Post trade risk reduction services (PTRRS) used to centre around portfolio compression. Today, they have expanded their reach, evolving to include counterparty risk optimisation. Given their increasing popularity, the International Organization of Securities Commissions (IOSCO) has deemed that PTRRS should “merit further consideration from the risk perspective”. In its recent publication titled “Final report on post trade risk reduction services: Sound practices for consideration”, the association highlights policy considerations and risks associated with PTRRS and presents seven sound practices.
Although the demand for PTRRS has increased in recent years, an IOSCO survey revealed that most portfolios are currently hedged or rebalanced “through just a few third-party PTRRS providers”. The concentration of service offerings in “a handful of firms” may exacerbate existing risks, such as those pertaining to the governance of algorithms, fair treatment of participants, data protection, legal certainty, and operational resilience.
Self governance
Despite these risks, it is uncommon for authorities to directly regulate risk reduction service providers. Instead, the responsibility to do due diligence remains with the entities that employ PTRRS. IOSCO points out that this approach is similar to that taken for other external service providers, such as those offering technology.
The association suggests seven areas PTRRS users should focus on when conducting due diligence checks:
• Transparency, governance, comprehensibility and fairness of the algorithm;
• Operational risk;
• Data integrity and security and regulatory data;
• Legal certainty;
• Considerations of potential counterparty risk by IOSCO members and PTRRS users;
• Market concentration and competition;
• Standardisation and predictability of runs and file formats
Regulatory considerations
The role of PTRRS is to “mitigate the operational and counterparty credit risks associated with OTC derivative transactions”. With the increased usage of these services across the industry, it is expected that certain systemic risks are being mitigated. However, “given the unregulated nature of the sector, the question remains as to whether other types of risks are being introduced into the system”.
In addition, the impact that PTRRS have on the level and use of collateral, as well as on the calculation of regulatory requirements such as the initial margin (IM) is leading the IOSCO to “considering whether further policy work is needed”.
