Trade Compression

Reducing outstanding trades

When banks trade derivatives the trades start to accumulate. This means active trading increases gross notional exposures. Despite collateral and clearing this is not desirable. It potentially increases credit and operational risks. Regulators have taken note and under EMIR and Dodd Frank firms with large portfolios are required to put in place procedures to compress trades or alternatively explain why compression hasn’t been adopted.

Compression reduces the outstanding notional amounts. It does this by matching trades between counterparties and then removes the matching trades leading to a smaller trade that represents the net risk. It means that the market risk remains unaffected but credit risk and operational risk decline. This reduces the leverage ratio and the amount of capital tied up by the business and can be applied to rates, foreign exchange, credit and commodity trades.

The process may be undertaken on a bilateral (trades between two parties), multilateral (trades between several parties) or unilateral basis (unlinked cleared trades).

To compress and reduce trades banks upload a trade file into a service like Trioptima, an algorithm then facilitates compression, matching trades are removed and cancelled leading to a reduced net trade position.

First Published by Barbican Consulting Limited 2017