Compression Squeezes Out Derivatives Risk

Terry Flanagan

Compression is a big focus for banks and the buy side, as pressures have intensified since the Basel III standards were unveiled.

Historically in the non-cleared world, a bank may have traded with many counterparties. In the cleared world, those transactions are effectively with just one counterparty: the clearing house.

“We’re trying to help firms improve their capital efficiency through services such as compression,” said Cameron Goh, head of clearing solutions at SwapClear. “As a central counterparty, we can run a portfolio through a compression cycle to terminate off-setting transactions and replace them with equivalent risk positions. This means the participant has a lower gross notional exposure against the clearing house.”

Cameron Goh, SwapClear

Cameron Goh, SwapClear

CLS Group, a global FX financial market infrastructure, and TriOptima, a provider of OTC derivatives post-trade risk management services and infrastructure, are collaborating to deliver an FX forward compression service to the market.

CLS and TriOptima are delivering this service to address several needs of market participants, including the regulatory requirement for financial counterparties to consider the use of a compression service for non-centrally cleared OTC derivatives if available.

FX forward transactions currently account for 13% of overall trading in the global FX market, according to the Bank for International Settlements– with trading volumes rising by 43% between 2010 and 2013. The new service will enable participants to reduce the number of trades effectively, limit their gross notional exposures and therefore reduce counterparty credit risk and leverage ratios, while ensuring compliance with Emir, Basel III and Dodd-Frank.

“International regulators have recognized the importance of portfolio compression from a risk mitigation perspective, and CLS is ideally placed to deliver optimal access to an FX compression solution,” David Puth, CEO of CLS, said in a release. “The new service will significantly reduce exposure to risk and provide numerous operational and cost efficiencies that will help participants to comply with international regulatory requirements.”

“This collaboration creates value for our settlement members through additional services that use our core operational and IT capabilities and those of TriOptima,” he added. “We will continue to invest in new technology to ensure we provide the best possible risk mitigation service to the FX market.”

Peter Weibel, CEO of triReduce, TriOptima’s compression service, said: “Adding FX forwards to our compression catalogue underscores TriOptima’s continually expanding role in the OTC derivatives post trade infrastructure, having already eliminated more than USD524 trillion notional principal across multiple asset classes in cleared and uncleared environments.”

“We believe this kind of collaboration serves the best interests of our mutual customers,” he added. CLS and TriOptima plan to begin offering the service later this year, subject to any necessary approvals.

Risk-constrained compression involves a number of other banks or members of a CCP. Trades are replaced with similar transactions such that a participant’s market risk profile remains economically the same.

Risk-free compression allows banks to take unilateral decisions to net down transactions, where the cash flow profiles are identical, into fewer line items. “Most of our clearing members have reduced their notional outstanding via compression,” Goh said. “If you clear a trade in the first place you always get a reduction in risk weight.”

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