Middle Office Seeks Middle Ground

Terry Flanagan

The evolution of swaps from a bilaterally-executed and cleared model to a centrally executed and cleared model is forcing changes to risk management, the domain of the middle office.

Under the new real-time paradigm, the middle office is being challenged to provide timely information to the front office and to clients without interfering with core processes.

“With a flexible, competitive middle office, counterparty and position risk information can be made available in real time to the risk department or even to the front office to help trading decisions—enhancing risk control,” said Alex Walker, head of post-trade securities at SunGard’s capital markets business, a trading and technology firm.

In the capital markets industry, the front office has seen much growth and innovation in recent years supported by substantial technology changes. At the same time, the back office has seen very little investment.

“While it’s been a feast in the front office and a famine in the back office, can investment in the middle office now bridge the gap to help firms achieve an edge over their competition?” said Walker.

FFastFill, a provider of risk software to the global derivatives community, has enhanced its Orbit Risk platform to conform with the newly revised Regulation 1.73 issued by the U.S. Commodity Futures Trading Commission (CFTC), which stipulates certain risk management obligations for both futures commission merchants (FCMs) and non-FCMs.

The new CFTC rule, scheduled to take effect on October 1, is intended to provide non-discriminatory access to counterparties and clearing, straight-through processing and effective risk management among clearing members.

In particular, the rule bans the use of trilateral arrangements, or “give ups,” which govern the relationships between customers, dealers and FCMs on the grounds that they don’t comport with key provisions of the Dodd-Frank Act that prohibit conflicts of interest between swap dealers, FCMs and derivatives clearing organizations.

Under a trilateral arrangement, the customer is allocated an overall credit limit by its FCM, and each executing counterparty is assigned an individual limit, below which there is enhanced degree of certainty that its side of a transaction will be accepted for clearing by the customer’s FCM.

Last year, trade bodies the International Swaps and Derivatives Association and the Futures Industry Association published the FIA-ISDA Cleared Derivatives Execution Agreement to serve as a “template” for participants in the cleared swaps market in negotiating execution-related agreements with counterparties to OTC derivatives.

The agreement includes optional annexes for those parties that want a clearing firm to be a party to the agreement as part of a trilateral agreement.

In the CFTC rule, the regulator effectively bans such trilateral agreements by preventing FCMs and swap dealers from entering into an arrangement with a customer that would limit the number of counterparties with whom a customer may trade, restrict the size of the position a customer may take with any individual counterparty and impair a customer’s access to trade execution venues.

“The ability to see the firm’s full exposure on a single screen, factoring in give-ins and give-ups, is of enormous informational and operational benefit to risk managers and compliance officers,” said Ryan McElvogue, managing director of FFastFill.

SunGard’s Stream RIMS features modules to automate middle office tasks, including direct market access, trade fee calculation, trade capture and netting, and confirmations and allocations (to Oasys, for example).

“A smart and flexible middle office system used as a global transaction management layer can help the post-trade world transform a legacy client service into a market differentiator as well as improve efficiency and risk control,” said Walker at SunGard.

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