EquiLend Brings Automated Trading to Total Return Swaps

EquiLend Holdings, which was formed in 2001 to operate an electronic trading platform for securities finance, has expanded into the equity total return swaps (TRS) market.

The New York-based company, which is owned by a consortium of major financial institutions and was part of a wave of institutional automated trading start-ups around the turn of the century, now facilitates more than 60,000 transactions daily in the $2 trillion-plus securities lending market. Its Next Generation Trading platform enables users to broadcast their trading intent and compare bids and offers across counterparties, negotiate rate levels and define the order of counterparties they want to transact with, alongside other stock-loan trading, post-trade, data and clearing services.

With Swaptimization, EquiLend looks to bring similar transparency, liquidity, cost-efficiency and risk-reduction benefits to TRS, which, like securities lending prior to automation, is an opaque and highly manual over-the-counter asset class.

“Our clients have solicited our ability to automate, streamline and standardize a workflow to allow TRS traders to focus on revenue generation for their firms,” Paul Lynch, global head of products at EquiLend, said in the December Swaptimization announcement.

“Swaptimization is a solution that provides technological efficiency to a marketplace that would greatly benefit from automation,” he added.

Filling a Need

Russell Rhoads, head of derivatives research at Tabb Group, said TRS is one of the least automated markets. He noted that there has been a push to trade over-the-counter, often bilateral transactions over swap execution facilities (SEFs), but achieving sufficient standardization for TRS transactions to trade on SEFs may be difficult.

“What [EquiLend] is doing is definitely needed. It's filling a need that not a lot of other people are looking at right now,” Rhoads said.

EquiLend is going up against interdealer brokers (IDBs) that match TRS-trading counterparties. Matt Collins, director, markets and trading at EquiLend, said the firm is charging less for its automated system than the fees charged by IDBs for doing this activity manually. TRS transactional information tends to be exchanged using spreadsheets, and that risks missing or misinterpreted data, and potentially bias can result, he said.

“We automate a lot of that information exchange, putting buyer and seller together, the confirmation process, and giving market participants the ability to look across their risk limits and stipulate which counterparties they want to trade with,” Collins explained.

Dealers can deliver their data via API or an FTP file, as well as upload spreadsheets to the Swaptimization platform. The system then algorithmically finds optimal matches, validates that transactions are meeting users' specific requirements and ensures, for example, that there is not a pending corporate action forcing the dealer to exit the position sooner than anticipated.

Plan for Growth

Swaptimization was launched with a core group of TRS market participants. A broad array of firms participated in the Swaptimization working group, EquiLend said. It expects upwards of 20 firms to be on the platform in 2020 and has plans to launch in Europe and Asia, pending regulatory approvals.

Collins said that with Swaptimization's “enhanced client engagement model,” fully automated trading is backed by phone support as needed. As the platform determines the most appropriate counterparty matches, users can manage their balance sheets efficiently and avoid exposure to counterparties whom they don't wish to face. Swaptimization allows for a more optimized trading book and puts the user in charge of whom they trade with, rather than an IDB making those choices for them, Collins said.

“We've built those things into the DNA of the platform,” he added

An automated platform also reduces the risk of errors that can stem from manual operations and, perhaps more importantly, lowers costs. Said Rhoads: “There's a lot less time spent double checking and figuring out where mistakes were made, and that greatly reduces trading costs - probably the top benefit.”

CCP Connectivity

Swaptimization has “plug and play” capabilities to connect to central counterparties (CCPs), with the expectation that the system will draw enough TRS volume to warrant such connectivity, much as what occurred in the securities lending market, Collins said. Should a regional or global CCP at some point decide to clear TRS transactions, then by netting them and other products it clears, such as options and futures, it could provide members with additional regulatory capital relief.

“Our hope is to foster a way to get TRS to fit into a similar risk framework and get the CCPs to say, 'We see this activity as essentially net neutral in terms of the risks members are taking,'” Collins said.

However, that may take a while. Audrey Blater, a senior research analyst at Aite Group and formerly director of research at the International Swaps and Derivatives Association, said that the appropriateness of clearing various OTC financial instruments is often a discussion point given the industry's push to clear derivatives. TRS transactions could “absolutely” be cleared at some point, she said. “There has to be a lot of due diligence before that can happen, and those steps occur awfully slowly.”

Blater added that liquidity and instrument standardization are key factors, and should significant liquidity emerge in one type of TRS, and there's a push by users of that instrument, then clearing houses may opt to offer services, assuming they are comfortable with the risk.