Pricing of Fixed Income Derivatives Cafe Takeaways

Key challenges faced by the group:

  • Currently derivatives trading remains very manual with lots of touch points and a high chance of trader error. Buy side members agree that there must be a way to improve and streamline processes. 
  • Effective pre-trade analysis within OMS/outside OMS for derivatives is also a challenge, with one member building in-house tools including python libraries to improve their decision making.
  • Many members are facing end of day issues; some trades happen at 9am and settle at 1pm, and attributions do not really capture this.
  • There is a need to standardize data sets between the time of trade and settlement. There is often discrepancy on how swaps in particular are valued, with different discount curves and interpretations being used across the buy and sell side. Even a couple of bips can have a huge swing on the P&L and lead to redundant discussions around performance on different days. 
  • It is especially difficult to get accurate pricing within emerging markets e.g. China & Taiwan, when trying to trade cross currency swaps. 
  • A few members are working with multiple legacy funds with their own subsets of counterparties. This makes derivatives trading tricky in terms of pre-trade compliance and crucial to ensure that you’re not mixing up counterparties. 
  • Resources are generally limited for vendors as well as buy side members. Additionally, many of the vendor solutions were built for the equities world and still have big functionality gaps on the FI side. 
  • Most of the buy side are looking for one comprehensive system for derivative pricing, booking, cash management and cash settling.

Potential solutions mentioned by the buy side:

  • Buy side members agree that G10 IRS is a good place to start in electronic trading for derivatives.
  • In some cases, curve construction can be outsourced to 3rd party vendors so they do the heavy lifting.  Bloomberg, for example, enables you to build your own curves but also provides their own curve calculations. 
  • When trying to make sense of how swaps are being valued, keep in mind that it depends on the CSA you have in place. 
  • Avoid ‘putting yourself on the hook’ with one counterparty. Instead, try to make the package risk neutral then put it in competition.
  • To avoid mixing up counterparties that are associated with particular legacy funds, ensure that a member of your team has done a diligent job in mapping the right counterparties to each fund. One firm uses a colour-coded grid that is part of their OMS and gives quick visibility, highlighting which counterparties they are able to trade with.

Pricing mechanisms used by the group to determine value of derivatives: Bloomberg, QuantLab, Murex, Calypso, Quasar.

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