps.
In 2006, the DTCC created a Trade Information Warehouse to keep track of just about every credit default swap contract globally. In July 2008, DTCC teamed up with Markit to create a joint venture that will provide a front-to-back office platform for over-the counter derivatives Its goal is to provide buy and sell side firms a unified system for OTC derivative confirmations, affirmations, allocations and novations for credit default and interest rate swaps.
What’s left? DTCC has now set its sights on playing yet another role in the often neglected aspect of the OTC market – managing collateral. But it doesn’t know what to do yet. It just knows what it doesn’t want to do.
DTCC has been talking to fund managers, banks and brokerage firms about the types of automation DTCC might provide to help make the collateral management process more efficient, says Daniel Faryniarz, DTCC’s managing director of market structure and industry relations who took on the new role in April 2009. His job description: to help oversee DTCC’s strategies in OTC derivatives. DTCC also hired John Straley, director of financial services consulting firm Acquis Capital in New York, five months ago to come up with a gameplan.
While Faryniarz won’t give any inkling of DTCC’s intentions, he is eager to hear any ideas.
“Collateral management processing and reporting are areas we believe DTCC could provide benefit potentially. “Over the years with the industry's guidance we have developed processing capabilities as well as network connections which led to more efficient and streamlined processing across the securities arena. We would hope to do it again."
But so far, no timetable has been set for any project. And until there is an industry consensus on messaging formats DTCC’s efforts will be stalled, insists Faryniarz.
“Deciding on message formats is a necessary first step and there is enough involvement in this space already,” says Faryniarz. “DTCC would look to work with whatever message standard is chosen by the industry but is not working on developing a messaging option itself. DTCC is also not building any messaging hub on its own.
One intriguing and practical possibility that two operations executives involved with collateral management suggested to Securities Industry News last week: a link between DTCC and AcadiaSoft. The Boston-based firm has already nabbed some of the world’s largest broker-dealers to use its hosted message hub for margin calls. That means it can provide an automated means for fund managers and broker-dealers to electronically communicate margin calls with each other regardless of whether they use an internal or third-party collateral management system. And it provides workflow management, time stamping and an audit trail
A group of 14 of the world’s largest broker-dealers have now promised the New York Federal Reserve Bank that they will being to test electronic messages with standardized formatting of data by December. Some have already selected AcadiaSoft as their message hub.
But AcadiaSoft’s role ends at the point of making the margin calls. It doesn’t actually move collateral once the margin call is agreed upon or any disputes are resolved. DTCC, said the operations executives, could find a way to help fund managers, broker-dealers and custodian banks representing fund managers figure out just how they can verify that the collateral as actually been moved between counterparties. They said that such a link could be expanded beyond OTC derivatives collateral management to triparty repurchase agreements.
Here is how the process currently works: Firms reconcile their positions, value their portfolios, then issue a collateral call, in various handwritten and typed forms. The two counterparties reach agreement regarding the changes in the portfolio value and then collateral is moved between the firms to secure any uncollateralized credit exposure. It happens every day in every major bank, brokerage firm or fund management firm.
The problem? There are no agreed-upon formats for the data and the communication is taking place via fax and email.
That means that operations executives in the collateral management departments have to read narratives and then determine whether the other side is right or wrong. Then, they must decide what to do about it. It’s not just one or two emails a day - it could be several hundred. Hence, there is plenty of room for disagreement and potential error.
The International Swaps and Derivatives Association (ISDA) is promoting the FpML message type – often used in derivatives processing -- while the Society for Worldwide Interbank Financial Telecommunications (SWIFT) is developing yet another set of messages that will be compliant with the International Standardization Organization’s 20022-formats. The two message types will likely contain the same information, but they aren’t interchangeable. And they aren’t providing message hubs with workflow management tools. AcadiaSoft is.
Just as inefficient as margin calls is the movement of collateral. Even if the margin call ends up being accurate, the next and final step of the process could easily go awry. Most custodian banks working on behalf of fund managers say they send an ISO 15022 compliant message over SWIFT’s network to indicate that collateral is being delivered.
But they have no way of knowing whether the broker-dealer has received the collateral, if they don’t receive a confirmation. They often have to call the broker-dealer to check on the status of the collateral. And the collateral can sometimes find its way into an incorrect subsidiary of the broker-dealer.
Operations executives at two fund management firms in New York say they have encountered a few cases in which collateral was either not delivered on time or delivered to the wrong unit of either their firm, the broker-dealer or the custodian bank. In other cases, nobody knows where the collateral went. And some fund managers are now discovering that their collateral has become an unsecured asset in Lehman Brothers’ bankruptcy proceeding. That means - they might not get it back.
In late 2008, the International Securities Association for Institutional Trade Communication tried to do something about this. The payments working group of this trade association of fund managers and custodian banks began to develop post-trade communication standards and came up with some guidelines on how cash collateral is to be delivered between fund managers and their custodian banks. Now, the group is working on how securities collateral is to be delivered.
If you have any ideas on what DTCC's role can and should be, Faryniarz' inbox is open. Email him at:
dfaryniarz@dtcc.com
