OTC Clearing ‘FIX’ed Up!
Up to this point we have discussed only the back-end aspects of a central clearing service offered via the clearing house. Let’s discuss how trades are actually submitted to the clearing service by market participants. Most participants transact their deals on a third-party trading platform designed to support an affirmation and matching process. Once a deal has been matched it is submitted to the clearing service. This requires that the trading platform know the valid set of instruments, parties, and accounts which are accepted by a clearing service. Taking the CDS market as an example again, trade reports specifying the buyer, the seller, their respective accounts, the contract, price and upfront amount are submitted for clearing. The designated clearing members (DCM) for each party must also be specified. When received by the clearing service the trade is validated and credit limits are checked. If all checks are passed, the clearing service returns a cleared trade confirmation to the trading platform and the trade can be considered “cleared”. In the case of a credit failure the platform will be informed that the deal cannot be cleared.
Now let’s turn to the question of how FIX can be used effectively throughout the OTC trade submission and clearing process as has been described above, keeping in mind that the recent standardization of OTC products makes FIX a relevant player in the OTC arena.
FIX- A relevant player indeed
Firstly, FIX provides an effective mechanism for OTC trade submission. The rich trade reporting workflow allows either single sided or two sided trades to be submitted with all requisite OTC trade attribution. Both models are commonin the OTC market; single sided trades for affirmation and matching, two sided trades if matching has already taken place and immediate submission to the clearing service is desired. CDS, FX, Energy, and other types of OTC commodities such as gold forwards can be fully described using the recently extended FIX Instrument definition. Trade status and report types can be used to concisely convey the trade state at any point in the workflow. CME uses FIX for the purpose of receiving OTC trades submitted for clearing in the aforementioned products from trading platforms. Several of these commercial platforms have been able to leverage existing FIX implementations.
FIX may also be effectively applied in the reconciliation and cash flow reporting aspects of OTC clearing. The Position Report message allows OTC trades which have been multilaterally netted to be expressed as positions and reported for reconciliation purposes at the end of each day. In the same vein, FIX has recently been extended to represent all the cash flows that are relevant to CDS. Reset to par, Initial Coupon, Daily Accrued Coupon, Quarterly Coupon Payment, and Collateralized Mark to Market are all cash flow amounts that are supported in the FIX lexicon. Additionally, the same FIX workflow used to submit trades to clearing can be used for static trade reporting. In the case of CDS, the FIX Trade Capture Report carries all fields necessary for the DTCC Copper trade reports. CME uses FIX in exactly this capacity in order to provide clearing firms with all details of a clearing cycle.
Reporting of OTC settlement prices on a consistent and timely basis can be accomplished through the use of the FIX Protocol. FIX allows settlement prices to be expressed in a number of terms required by market participants including percent of par, points and spread. This is done using the Market Data Snapshot message. FIX price reporting also provides support for secondary OTC pricing needs, including discount rate which is used to determine the present value of forward style instruments as well as the recovery rate used during a CDS credit event.