This document discusses the operational challenges that clearing firms face in clearing swaps executed on swap execution facilities (SEFs) under new regulations. There are multiple models for checking credit limits during the clearing process, and differences in how trades are routed, which complicates risk management. Firms are working to standardize the use of "credit tokens" to confirm credit checks were passed throughout the trading and clearing lifecycle, but not all trades currently receive tokens due to complexity in workflows. Representatives from major banks discuss these issues and the need for continued industry dialogue to develop more harmonized and efficient clearing processes.

1. SEFs and Clearing:
Managing the
Operational Challenges
By Will Acworth
26 Futures Industry | www.fia.org
Marcus Denne
Director, OTC clearing, Bank of America
Merrill Lynch
Mark Willkehr
Executive director, product management,
global execution and clearing, UBS
Diana Shapiro
Product specialist, investor services,
futures, clearing and collateral, Citi
Tony Smith
Global program manager, derivatives
clearing services, Goldman Sachs
Mike Torretta
Executive director, cleared derivatives
product development, J.P. Morgan
Participants

2. Futures Industry | November 2014 27
It’s been more than a year since swap execution
facilities went live, and the swap execution land-
scape continues to evolve. This is particularly true
for the firms involved in clearing the trades. While
swap clearing has been around for more than a
decade, the introduction of SEFs has dramatically
changed the workflow and introduced new com-
plexities to the clearing process. Earlier this year,
several experts in the operational aspects of clearing
swaps came together as a group to address these is-
sues collectively. The FIA Cleared Swaps Operations
Committee began discussing how the industry could
move towards a new model for clearing swaps in the
new execution landscape.
As five members of the committee explain in the
following roundtable discussion, most trades are in
fact cleared without a problem, but the complexity of
the infrastructure and the lack of common practices
causes delays and increases the risk of broken trades.
It is a regulatory requirement that all trades must be
checked against risk limits, but there is no standard
process for achieving this. Some firms are linked di-
rectly to the SEFs while others are using credit hubs,
centralized databases where credit limits are stored.
Some are using a “ping” model for checking limits,
others a “push” model. This is making it difficult to
manage credit risk accurately in real-time, particu-
larly when clients are trading across multiple SEFs
and bilaterally as well.
Equally important, these conditions are discour-
aging end-users from trading on SEFs and slowing
down the transition to more efficient electronic trad-
ing. For some trades, the limit checking process can
take a fraction of a second, for others it may take
hours before a trade is cleared.
The committee, which now consists of repre-
sentatives from more than a dozen clearing firms,
is in the process of discussing an initial set of op-
erational recommendations with key stakeholders
in the markets, and in particular with SEFs and
clearinghouses. One of those recommendations,
which is discussed in detail below, involves the use
of “credit tokens” to confirm that trades have passed
a clearing firm’s risk checks all the way through
the trading and clearing process. According to the
roundtable participants, a standardized approach
to determining who sets these tokens and how they
are attached to trades would go a long way to im-
proving clearing certainty of trades, a key concern
for the buy-side.
This highlights one of the key lessons learned from
SEF trading so far. As the roundtable participants
explain, there are important differences in how
swaps and futures are traded and cleared, and as
a result all of the participants in the cleared swaps
markets need new ways of processing trades and
managing risks.
Given the number of entities involved in the
clearing process—SEFs, clearinghouses, credit hubs
as well as the clearing firms themselves—the land-
scape is likely to continue to be extremely complex.
But the committee is hopeful that an industry-wide
dialogue on a new model would be a good place to
start moving toward a more harmonized and effi-
cient process for clearing trades. That would help re-
duce costs and risks for all market participants and
provide customers with greater certainty of clearing.
Roundtable Discussion ➝
Photos by John Rizzo

3. 28 Futures Industry | www.fia.org
Challenges
FI: All of you are involved in the operational aspects of clearing
swaps. What kinds of operational issues does the SEF landscape pose
for futures commission merchants like yours and how does that con-
trast to the operational issues that you face in the futures markets?
SHAPIRO: I think there will definitely be a harmonization over
time between futures and OTC, but I do think that there will con-
tinue to be differences based on two primary facts. First, the prod-
ucts are different. In general, futures are more standardized, trade in
smaller sizes and tend to trade more frequently. There are also dif-
ferences in the regulatory landscape. For example, with OTC you
have LSOC (legally separated but operationally commingled), with
futures you don’t, and having a different segregation model means
different funding requirements.
Second, the market structure is different. In the futures model,
when you execute a trade on behalf of clients, you have confidence
that it is going to clear due to the vertical integration model. In the
OTC space, there is no guarantee that the trade is going to clear.
When I say, as an FCM, “yes” to a trade on a SEF platform, I am
guaranteeing that I will clear that trade. However, the clearinghouse
is still going to do a credit check on me, and if they reject that trade,
it’s void ab initio per the CFTC guidance. Basically, it’s as if that trade
never existed. That’s a primary difference between futures and OTC.
Having said that, I think that we will see a convergence over
time. As businesses tend to organize themselves around the simi-
larities, we will see a push to have both products grow and evolve,
and they will become more and more similar. But I don’t think that
there will ever be an identical regime.
TORRETTA: You touched on a really important point in terms
of the differences in how trades are executed and screened across
cleared derivatives. In the futures space trades are executed via an
agency model and the executing FCM performs the screening of the
orders, whereas in the OTC clearing space it’s the clearing FCM that’s
responsible for performing the credit check against the counterparty.
That’s a major distinction in terms of how the whole clearing process
is then facilitated technologically.
It also highlights the fact that the credit check being performed
in OTC clearing is in line with the clearing limits that we’ve estab-
lished with our clients and reflects our appetite to clear that activity.
In contrast, for futures the limit check is an order-screening pro-
cess. I think there’s an opportunity to look at how we are screen-
ing cleared trades across OTC and futures and determine the best
practices for managing that risk.
DENNE: I would add that globally this is still a work in prog-
ress. Given the size of the swap market outside the United States, I
don’t think we’re going to see the full impact of these changes until
we see similar sorts of legislation and regulations put in place in
Europe and Asia.
The other part of this evolution is the shifting economics be-
tween the bilateral market and the cleared market. There’s a discus-
sion now on the requirements for initial variation margin on bilat-
eral swaps, and that will start to normalize the economics of when
you clear a trade or don’t clear a trade. Clearing probably will look
relatively more attractive than it’s been in the past, and we might
start to see a voluntary shift toward swap clearing, even from those
institutions that are not impacted by the U.S. regulations.
FI: In the SEF landscape, trades can take various routes to clearing.
How does that affect your risk management process?
WILLKEHR: It goes back to the question of who is responsible
for applying the risk check. For voice trades we do internally, we
have the ability to control the amount of credit that we extend. For
SEF trades, on the other hand, the SEF applies the limits that we
establish and there are a lot of variations in how these are applied.
Some have the ability to do this internally. Others may outsource
that to a third party or a credit hub. Even with the SEFs that have
the ability to calculate it internally, the methodology may differ.
So when you’re establishing a limit for a client and then split it out
among all the different SEFs, the shape of that limit may differ at
the different SEFs. That causes problems when you try to aggregate
the information and determine how much of that credit has been
used at the different SEFs or off-SEF. It’s kind of like combining
apples and oranges.
SHAPIRO: I think the different models
are based upon what clients ultimately want. If
a client wants to trade quite frequently and is
concerned about latency, they may want us to
push a limit to a SEF. That’s especially impor-
tant if we move to order book trading, because
that gives them the quick dynamic of getting
the orders approved in a timely fashion.
Some clients care a little bit less about time
and more about full utilization of their credit
line. In that model, maybe the SEFs are ping-
ing a hub where the FCMs house their limits,
or maybe they’re pinging the FCM directly, or
maybe they’re pinging a hub that’s pinging the
FCM. I think every FCM in the market has a
little bit of a different approach, but regardless
of the differences, we are all working with our
clients to understand which model, push or
ping, works best for them and then supporting
them accordingly.
Diana Shapiro and Mike Torretta

4. Futures Industry | November 2014 29
FI: If the market continues to have these different client segments,
does that mean that there will continue to be multiple models for
the clearing workflow?
SHAPIRO: I think that’s correct. There are multiple models to-
day, and I don’t think the multiple models are going away. We want
a highly automated and flexible infrastructure that accommodates
all shapes and sizes of clients.
To add to that, I think we want competition. You don’t get the best
product unless you have competition and people coming up with
new thoughts and ideas. But at the same time, as these new thoughts
and ideas are introduced to the market, we don’t want to have broken
process flows, manual workarounds, and people looking at spread-
sheets. With the time parameters that the CFTC has put on us, and
the parameters and the standards our clients hold us to, we need to
make sure that good operational workflows are in place.
FI: How long does it take to run SEF trades through the credit
checks and to get a result?
TORRETTA: It depends on the model that the FCM adopts.
It will differ depending on if they’re internalizing that credit check
versus allowing an electronic trading venue or a hub to perform the
credit calculation. At a minimum, the credit check is being performed
sub-second. This means that a client goes onto a venue, requests to
introduce an order, and within less than a second they know that they
have credit approval from their FCM to clear the trade. That is the
process referred to as the ping model, where the order actually gets
routed to the FCM, or to a hub that’s facilitating the screening of the
order for them. That’s an order-by-order type of screening that’s hap-
pening outside the SEF, and that’s happening sub-second.
WILLKEHR: We can’t forget that we still have a number of
participants on the other end of the spectrum that support request-
for-quote trading via manually calling someone up on the phone.
We’re talking milliseconds on one side and we’re talking half an
hour on the other side, depending on when emails get sent around.
DENNE: People assume that SEF trading is shorthand for elec-
tronic trading, but it’s not. There are still trades that are going to
be voice brokered with intermediaries on both sides. Those are the
areas where it may take minutes or longer.
SHAPIRO: I think the speed requirements are, again, an evolu-
tion. When we initially started clearing trades, it could take hours
for a trade to reach the clearinghouse and ultimately to the FCM
to get cleared. As the infrastructure for clearing was standardized,
clearing timelines improved and now regulation is in place that re-
quires FCMs to approve or reject off-SEF trades within 60 seconds
and perform pre-execution credit checks on SEF trades.
The question always becomes, well, when does that time clock
start? For off-SEF trades, the time clock starts at the point that I,
as an FCM, receive the trade. So a bilateral trade could happen
between a dealer and a client four hours ago. It still has to get into
the middleware platform, it has to be matched, it has to go to the
clearinghouse, and then the 60 seconds starts when it comes to me.
Yes, things are clearing a lot faster, most FCMs are well within the
60 second timeframes, but there are still some processes higher up
in the work flow that may take a while.
The other critical piece is the clearinghouse credit check in the
SEF workflow. The regulation says that a clearinghouse has to ap-
prove or reject a trade within 10 seconds. But just like the off-SEF
flow, that 10 seconds does not start until the clearinghouse receives
a trade. When a trade is done electronically on a SEF, there are
multiple paths that it can take to the clearinghouse. The SEF could
submit that trade directly to the clearinghouse or it could route it
through a middleware platform, which is still fast but adds a hop.
Some of the SEFs also support a manual affirmation process, where
the client will go into the middleware platform and manually af-
firm the trade, and then it will be submitted to a clearinghouse.
Currently, there’s no specific timeframes enforced for the manual af-
firmation. For example, a transaction may sit in a middleware plat-
form for four hours, which means the clearinghouse is not clearing
the SEF trade within 10 seconds, they are processing the trade for
clearing within four hours and 10 seconds.
So when we look at the regulatory timeframes, it’s important
to remember that there are different workflows in the industry. As
we’ve moved to the SEF landscape, they’ve improved, but we’re still
learning along the way.
FI: Let’s talk about a specific example of the operational challenges
that you face. FCMs have started using something called a credit to-
ken to indicate which trades have passed the credit check. How does
this work and what are the challenges to making this work well?
WILLKEHR: Essentially, a credit token is supposed to be a
mechanism that allows the FCM to monitor and ensure that the
credit limit utilized on a SEF platform actually equals that of the
cleared trade. It’s really a control to ensure that our credit is being
used properly.
SMITH: I see credit limits as they exist today as really nothing
more than a yes/no parameter. Credit tokens will go further in that
they work like a digital signature that passes all the way through all
of the parties. It shows that you’ve approved credit for that specific
FCM to stand by that transaction.
A good analogy is the way banks monitor how people use their
credit cards. When you swipe your card, a message is sent to your
bank with information about how much credit has just been used.
And if you’re over the limit, a message comes back pretty fast saying
no, the transaction is not approved.
So that’s the idea behind the credit token. But we won’t have
When we look at the regulatory timeframes, it’s important to
remember that there are different workflows in the industry.
Diana Shapiro, Citi

5. 30 Futures Industry | www.fia.org
that type of function until we standardize how credit tokens are
generated, and do that in a way that persists all the way through
the workflow.
DENNE: We don’t want to get to a world where it is all entirely
vertically integrated with absolute standardization and no possibil-
ity of innovation in the process. That is not what we would want
the market to evolve into. What we want is a solution where it
doesn’t matter who issued the credit for that transaction, or where
that transaction has been executed, or which firm is clearing it, or
whatever path it takes to get to the clearinghouse. All we need to
know is that the transaction has been approved by someone via an
unambiguous message unique to that transaction that is traceable
throughout that whole process.
FI: Are all the trades that you are now clearing getting these tokens?
SHAPIRO: No, they are not. It goes to the complexity of the
workflow. As we said before, there are multiple SEFs, multiple
clearinghouses, multiple FCMs, and multiple clients. So one of
the first principles that needs to be addressed is who should set
the token. What we see is that sometimes the FCM is setting it,
sometimes it’s the hubs, and sometimes it’s the SEFs.
For example, we might set a token on a trade. Then, when it
gets to a SEF that has a token functionality, they overwrite our to-
ken with their unique token. Then that goes to the clearinghouse,
and then the clearinghouse sends it to me. I set my token as 123
and it comes back 456. There’s no way for me to confirm the credit
check I did on this transaction and tie it to the trade that actually
got executed.
DENNE: One final twist in this is that in the pre-SEF world,
all the credit checking was being done after the trade was executed
and before it cleared. When the SEF framework came along, the
FCM community didn’t get a second look at that trade. It’s as-
sumed that the trade has been screened by us before it’s executed.
So we need to have that token that says, yes, we really did issue
credit for that transaction. It’s not just a breakdown of the work-
flow between the SEF and the clearinghouse.
FI: Why do you think this is so hard to accomplish?
SMITH: I think it’s the timeframe. With mandatory clear-
ing, we all had a long lead-time to get comfortable with the
process and onboard clients in a semi-orderly fashion. With the
implementation of SEFs, I just don’t think there was enough
lead-time to make sure that we had this right and put a robust
architecture in place.
SHAPIRO: I would add that there are two other factors. One is
the number of parties that are involved. When you look across the
SEF landscape, you have probably 40 or more different parties that
need to implement the token. Remember it’s not just the FCMs,
it’s also the SEFs, the CCPs and the middleware platforms. Second
is that while everyone may agree in concept that a token is needed,
it needs to be standardized across all these platforms. That doesn’t
mean we should enforce these requirements or try to make every-
one alike. It means that we need standardization for basic require-
ments so that this is beneficial for operational ease and regulatory
compliance across the FCM community. As a first step, let’s set out
some principles on how tokens should be used, and then let’s all
work together to get a process flow that’s best for the industry.
WILLKEHR: Going back to your question, the reason why it’s
so hard is because people have built their systems already, and they
don’t want to go back and rebuild those systems because there are
so many other areas that are demanding attention. But it’s impor-
tant to keep talking about standardization. That’s all this is. Going
back to Tony’s analogy, that’s why the credit card reader works.
There are different readers and different service providers, but it all
works because it’s a standardized methodology.
DENNE: The fact of the matter is it’s a highly competitive
landscape now among the CCPs and the SEFs, and indeed among
the FCM community. So everybody has a strong vested economic
interest in expanding their product sets. If they want to solve next
month’s problem or next month’s opportunity, rather than patch
the process from last month’s error, then you know where the pri-
ority is going to be.
SMITH: I’d echo that sentiment entirely. But we’re all realists
around the table as well. We’re not expect-
ing all of this to be done by the end of
the year or some other date. I think all we
want to do is have an open dialogue with
all of the participants in the market about
a more robust market infrastructure. We
think this doesn’t just benefit FCMs. It
benefits clients and CCPs and SEFs. We
all have a vested interest in making sure
this infrastructure is as robust as possible.
FI: What are the benefits for the buy-side
from these improvements in the clearing
workflow?
DENNE: Execution certainty. That
has to be the key concern of the buy-side.
Having the certainty that when they’re
done, they’re really done, and they’re not
going to receive a phone call from an
Challenges
Mark WillkehrMarcus Denne

6. Futures Industry | November 2014 31
FCM or a dealer saying, oh, sorry, that trade a half an hour ago or
four hours ago in fact is not done. And, by the way, the market’s
moved five basis points since then. I think that’s probably the num-
ber one concern for the buy-side.
TORRETTA: I’d agree. And that’s even more of a concern as
this evolves. Right now, we’re in a world where you know who
you’re trading with. In the event that something goes wrong, you
can have a gentleman’s agreement and work it out. But as we move
to a central limit order type of world with anonymous execution,
nobody is going to stand behind those trades. If something doesn’t
get accepted for clearing, there’s really nothing to be done at that
point in time. This highlights why the best market structure is one
that provides executing participants with pre-trade certainty. This
requires both the FCM vs. client check and the CCP vs. FCM
check to be performed at the point of execution.
FI: How does the industry get closer to that certainty?
DENNE: Through a variety of practical or technical ways. The
token is definitely one of them. We’ve also talked about some of the
controls around making sure the transaction that is actually submit-
ted for clearing can in no way possible shape or form be anything
other than the trade that was approved for execution. Again, we’ve
seen various deficiencies in the infrastructure that haven’t been able
to eliminate that possibility.
SHAPIRO: I think the other point is to have accuracy of limits
and messaging across platforms. Suppose I set a limit on a client of
a hundred dollars. A trade comes in with a value of 20 dollars. Now
I’m saying that the client can only trade eighty dollars more. Well, if
I’m not told that they canceled that 20 dollar order and I should re-
lease that limit, it falsely impacts the client’s ability to trade. So these
operational conundrums aren’t only about getting trades that have
already been executed through the pipes. They’re also about allowing
the future trades to go through because all the systems are linking
together and giving an accurate picture of that client’s standing.
I also think that the FIA Cleared Swaps Operating Committee
helps to foster regulatory compliance. I don’t necessarily think that
all the parties in the industry recognize the regulatory obligations
of the other parties. I don’t think every SEF can say they know what
the FCMs’ obligations are, and vice versa. What’s really important
is to bring people together to find a common ground, to facilitate
execution certainty for clients, support regulatory compliance, and
ensure accuracy of data flows.
DENNE: To be fair, I think we all experience very high straight-
through processing rates and I don’t think any of these problems
manifest themselves on an hourly basis. But the number of transac-
tions in this market is very different from the futures market or the
cash equities market. It doesn’t take very many transactions to go
wrong for those to be relationship-ending and even business-ending
type mistakes. I don’t think there is a tolerance for any significant
rate of error.
WILLKEHR: I think some of these deficiencies in the down-
stream clearing infrastructure are definitely impacting the rates of
execution on some platforms and the ability to move to where I
think regulators want us to go in terms of increased electronic ex-
ecution. It’s a mix of things. FCMs might feel somewhat reluctant
to push out larger limits on so many different types of platforms
because those controls aren’t robust enough. Some clients might be
frustrated with figuring out where they have limits and not being
able to consolidate them to know where they have head room.
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7. 32 Futures Industry | www.fia.org
FI: Looking forward in time, what changes do you expect in the
work flow?
SMITH: If we look at where we are today with regards to rates
and credit, the regulations for mandatory clearing and SEF execu-
tion are largely in place or in motion. The next step in the U.S. is
going to be new products like foreign exchange NDFs (non-de-
liverable forwards) and potentially some of the push controls that
we’re going to see with central limit order books on swap execution
facilities. But I think we’re now in a position where we can take a
little bit of stock of what’s happened. The last three and a half years
have been a bit of a maelstrom, really, when you look at regulation
in the U.S. I expect that European and Asian regulation will throw
up its own challenges. But we would all prefer consistency in work-
flow across regions and hopefully, we can take some of these lessons
learned out to the European and the Asian side.
SHAPIRO: When we look at the SEF landscape, the thought
originally was that client activity was going to be spread across 16
different venues. I think what we’ve seen in actuality to date is that
activity has centralized on one or two dealer-to-client platforms
and clients have mostly become direct members of those platforms.
By comparison, in the futures space, almost everyone is using an
agency model. It will be interesting to see how the models change as
the market evolves and as clients change their trading strategies and
how they access the market.
DENNE: I think we touched on something in the conversation
around the different execution models and whether we’re going to
see this transform into an agency or remain a largely principal-based
market. The next six to nine months is when we’ll start to see whether
the industry moves to that model or whether it stays as it is today.
I also think that clearing has created a demand for solutions to
problems that we didn’t have before. For example, compression
trades. How do clients deal with swaps that can’t be netted? That’s
created a problem for the buy-side and we’re starting to see SEFs play
a part in solving that problem, bringing up packages of compres-
sion trades for dealers to bid on. For example, CCPs have started to
come up with more imaginative ways of netting down transactions
that are economically similar but not precisely the same. I think
we’re going to see more of those types of developments as people
become more experienced with client clearing.
WILLKEHR: I think we all need to remember that it’s taken
quite some time to get where we are today with clearing. I mean,
the dealers were clearing swaps for 12 years ahead of the mandate.
As Tony said earlier, we had the time to develop the infrastructure
to extend those protections to clients, and we’re still working on
perfecting that. Contrast that to how rapidly we pushed execution
onto the SEFs. They haven’t really had the time to properly build
out their infrastructure and evolve their platforms.
To be fair, some of the infrastructure problems we’re seeing have
been addressed by some of the participants, but they need to be
addressed by all of them, front to back. For example, the clearing-
houses have rolled out controls around bunched orders and the allo-
cation process. Clearinghouses have specified the message structure
needed to ensure that a bunched order trade is allocated properly
and not over-allocated. But unless the SEFs send that information
down, the process doesn’t work. That has an impact on some clients
because they feel there’s too much risk around that process and as
a result they may not be executing block trades. They continue to
execute in end accounts. Those are smaller trades and that will im-
pact the price.
Going back to your question, looking ahead to where the market
is evolving, it’s key to iron out some of these clearing infrastructure
issues now in order to offer some of those services that Marcus just
talked about and bring new products onto the market. For example,
the MAC swaps. MAC swaps are a standard product that is well
suited for order book trading. Right now they’re largely traded on
RFQ (request-for-quote) but one or two SEFs are offering them or
planning to offer them in the next month on their CLOB (central
limit order book).
So we really need to address these infrastructure issues now.
That’s why it’s so critical to agree on certain basic principles like the
credit token we spoke about before. I think there’s good buy-in for
these principles. There’s a lot of work still to do in terms of imple-
mentation but those should be the next steps.
...............
This interview was conducted by Will Acworth, editor of Futures Industry.
Challenges
To be fair, some of the infrastructure problems we’re seeing have
been addressed by some of the participants, but they need to be
addressed by all of them, front to back.
Mark Willkehr, UBS
Mark Willkehr and Tony Smith