Multilateral compression of OTC derivative contracts is an effective and efficient process not only for
reducing notionals and eliminating trades but also for managing counterparty exposures and
releasing capital for redeployment in other parts of the business. Portfolio Compression is the process of reducing the number of trades in a portfolio whilst maintaining a risk equivalent position and reducing the number of trades by eliminating “unnecessary” trades with a counterparty reduces both credit and settlement risk. In Europe, EMIR mandates that portfolio compression should take place every six-months for Financial Counterparties and Non-Financial Counterparties with counterparty portfolios with more than 500 trades. EMIR also “encourages” compression wherever possible.
Portfolio compression can be performed either bilaterally or multilaterally and multilateral compression can be a great deal more effective than bilateral compression. It involves viewing the trades between all of the counterparties in a group, and then reducing them down as much as possible using a combination of trades and closures. The more parties involved in a compression, the more benefit it will have.
TriOptima‘s triReduce service offers such a service, both within the energy industry and within banking. Last week it completed a successful portfolio compression cycle in European power, natural gas and coal. It had 13 parties participating in the cycle, and the live execution resulted in full termination of 4322 trades (79% of submitted eligible trades). The gross notional value terminated was EUR 8.4 billion.
Multilateral compression involves the following steps;
1- Set calendar – multilateral compressions take place periodically (typically quarterly depending on market characteristics).
2- Send in trade portfolio – each party sends in candidate trades with the other entities in the group to the service. Nominate trades – each party agrees to the compressions from the suggestion list
3- Dress rehearsal – on a specific day, the compression is “simulated” by all parties
4- Execution – On a nominated day, all of the agreed trades are closed out and new ones created. Service suggests trades – the service will suggest which trades can be compressed, which trades will need to be closed out and which new ones created
A typical cycle lasts two weeks, with trade submission and matching in the first week, and dress rehearsal and live execution the second week.
As with bilateral compression, all trades resulting from a compression must be marked and reported.
At the moment, TriOptima is conducting runs on a quarterly basis but hopes to get to monthly in the six-months according to Matthias Palm of TriOptima. It prices the service based on a per terminated ticket basis and more details can be obtained from TriOptima.
For more information on EMIR and portfolio compression please download our recent report written in conjunction with ETR Advisory and kindly sponsored by TriOptima.