In the wake of the financial crisis of 2008, the Group of Twenty (G20) nations agreed to a series of regulatory reforms for the over-the-counter (OTC) derivatives market. The Financial Stability Board (FSB) was tasked with revamping the system, and proposed measures to improve the transparency of the market, protect against market abuse, and mitigate systemic risk. One of the key changes has been the emergence of middleware platforms and the changing role that they play in the OTC derivatives market.

Revised Functionality of Middleware Applications

The G20 countries had envisioned the creation of a central database for all OTC transactions as a tool for preventing systemic risk. However, instead of one central source, the data is now flowing into a number of entities that are competing to serve as repositories. As a result, there is a need for more efficient processes such as near-real-time reporting of trades, shorter durations for posting allocations, submission of trades for clearing post execution, and operating in an exchange-like world. In order to meet these requirements, new players such as SEFs, CCPs, DCOs, SDRs, and independent repositories for each of the regulators – CFTC, ESMA, and HKMA – have been introduced to the OTC derivatives trade lifecycle process. DTCC, CME group and ICE trade vault have applied for licenses in multiple regimes and become key players in the trade repository world. Middleware applications have been essential in creating software solutions that can provide real-time compliance with reporting requirements by providing connectivity to the various market players. As affirmation/confirmation platforms become less popular for contracts executed on electronic venues, middleware applications have taken on a renewed role.

Middlewares address the demands of two major industries.

MarkitServ, Markit’s flagship offering, has evolved in the post-regulatory world and now offers unparalleled industry connectivity. It connects trading counterparties, execution venues, clearinghouses, and trade repositories to streamline trade processing across asset classes and help market participants meet regulatory obligations. Middleware services like MarkitServ cater to two big industry needs – connecting the growing number of OTC market players and allowing the counterparties to compare and affirm the details of the trade. Jeff Gooch, CEO of MarkitServ in London, emphasizes that even if the trade affirmation side of middleware services disappears for trades executed on SEFs, the value proposition of middleware still stands. According to Gooch, middleware also provides important status messaging information to clients, such as whether the CCP has cleared the trade and whether the data warehouse has accepted it.

Requirements for Mandatory Clearing and the Necessity of Collateral Management

To mitigate counterparty risk, the use of collateral management has become an integral part of the process. Collateral management involves monitoring, measuring and managing the credit exposure of counterparties through the exchange of collateral. It involves the exchange of collateral on a regular basis to ensure that the required margin is maintained. The use of collateral management enables market participants to reduce counterparty risk and ensure that they have sufficient collateral to cover their exposures. The amount of collateral required will depend on the counterparty risk profile of each counterparty, the type of swaps traded, the creditworthiness of the counterparties and the market conditions. Each clearing house will have their own rules and requirements for collateral management, which must be followed in order to ensure compliance.

Collateral management is an essential component of the modern trading system. Clearing houses accept trades based on the collateral posted by clearing members at the time of executing the trade, making it necessary to route these trades to the CCPs in real-time in order to confirm clearing acceptance. To this end, messaging platforms such as MarginSphere from Acadia Soft, which facilitates and manages the communication of collateral calls, have become increasingly popular. Furthermore, SEFs need to be connected to multiple CCPs and trade repositories in order to stay on top of the ever-changing market. This has led to an increase in industry spending on technology, as firms are now looking for clearing members with reliable technology.

The Necessity of PreTrade Credit Checks

In order to ensure clearing certainty, regulations have mandated that a clearing member must perform credit checks for each transaction. As a result, there is an increasing requirement for real-time pre-trade credit checks. This is necessary in order to prevent trades executed on Swap Execution Facilities from being rejected by the client’s FCMs. To meet this requirement, SEFs must connect and access clearing members to confirm credit lines before executing trades. MarkitServ’s Credit Centre was designed to serve this purpose.

Credit Centre was an innovative, cost-effective pre-trade credit checking service that provided ultra-low latency verification of customers’ credit with their FCM for orders placed on electronic execution venues such as swap execution facilities (SEFs). Traders could manage their credit lines across multiple venues in real time with a single web-based dashboard, and it also served to meet the regulatory requirements of mitigating the risk of clearing-eligible trades being rejected at the clearinghouse due to insufficient credit. As markets continue to evolve, Credit Centre can prove to be a game-changer, as its early introduction has provided a platform for future developments.

What is Straight Through Processing (STP)?

Straight Through Processing (STP) has emerged as a key concept in the financial services industry since the introduction of FpML 5. STP is an automated process in which transactions are processed with minimal manual intervention. It reduces the cost of processing transactions and enables faster and more accurate trade execution. With STP, transactions are executed, cleared and reported in real time, leading to improved accuracy, speed and cost-efficiency. Additionally, it reduces the risk of errors and fraud by providing a single source for trade data that can be monitored for accuracy, compliance and risk management. By automating the processing of transactions, STP improves the efficiency of the financial services industry, making it easier for firms to meet regulatory requirements and deliver better value to their clients.

MarkitSERV’s TradeSTP solution provides a mechanism for transforming customer-specified XML into the standard FpML format required for delivery to counterparty and clearing houses. This offers customers an effective way to access market participants supported by MarkitSERV for post-trade STP. TradeSTP also supports industry standards, like FIX and FpML, to ensure smooth and accurate messaging flows.

With the rise of trade repositories, CCPs, and SEFs, the emphasis is on achieving connectivity, conducting pre-trade credit checks, and achieving straight-through processing (STP) in order to meet real-time clearing requirements and reporting needs. MarkitServ middleware is a key element in this area, providing the necessary tools to facilitate these efforts.