Operations Management - Improving Credit Derivative Operations

Improving Credit Derivative Operations

A combination of factors has presented severe and on-going operational challenges across the life-cycle of the credit derivatives processing (see Figure 1 for depiction of the credit derivatives processing life-cycle). First, an explosive growth in the trading volumes has put tremendous pressure on the already scarce resources that were managing the credit derivatives processes (see Figure 2a). Second, this has been further complicated by the introduction and subsequent proliferation of increasingly complex products in this space (see Figure 2b). Finally, the increasing involvement of a larger base of participants (especially hedge funds) has compounded the challenges exponentially (see Figure 2c).

One of the key fallouts of these challenges has been the delays and inaccuracies in the confirmation process for credit derivatives potentially exposing financial institutions to disputes, losses and risks--including compliance and reputation related risks. As per Government Accountability Office analysis of Markit more than 150,000 trades in September 2005 were unconfirmed among the 14 major dealers, with more than two thirds being more than 30 days outstanding. One of the key reasons contributing to the backlog was the industry-wide practice of assigning a contract to another participant without consent from the original counterparty--which was exacerbated by the involvement of hedge funds. In addition, the process of confirmation was manual and not scalable, resulting in delays and inaccuracies.

On the settlements side, the key problem area for the financial institutions has been the impact on the ability to make settlements on time, especially delivery of reference obligations for physical settlement. In addition to unconfirmed trades, the key contributors to settlement-related challenges are: (i) a price squeeze on the reference entity that has defaulted, and (ii) lack of adequate back-office personnel to address the high volumes of settlements.

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Covering TransactionProcessing Issues BeforeThey Clear and Settle

Improving Credit Derivative Operations

Covering Transaction
Processing Issues Before
They Clear and Settle