Guide to OTC Trading

Lifecycle of an OTC trade
Welcome to:
LEARNING UNIT 2 | OTC TRADING
‘Workflow, Regulation and Solutions’

INTRO
First, lets have a 1st approach to the lifecycle of an OTC trade by having a look into the standard
trading of a share on a spot (or cash) market as opposed to derivatives trading.
 https://www.youtube.com/watch?v=mEnCKNIb0Bs&index=1&list=PLNea5CpV4u8mE1H-
Di9dmebWtFc1UbQdy
Now, moving on the lifecycle of an OTC derivative trade, we will focus on the trade of an Interest
Rate Swap (IRS) as swaps are the most traded OTC derivative in the world.
For a review of swap basics visit these two links:
 http://www.slideshare.net/RubnGarcaNavarro/financial-derivatives-
55545674?qid=ccc962bd-c524-40c7-b5a6-0aa808e84267&v=&b=&from_search=9
Slides 30, 31, 32, 33, 34
 http://www.investopedia.com/articles/optioninvestor/07/swaps.asp

ROAD MAP OF THIS PRESENTATION
I. PLAYER’S DEFINITION
II. PLAYER’S DESCRIPTION
III. REGULATORY REPORTING, ACRONYMS AND IDS
IV. TRADE TYPES BY EXAMPLES
V. TRADE LIFECYCLE AND WORKFLOW
VI. TRADE EVENTS
VII. INTRO TO MARKETWIRE & VCON
Main sources:
 http://www.cftc.gov/index.htm
 https://riskfocus.com/
 https://www.clarusft.com/
 http://www.marketsreformwiki.com/
Other sources:
 http://global-emarkets.com/
 http://www.dtcc.com/
 http://www.investopedia.com/
 https://en.wikipedia.org/

Link:
 https://riskfocus.com/infographic-the-u-s-derivatives-trade-reporting-ecosystem/
I. PLAYER’S DEFINITION

II. PLAYER’S DESCRIPTION: SEF
1.The role of Swap Execution Facilities (SEF) in derivatives trade execution,
Be the principal execution venue of all swaps in US.
A SEF is defined as a regulated facility, trading system or platform in which multiple participants
have the ability to execute or trade swaps by accepting bids and offers made by multiple
participants in the facility.
Responsibility to report real time data and creation data of swaps executed on a SEF to a Swap
Data Repository (SDR) of its choice, both CPs must also report to the same SDR.
Links:
 https://riskfocus.com/role-of-swap-execution-facilities-sef-in-derivatives-trade-execution-clearing-reporting-part-1/
 https://riskfocus.com/the-role-of-swap-execution-facilities-sefs-in-derivatives-trade-execution-clearing-and-reporting-part-2/

 http://www.cftc.gov/IndustryOversight/TradingOrganizations/index.htm
These SEFs are usually owned by:
1. Either classic US market intermediaries that joined SEF
ranks with brokers, swapdealers and interdealers as
Icap, Tullett Prebon, BGC, Tradition, GFI.
2. Or fintechs, old and new, like Bloomberg,
Reuters and 360T, Tradeweb, Dealerweb.
SEF in the world: 68% of $ denominated IRSs are traded on
United States SEFs | 53% of world swaps for $, €, Yen, GBP
 https://www.clarusft.com/what-is-left-off-sef/
 https://www.clarusft.com/2015-sef-market-share-statistics/
II. PLAYER’S DESCRIPTION: more colour on SEFs
There are 27 SEFs registered lately. See IRS pie for market share,

II. PLAYER’S DESCRIPTION: SDR
2. The role of Swap Data Repositories (SDR) in derivatives trade execution,
Be the mandatory reporting and reportkeeping body for all swaps.
Since all of the steps are done electronically, the trade processing and data comms SEF|SDR occur
nearly instantaneously.
The SEF can choose which SDR to report its trades. Most popular SDRs are the DTCC, CME and
Bloomberg SDR.
Two stages in reporting, the creation of the swap¹ and the continuation of the swap² over its
existence until its final termination or expiration.
Links:
 http://www.cftc.gov/IndustryOversight/DataRepositories/index.htm
 http://www.dtcc.com/derivatives-services/global-trade-repository

II. PLAYER’S DESCRIPTION: DCO, Uncleared Swaps
3. The role of Derivatives Clearing Organization (DCO) in derivatives trade execution,
Be the mandatory submission body for clearing of all swaps.
PRIOR to be accepted a swap deal:
 Is Uncleared
 Has to be reported to a SDR by both the SEF and
the Reporting Counterparty.
 Receives an Alpha USI and the Reporting
Counterparty ID (RCP)|Known also as LEI.
Links:
 http://www.cftc.gov/IndustryOversight/ClearingOrganizations/index.htm
 http://www.marketsreformwiki.com/mktreformwiki/index.php/Mandatory_Clearin
g_Regulation

II. PLAYER’S DESCRIPTION: DCO, Cleared Swaps
3. The role of Derivatives Clearing Organization (DCO) in derivatives trade execution,
WHEN ACCEPTED several things happen simultaneously (see blue lines):
 Is Cleared
 SEF submits an Exit message for the Alpha USI
(the original trade ID).
 DCO creates & communicates new USIs (Beta,
Gamma) to the relevant CPs.
 DCO sends the creation data for the
cleared transactions to a SDR of its choice
using the Alpha USI as the Prior USI.
Links:
 http://www.cftc.gov/IndustryOversight/ClearingOrganizations/index.htm
 http://www.marketsreformwiki.com/mktreformwiki/index.php/Mandatory_Clearing_Regulation
 http://progressive.powerstream.net/008/00102/cmeg_es/CMEClearPort/multiscreen.html

RECENTLY we got two different status coexisting in US for OTC clearing,
plain CCPs and DCO.
1. The main gap being DCO got harder requirements than CCP’s in terms of (credit)
risk management & financial resources.
2. Promoting entity duplication for clearers within US framework as CCP AND as DCO
(See case of JSCC in DCO chart).
NOW an US|EU agreement has been reached to get common ground,
 http://ec.europa.eu/finance/financial-markets/docs/derivatives/20160210-eu-cftc-joint-statement_en.pdf
 http://www.shearman.com/~/media/Files/NewsInsights/Publications/2016/02/EUUS-Agreement-On-Regulation-Of-
Central-Counterparties-FIAFR-021616.pdf
II. PLAYER’S DESCRIPTION: DCO vs. CCP
DF and EMIR regulate OTC clearing in US and EU.
In US the CFTC stablished the DCO as the main player to
clear OTC trades vs. In the rest of the world the figure was the CCP.
Most popular global CCPs are LCH, CME and JSCC (See CCP chart).

III. REGULATORY REPORTING
US with DF and the CFTC set up a regulation framework that defined the appropriate channels to
trade OTC derivatives.
Specifically on swaps stablished that they were to be:
1. TRADED PRIMARILY THRU SEF
2. THEN SUBMITTED FOR CLEARING TO DCO
3. AND FINALLY MANDATORY REPORTING AND REPORTKEEPING INTO SDR
Being US markets the lion share of global trading these rules have become principal to every
market player and to the financial industry as a whole.
Some exceptions are allowed but the bulk of OTC swap trading is subject to these laws.
Links:
 http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm
 http://www.cftc.gov/PressRoom/PressReleases/pr7343-16
 http://www.cftc.gov/PressRoom/PressReleases/pr7342-16

III. REGULATORY ACRONYMS AND FPML
Links:
 http://www.fpml.org/
 http://www.fpml.org/fpml_focus/regulatory-reporting/
 http://www2.isda.org/functional-areas/technology-infrastructure/data-and-reporting/identifiers/
FpML stands for Financial products Markup Language and for OTC derivatives:
 It’s the open source XML standard for electronic dealing and processing.
 Enbodies the industry protocol for sharing information on|and dealing in dervs & structured products.
 Provides the standard data content and structure to exchange derivatives transactions electronically.
The main users of FpML are dealers, asset managers, hedgefunds, service providers, fintechs.
Widely used both in execution, clearing and regulatory reporting to CFTC (Dodd-Frank), SEC (DF)
and ESMA (EMIR, MiFID II, MIFIR).
Guide to some of those acronyms, and how FpML and other standards relate to them,
http://global-emarkets.com/acronyms.html

III. REGULATORY IDENTIFIERS
International regulators and supervisory bodies have called globally for the adoption of unique
identifiers to improve derivatives data reporting, the three main are:
Unique Swap Identifier (USI)|Unique Trade Identifier (UTI)
 Allows to uniquely identify a trade or contract for regulatory reporting.
 That stays unique throughout the life of a trade.
 USI is the CFTC term for UTI used more globally.
Legal Entity Identifier (LEI) is an unique identifier associated with a single corporate entity that
identifies that entity in the financial market. Although no common entity ID convention exists today a
range of regulatory initiatives, as the 20-character alphanumeric code, are driving the creation of a
universal LEI standard.
Unique Product Identifier (UPI) is used to uniquely identify a product and has sufficient specificity
to be used for reporting to global financial regulators. The classification of products is provided via
the ISDA OTC taxonomies.

IV. TRADE TYPES BY EXAMPLES: Simple, With two or more Legs and Structures
SIMPLE These trades involve the use of just one derivative instrument.
 For instance, 50 million euros on a 3 month forward on eurocurrency.
 Another trade would be a Feb 2022 1.10 Call relating Euro/GBP on 25 million of dollars.
With TWO or MORE LEGSThis trade involves the use of several derivative instruments of the same
kind. Let’s think on option strategies like a bull call spread on the eurocurrency. Here we have two
legs, buying the Sep20 1.05 Call & selling the Sep20 1.20 Call. On a long call butterfly we
would have 3 legs again of the same derivative instruments (options).
STRUCTURES Involve the use of several derivative instruments of different kinds. For instance, a
guarranted fund that delivers in 2 years either the invested capital or the 60% of the rise of the SP500.
In this case we might buy a 2yr Forward on the SP500 together with the buy of a 2yr Put at closest
strike to present SP500 levels, thus, using forwards and options.
Links:
 http://www.theoptionsguide.com/bull-call-spread.aspx
 http://www.optionseducation.org/strategies_advanced_concepts/strategies/long_call_butterfly.html

V. TRADE LIFECYCLE AND WORKFLOW

V. TRADE LIFECYCLE AND WORKFLOW: Acknowledgement and Trade Confirmation
What? Both are important processes aimed to reduce the risk of the traders P&L.
 Sending trade Confirmations to the counterparty.
 Receiving trade Confirmations from the counterparty.
 Trade or Contract Matching.
 Trade Affirmation.
The counterparty acknowledges the trade details. Before that, some amendments|updates
might arise on the price or quantity of the trade, impacting the trader’s P&L book. This
agreement on trade details can be achieved through:
How?

V. TRADE LIFECYCLE AND WORKFLOW: Trade Matching
TRADE MATCHING generally applies to mandatory electronic matching of trade details.
Both parties are required to input details to a central matching facility.
Matching results (i.e. matched, unmatched) are provided by the trade matching facility to both
parties.
Examples include:
 Omgeo Central Trade Manager (CTM).
 TRAX (Internationally traded debt & securities).
 Depository Trust & Clearing Corporation (DTCC).
 National Securities Clearing Corporation’s Trade Matching Service (NSCC).

V. TRADE LIFECYCLE AND WORKFLOW: Trade Affirmation
TRADE AFFIRMATION relates to the electronic matching & processing of trade details typically
between Securities Institutions and Institutional Clients (being both subscribers of this service).
The Institutional Client agrees (AFFIRMS) or disagrees (REJECTS) and the response is sent back to
the Securities house. When affirmed by both parties It’s usual that the Hub generates and sends
automatically Confirmations to both counterparties with the affirmed trade details.
Examples include:
 Omgeo’s Oasys Global system.
 FIX – (Global)
 Oasys Domestic - (US)
 DTC ID (Institutional Delivery) – (US)
INPUT of Trade Details
By the Securities Institution
PROCESSING and SENDING to CLIENT
By the Affirmation Central Hub
AFFIRM|REJECT of Trade Details
By the Client

VI. TRADE EVENTS: Intro
In the Booking & Record Keeping of Trade Events each Institution face 3 Conditioning Factors,
 Its Record Keeping and Booking Systems
For example, as in Murex there are just 7 actions and It is thru those actions that the institution has to reflect
a bigger number of trade events, each trade event can be articulated in several valid ways. The institution
procedure to articulate and name, let’s say, a novation in Murex has to be taken into account. Thus, a
novation for ‘Bank A’ which is a Murex user is done thru two actions, a new trade and a cancellation.
 Its Procedures & Terminology
 The Regulatory Reporting Requirements
At the end of the day, from the regulator point of view, it is not so important how Banks articulate their
booking internally. Trade events are to be reported as defined and indicated by the authorities in terms of
frequencies, formats, fields and so on.
Using Murex, Star, Kondor or WallStreet matters when it comes to ‘How to reflect trade events’ thru its
lifecycle.

 Allocation
 Amendment
 Backload
 Compression (ie, TriOptima)
 Corporate Action
 Credit Event (also succession)
 Exercise ( Full | Partial )
 Exit
 Increase
 Modification
 Novation (F|P)
 Position cancel or Error
 Termination (F|P)
 Trade or New Trade
 Unwind (F|P)
VI. TRADE EVENTS: Overview
Brief terminology on OTC trade events reported to Global Trade Repositories (GTR),
A SDR is a GTR specilized in swap trade reporting under US jurisdiction.
Here a DTCC link showing in pages,
 18 to 22 Complete Table with compatibilities between Business Events | Lifecycle Events
 24 to 29 Models of reporting depending on:
o Trades being: Bi-lateral | thru SEF
o Reporting being: Independent| DelegatedLink:
 http://www.trioptima.com/services/triReduce.html
http://www.dtcc.com/~/media/Files/Downloads/Data-and-Repository-
Services/GTR/GTR-Europe/DTCC-GTR-OTC-Lite.pdf?la=en

VI. TRADE EVENTS: Main Post Trade Events
Trade events rules set by Regulators focus specially in the full reporting of three fields:
Counterparties, Notionals and Expiries. Both initial values and later changes.
NOVATION (Full|Partial) It’s the act of replacing one Counterparty in a contract with another.
 http://www.investopedia.com/terms/n/novation.asp | http://www.isda.org/publications/pdf/2004ISDANovDefinitionsUG.pdf
INCREASE|DECREASE
It’s an early termination by means of changing its Maturity. From that moment, both
counterparties will cease to make the previously agreed-upon payments.
EXERCISE (F|P)
UNWIND (F|P)
COMPRESSION
To implement the Right of the holder of an option to buy (in the case of a call) or sell (in the
case of a put) the underlying of a contract. Usual also in credit events.
A process of terminating a swap by marking it to market and calculating its value in order to
determine which counterparty has a positive terminal value that would be paid by the one
whose terminal value is negative.
TriOptima allows to reduce the size of OTC derivatives notional exposure|number of items in
a Portfolio vs. each Counterparty in order to improve risk management.
Implies modifying the Notional of an existing contract.
TERMINATION (F|P)

MarkitWire is the most widespread OTC trade and postrade solution in the financial markets,
 How it works? Intro to MarketWire (32 min. video)
http://cdn.markit.wallst.com/MarkitServVideo/Content/MarkitWire/Equity/MWEQ05.html
 Who owns it? Intro to Markit: History, shareholders, acquisition
 More Markit solutions
VII. INTRO TO MARKETWIRE & VCON
VCON is Bloomberg platform widely used for trading and clearing of cash and derivatives.
 Connects buy and sell side firms to multiple CCPs, specially in IRS|CDS.
 Allows trade matching, generation of confirmations and sending of trades to clear on CCPs.
 Standing for Voice Confirmation its workflow shows trade status (affirmed, rejected, cleared, pending).
 Interacts with MarkitWire/MarkitServ
http://www.idcg.com/pdfs/idcg_news/VCON.pdf
https://en.wikipedia.org/wiki/Markit
http://www.markit.com/product/markitserv

End of presentation,
Thank you.
Fonetic Trading Unit
LEARNING UNIT 2 | OTC TRADING
‘Workflow, Regulation and Solutions’

Guide to OTC Trading

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