With new cleared swap instruments being created for each new day and each unique coupon traded, and tenors that can extend 20 or 30 years, one easy-to-predict consequence of the migration to centralized clearing of swap derivatives is that trading and clearing firms must prepare to support a proliferation of open position line items for each customer.
The natural reaction to this realization is to call for increased use of compression within the industry. What we shouldn’t miss, however, is that the migration to a cleared swap environment provides opportunities to re-think and improve the traditional methods for compression of swaps contracts, in light of the important structural differences between the OTC and CCP environments. Legacy compression techniques have evolved from a world characterized by factors that are increasingly irrelevant in the cleared swap paradigm: Bi-lateral credit relationships, inconsistent collateral exchange terms and non-centralized pricing calculations.
Trading swaps as freely tradable, centrally-cleared futures, on the other hand, offers compelling advantages to these legacy constraints, without the inflexible product specifications traditionally associated with futures contracts. Realizing the full potential of the CCP model calls for a reevaluation of compression methods to take full advantage of the standardization of terms for contracts, collateral, pricing and counterparty risk. With all participants on a swap execution venue eligible to participate on equal terms, the reduced complexity of compression may even lead to an integration of compression into the trading routines, rather than requiring manual, time-consuming, complex back-office processes.