The asset manager BlackRock Inc. is updating its technology platform and derivatives operations in anticipation of a newly transparent credit derivatives market.
The New York fixed-income specialist is tweaking the analytics and derivatives modules that feed its Aladdin investment system to accommodate new protocols for the standardized trading of credit default swaps, according to Stephan Bassas, the director of BlackRock's portfolio management group. The portfolio management, operations, legal, client and technology teams are participating in the effort, as the company adapts to a sector that is being reshaped by regulatory and industry initiatives.
The Aladdin platform, which handles every transaction that passes through BlackRock, performs risk, portfolio management, compliance and processing tasks.
Even a seemingly simple change to credit derivatives systems can have extensive repercussions. Because the industry is moving to fixed 1% and 5% coupons for CDS trades, for example, the duration of the instruments and their responsiveness to changing interest rates will be affected, Bassas said, which in turn requires alterations to the assumptions embedded in risk management systems and cash-flow models.
And every change has secondary impact on the way companies value and model credit derivatives, he said, citing the International Swaps and Derivatives Association's move to a hardwired default cash-settlement auction protocol and the trade group's decision to exclude restructuring as a payment-triggering credit event.
"We urge everyone in the CDS market to think of what the impact of the new cash flows linked to the CDS will be on the systems with which they've been monitoring their exposure and modeling their cash flows," he said.
BlackRock is playing a role in the bailout of the U.S. financial system, helping alleviate systemic risk by managing assets for the government. In December the Federal Reserve Bank of New York picked BlackRock to manage a fund that purchases assets linked to credit derivatives underwritten by American International Group Inc. In June, AIG selected BlackRock's technology and risk management subsidiary to comb the insurer's portfolio for losses likely to be triggered by defaults of underlying assets in the swaps it sold.
Last year a group of trade associations and major broker-dealers told the Fed that by July they would submit 85% of eligible CDS trades, including trade assignments, on the day of the transaction. BlackRock already submits most of its credit derivatives on trade date, according to Ila Eckhoff, a director in the firm's operations and administration group and a co-chair of the Asset Managers Forum's derivatives operations committee.
One obstacle to BlackRock's implementation of its new CDS operations is the remaining legal issues surrounding the adoption of centralized clearing. Though there are several clearing initiatives on either side of the Atlantic, the clearing houses have yet to lay out a plan that satisfies the buy side, Eckhoff said, pointing to concerns that client assets may not be portable to solvent institutions — and segregated from other funds — if a clearing member defaults.
"If we post to the central clearing mechanism to clear a client's trades and the clearing broker we give it to goes bankrupt, we want to ensure the client's assets are protected," she said. "The questions firms need answered are: Do I have segregation of assets, or were those assets commingled with some other business of the clearing broker? Is it going to be in a segregated account? Is it going to be in a third-party account? Is it going to be in a dealer's segregated account? How easy is it to assign or move my position to another clearing broker, assuming I want to keep that position on?"
