Tradition To Enter Rates Compression
Interdealer broker Tradition plans to extend its partnership with LMRKTS, a compression and analytics provider, into interest rates after expanding their foreign exchange compression service into decreasing initial margins.
Last year Tradition partnered with LMRKTS to launch compression for G10 foreign exchange forwards, which was expanded to non-deliverable forwards. This month the two firms completed a compression cycle to minimise the exchange of initial margin for NDFs.
Dan Marcus, global head of strategy and business development at Tradition, told Markets Media: “Compression can be expanded to any asset class. Expansion is on our joint timeline in 2017.”
Compression is a process in which clients can “tear-up” offsetting trades in their portfolios to reduce the notional outstanding and number of line items in their portfolio while maintaining the same risk exposure. Use of compression services has increased following the introduction of stricter capital requirements, such as the Basel III leverage ratio, which has led to banks reducing their balance sheets and capital efficiency becoming increasingly important.
Tradition said 17 banks were involved in the tests to optimise initial margin which led to reductions of between 32% and 43%. A live run was completed for NDF trades and the processing of 132 sides of trades was completed within 8 minutes and 9 seconds. The banks send their position data and criteria to LMRKTS for the compression cycle and the resulting trades are executed by Tradition, so the broker does not receive data on the portfolio positions.
“We focused on banks first as they are still the primary wholesalers of risk, and the primary market makers in financial markets,” added Marcus. “They are heavily impacted by regulation, so they benefit the most from capital reductions. However, this does not preclude us from expanding beyond banks; it’s about focusing our resources on where it is most needed right now and solving those problems.”
Marcus continued that the partnership has proved, through the quality and efficiency of the LMRKTS algorithm, the benefit of compression in FX forwards and NDFs.
“It is our intention to expand into other asset classes with interest rates being next,” Marcus added. “There is room for competition in compression and we have the international client base, regulatory oversight and connectivity to deliver meaningful reductions in risk exposure and capital requirements.”
Last month fintech venture capital firm Motive Partners invested in LMRKTS.
Hilary Park, CSO at LMRKTS, said in a statement: “LMRKTS strives to drive the counterparty risk of a derivatives portfolio down to its net market risk and to do so through a post trade process as easy if not easier to use than existing compression services. We have developed math that reverse solves from this ideal end state and are excited to roll out new applications of these methodologies over the coming months and years.”
In September last year, LMRKTS eliminated $430bn worth of foreign exchange notional exposures across five currencies for six banks in its first scaled commercial run. LMRKTS reached the trillion-dollar mark of gross notional reduction in the third run.
Last week CLS Group, the bank-owned FX settlement infrastructure, and TriOptima, the Nex Group unit which provides post-trade infrastructure for OTC derivatives, said counterparties had eliminated $1 trillion in gross notional value from their outstanding portfolios using the triReduce CLS FX Forward Compression Service. The statement said an upgrade to the service in the coming months will offer standard multilateral compression and introduce the ability to achieve net exposure reduction by adding new, offsetting trades.
David Puth, chief executive of CLS, said in a statement: “This is a significant milestone for the compression service which has shown substantial growth over the last year, both in the number of participating banks and in the amount of notional reduced. The enhancement to the service will create additional value for our clients, enabling them to further improve their leverage ratios and significantly reduce risk in the FX market.”
Amir Khwaja, chief executive of analytics and research firm Clarus Financial Technology, said in a blog that LCH ForexClear, part of the London Stock Exchange Group, cleared the vast majority of NDFs on US Swap Execution Facilities last month.
In addition LCH SwapClear service cleared record volumes of interest rate derivatives and compressed a record $384 trillion in notional last year. LCH said in a statement: “Increased use of LCH’s compression services was encouraged by recent expansions to SwapClear’s offering, including the compression of inflation swaps and the introduction of multilateral compression for clients.”
The derivative platform closed its second funding round this month.
New products include the launch of a SONIA futures contract.
Equities, fixed income and OTC derivatives clearing volumes all increased.
Efficiencies from clearing are being extended to non-cleared derivatives.
EU looks to align margin to physically-settled FX forwards with other jurisdictions.