Mind the gap: building evergreen style portfolios throughout the operational value chain

Evergreen financing structures are gaining popularity as a way to manage the complexity of Liquidity Coverage Ratio (LCR) funding requirements. However, most trading and post-trade systems are not set up for the operational risk management of these positions.

Over the last months we have seen serious discussions about the requirements and challenges to identify and ring fence High Quality Liquid Assets (HQLA). However, the LCR does not focus on a snapshot approach for HQLA balance sheet positions. Instead, it stresses the dynamic character of liquidity management in terms of a constructive stress period of 30 calendar days. This puts the requirements and efforts to effectively match maturity and term structures into the spotlight.[1]

As a consequence, the market is rediscovering already well-known financing structures like open-term repo and is inventing new product types like evergreen swaps. These are also known as Interest Rate Swap Index Average Constant Maturity Futures, which is a mouthful.[2]

For an open-term/evergreen style transaction, the constant maturity character is based on a mutual agreement between the participating parties to roll-over the trade at a maturity date (typically on a daily basis). Alongside the daily revolving maturity calibration, both parties typically agree on further adjustment features like regular interest/fee rate fixings and/or clean of interest payments during the lifetime of the transaction.

Considering the complexity of regular trading activities, the internal efforts to maintain an evergreen trading portfolio should be considered to be significant. That might even be the case without looking at scenarios of backdated fixing and failed payment corrections.

Some software vendors have already picked up on the need for evergreen style portfolios and enhanced their front-office products to offer standardised and automated post-trade functionality. A certain level of trade automation might be considered as an operational precondition to manage evergreen portfolios of significant size otherwise trading capacity is strained and operational risks can emerge. Trade position automation is provided for event types like daily roll-over or regular clean-of-interest payment requirements as well as an extensive deadline and fixing calendar information on negotiation/fixing date requirements.

A prominent problem for post-trade systems may be the roll-over activity, which operates the daily closing of an existing term transaction in favour of a new term transaction with a one-day extended maturity date. In fact, this transaction chain, which constitutes an evergreen structure, challenges post-trade services from a conceptual as well as form a technical point of view. The conceptual problem focuses on accounting and reporting for the term-structure requirement and roll-over concept. Early termination fee and carry interest requirements (for all interest bearing transactions types) can also be complicated. From a technical point of view, the reference structure to link transactions to a transaction chain and the pure number of transaction postings needs to be considered. At the start of such a project, it would be worthwhile to evaluate post-trade stakeholder education and their system requirement analyses in parallel to the trading infrastructure adjustments.

“Keep the end in mind” is an often-quoted advice. It seems to be a true necessity if you are asked for the implementation of evergreen workflows in order to manage LCR liquidity.

This article was contributed by Tobias Duchscherer, Consultant at CofiNet and Henning Vollbehr, Project Manager at DekaBank.

[1] “Summary description of the LCR”, p130106a.pdf, BIS; https://www.bis.org/press/p130106a.pdf

[2] See also: “GMEX IRS Constant Maturity Futures”;
http://www.gmex-group.com/wp-content/uploads/2013/09/gmexinterestrateswapfuturesproductsynopsisv4.pdf

Related Posts

Previous Post
Derivatives, Securities Financing and the Law of Conservation: Transforming Counterparty Risk into Liquidity Risk
Next Post
Reporting date differences allow non-US broker dealers to arb repo markets

Related Posts

Fill out this field
Fill out this field
Please enter a valid email address.

Menu
X

Reset password

Create an account