Orchestra & Tempo

Understanding the challenges the shifting regulatory environment poses to clients, Societe Generale has launched a new, fully integrated service to support clearing and processing of OTC derivatives.

Entitled Orchestra, this global solution brings together the clearing capability provided by Newedge (the prime clearing services division of Societe Generale) with the comprehensive post-trade derivatives processing and reporting services offered by Societe Generale Securities Services (SGSS). Completing the proposition is the range of swap dealer and execution services offered by Societe Generale Corporate and Investment Bank (SG CIB).

New regulation requires new arrangements

This novel solution comes at an opportune time for asset owner, buy-side and corporate clients that make significant use of OTC derivatives in their investment and trading strategies, along with financial institutions that support the use of privately-traded derivatives.

In the aftermath of the global financial crisis, G20 leaders agreed a comprehensive package of reforms applicable to OTC derivative markets to improve transparency, mitigate systemic risk and protect against market abuse. In the U.S., the core content of this reform agenda has been implemented through the Dodd Frank Act, which requires that sufficiently liquid and standardised interest rate swaps (IRS) and credit default swaps (CDS) are traded on new electronic trading platforms known as Swap Execution Facilities (SEFs) and cleared via a CCP. All OTC derivatives contracts, whether cleared or non-cleared, must be reportedto a licensed trade repository.

In the European Union, European Market Infrastructure Regulation (EMIR) is the parallel reform programme. Although some of its technical requirements are still being defined, the clearing obligation for eligible OTC derivative transactions is being rolled out via a staged migration:

  • Financial counterparties that are currently clearing members are expected to meet this requirement within six months of the regulatory technical standards coming into force, most likely by June 2015
  • Other financial counterparties will potentially need to be compliant by June 2016
  • For non-cleared trades, the requirement for bilateral counterparties to exchange variation margin will apply for all contracts entered into after 1 December 2015
  • The requirement to exchange two-way initial margin on non-centrally cleared contracts will be phased in between 1 December 2015 and 1 December 2019.

François Bouclier, Institutional Sales Manager at Newedge in charge of OTC Clearing for Continental Europe, believes that economic factors will drive many banks to begin clearing OTC derivatives as early as possible.

“Banks have a strong incentive to clear before the EMIR obligation actually comes into force. Why? Because they can reduce their Credit Valuation Adjustment (CVA) requirements and obtain better execution prices,” Bouclier explains. “Cleared transactions will benefit from CVA exemption, leading to lower capital costs, which will potentially translate into a lower execution price, not to mention standardising and simplifying most internal processes.”

Against the backcloth of regulatory change, Tier 2 and Tier 3 banks will need to evaluate their clearing strategies and decide whether to be a direct clearing member and develop in-house clearing capabilities, or employ a clearing broker.
Given the cost and complexity involved in adapting to new regulation, some firms may find significant benefit in outsourcing elements of these OTC derivatives clearing and lifecycle management functions.

Indeed, it should be noted that the mandatory central clearing requirement will not be applicable to all OTC derivatives. As a result, firms that choose to manage these activities internally will need to support multiple systems, maintaining one set of operational and legal arrangements for centrally cleared OTC derivatives, and a parallel set to handle any non-cleared OTC derivative transactions. Such replication may bring unwelcome organisational complexity and higher costs to maintain technology and manage legal requirements.

in tune with clients’ needs

A strength of the Orchestra solution notes Clément Phelipeau, Product Manager, Derivatives & Collateral Management Services at SGSS, is that it offers an integrated OTC derivatives solution – from clearing through the full post-trade lifecycle – regardless of whether the trade is cleared or non-cleared. “For clients that elect to outsource this activity to Societe Generale, Orchestra will remove the need to manage technology and systems upgrades and, subsequently, to maintain parallel silos for their cleared and uncleared OTC derivatives activity,” explains Phelipeau.

He adds: “Selecting Orchestra gives clients choice and flexibility. Connectivity between Newedge and SGSS is well established, which minimises the need for clients to adapt their interfaces to clearing brokers, affirmation platforms, and other third-party service providers. Additionally, customers can choose to employ a full outsource package, or source elements on a modular basis.” Newedge is renowned for its deep expertise in derivatives clearing, especially for listed derivatives. Building on this capability, it has developed comprehensive OTC clearing capabilities and is a clearing member on all the major CCPs in the U.S. and in Europe for clearing listed and OTC derivatives.

Additionally, recognising that capital is a scarce resource, Newedge offers cross-margining capabilities, enabling clients to reduce their overall margin costs by netting across asset classes. Clients can also benefit from pre-trade IMR simulation through the “What if” margin computation tool, which enables customers to evaluate their initial margin requirement across various CCPs on a pre-execution basis. Using this ex-ante margin cost analysis, clients can select the best CCP to clear a new transaction and monitor their aggregate cost of trading and ongoing initial margin commitments on a near real-time basis.

Complementing Newedge’s capabilities, SGSS offers a global approach to collateral management, enabling clients to optimise margin management across all types of OTC derivatives product and across their full range of clearing brokers, CCPs and bilateral counterparties.

“SGSS will track any excess margin at counterparty and CCP level and will initiate immediate recall of this collateral, thereby preventing overcollateralization and minimising potential fragmentation of liquidity,” says Clément Phelipeau. SGSS offers a range of reporting options, providing clients with a clear overview of their transaction portfolios and highlighting any outstanding exposures that require collateralisation. Phelipeau continues: “Our solution is built on an open architecture model, dictating that we can process OTC transactions and related collateralisation movements regardless of which clearing broker the client has selected, and whether or not the relevant collateral is sitting on our books as custodian.”

Orchestra – the coda

Orchestra combines the OTC clearing capability extended by Newedge with the comprehensive post-trade derivatives processing and reporting services offered by SGSS. The outcome is a fully integrated solution that covers positionkeeping, full management of lifecycle events, and collateral management for OTC derivative trades. Alongside this, SGSS offers market-leading valuation services for a range of OTC derivatives and structured products, providing the potential to challenge counterparty valuations and to accelerate dispute resolution when this may be required. “Such efficient dispute management plays a key role in the collateral management process. It’s a service our clients appreciate and – as such – distinguishes us in the market,” says Phelipeau. “Also, SGSS offers a Trade Repository reporting service that delivers integrated reporting of clients’ OTC derivative transaction data, current valuations, and collateral coverage to the DTCC Derivatives Repository Ltd (DDRL), the DTCC’s multi-asset class derivatives repository in Europe.”

“Societe Generale has a track record of innovation,” concludes François Bouclier. “Integrating Newedge is the next chapter in that history, a step driven by the age old maxim: remain relevant to clients. In SGCIB, Newedge and SGSS, we have advanced solutions, which evolved independently, to establish themselves as industry leaders. Now that the world has changed, we’ve responded with a new approach. Successfully mutualising our capabilities means that we are more than the sum of our parts: better placed to invest, to improve our service, and to deliver relevant solutions for clients.”

Note: In May 2014, Societe Generale finalised the acquisition of the 50 per cent share of Newedge that it did not already own, thus taking its ownership to 100 per cent. This acquisition brings together the strengths of a major international banking group with those of a leading derivatives broker; namely, leading prime brokerage and clearing services, agency execution, and access to more than 85 exchanges globally.

Momentum #24