DerivaTrust Offers Opportunity for Swap Buyers and Sellers to Match Up
Finding a counterparty to a swap contract is a common task for an originator -- the investment bank or broker-dealer who usually manages their contract transactions.
And it should be an easy one. After all, there are plenty of firms that want to enter into swap agreements to hedge risks and make some extra bucks, right.
That's true but finding the right one is almost as hard as finding the right spouse or partner. You might rely on a family member, friend or other intermediary to make introductions to prospective candidates or hope you meet the person through a chance encounter. Or you could depend on an online service. The first meeting is just the beginning. Then comes the short -- or even -- long process of getting to know one another before either a long-term commitment or marriage can take place.
A fledgling technology firm says its come up with a way to cut the effort, time and cost out of finding your right counterparty in the $700 trillion swap market. Developed by a group of Silicon Valley executives, DerivaTrust offers an online "catalog" of apps, each of which represents an over-the-counter derivatives contract. The platform operates on the same principles as the apps available on smartphones.
"Our goal is to enable sellers of customized risk management products to find buyers quickly and buyers to find the necessary products quickly," says Hieu Tran, one of DerivaTrust's founders and an investor. Tran is also the founder of San Jose, California headquartered Viosoft, an embedded software developer.
DerivaTrust's pending launch is pretty timely. As regulators insist standardized swap contracts to be traded on swap execution facilities and processed through clearinghouses, DerivaTrust will also offer a "standard way" of doing business in the estimated 30 percent of contracts which don't end up becoming standardized, says Tran. Market participants can still do business the old fashioned way -- bilaterally between counterparties. DerivaTrust won't have to register as a swap execution facility (SEF) because it doesn't provide price discovery; no bids and offers are posted.
"We could potentially compete against SEFs," says Saheed Awan, a partner for global collateral management consultancy Global Collateral Management Solutions and former director of global securities financing for international securities depository Clearstream in Luxembourg. Awan is promoting DerivaTrust in London, which rivals New York as one of the major centers for swaps trading activity.
Incorporated in California last year, DerivaTrust is now looking for test clients to kick the tires and finetune its technology, he says. Development work, begun eighteen months ago, is managed by a team of 15 computer programmers in San Jose as well as Vietnam and Taiwan.
Here is how DerivaTrust works: potential sellers of swap contracts can use the DerivaTrust application generator to upload an unlimited number of free-standing discrete applications that "virtualize" the terms and conditions of swap contracts such as term sheets, a detailed long-form confirmation and Excel pricing sheet. These documentations are incorporated into an anonymous application, which the sellers then upload to DerivaTrust's application repository. Through either a web browser, or application-enabled search screen, potential buyers can specify the criteria of the specific contracts they are interested in through a detailed list of checkboxes and search terms such as type of derivative contract, asset class, duration, currency, region and rate. Within seconds, buyers will be presented with a list of virtualized contracts that meet the specific criteria and click onto the applications they wish to download. The applications, once downloaded and run on the buyers' desktops, allow the buyers to review the terms and conditions of the contracts and pose additional questions to the sellers through an anonymous and secure message link. Buyers may not have full access to all information needed to make a decision, nor will the sellers disclose that information unless satisfied the counterparties are legit. Establishing that level of "trust" will likely take a few more rounds of messages. Only when the seller feels comfortable will the buyer be granted access all of the necessary information through either further messages or other off-line conversations.
"The current contact generation and marketing for OTC derivatives is a manual time intensive and archaic model involving a lot of paperwork that is difficult to share easily, cheaply and securely," gripes Tran. With investment banks also cutting back on their sales traders, it will become even more difficult to market their products so they will likely turn to interdealer brokers such as ICAP and Tullett Prebon.
Those interdealer brokers, he says, can charge anywhere from half a basis point to one basis point of the total notional value of the trade for each year of its duration. An example: a contract with a notional value of $1 billion could cost the originator about $500,000 a year in fees..
Compare that to the flat fee -- typically $100 -- that DerivaTrust will charge to sellers for each application downloaded. DerivaTrust will also charge $20 for each introductory message per app between buyers and sellers while they get to know one another. Subsequent messages are free. The buyer never has to pay a fee to download the information in the application. Counterparties will also end up having cheap and unrestricted access to each other on a 24-by-7 basis. And buyers -- namely institutional fund managers and hedge fund mangers -- can easily tap into a lot more sellers than they would through the interdealer brokers, says Tran.
But DerivaTrust has its shortcomings and might not appeal to every swap market player. Buyers and sellers still have spend a lot more time offline negotiating with each other before finalizing any agreements and there is no guarantee a deal will ever be completed. Unlike interdealer brokers, DerivaTrust can't sniff out potential credit problems or any other flaws of the prospective buyer or offer the sellers any recommendations. Buyers and sellers also can't construct customized bilateral contracts with each other other from scratch.
DerivaTrust is simply an automated "introduction" service to an inventory of pre-packaged contracts. Buyers and sellers are left on their own to decide whether they really like and "trust" each other enough to take the final plunge.
DerivaTrust's backers, who declined to be identified, won't disclose how much they have invested in the firm, but say they won't need much traffic to break even. Volume of less than 5,000 uploads per year can cover their costs and 150 messages interchanged between counterparties. Sellers usually know they want to do business with buyers after about five messages are interchanged, says Tran.
Written by Chris Kentouris, Editor-in-chief (Chris can be reached through Chris.Kentouris@hotmail.com)