Electronic netting system for bilateral trades

This application is a divisional of U.S. application Ser. No. 11/319,002 filed Dec. 27, 2005, which is incorporated herein by reference in its entirety.

1. Field of the Invention

The present invention relates generally to electronic trading systems and, more particularly, to a system for multi-lateral netting of bilateral trades of OTC derivatives.

2. Description of the Prior Art

Financial derivatives are contracts of which the price/value of the contract varies with the value of an underlying instrument. Financial derivatives can either be standardized contracts traded on a recognized Exchange or OTC traded. OTC derivatives are individually negotiated and tailor-made between two counterparties (so called “over the counter (OTC) transactions”). The parties do their own valuation of the contracts both when dealing as well as later on when establishing the market value of their contracts during their life.

Participants in the OTC markets are banks, investment banks and other financial institutions. The International Swap and Derivatives Association is a trade organization for dealers active in the OTC derivatives market. An OTC derivative transaction allows the financial institution to manage its market risk positions, either for the purpose of hedging or for the purpose of deliberate position taking to make a profit from an expected change in market prices. Derivatives allow the market risk of substantial amounts to change hands without the need and associated costs of transferring the underlying values.

A thorough discussion of other aspects of OTC derivatives may be found in U.S. Published Patent Application 2003-0083978 entitled “System and method of implementing massive early terminations of long term financial contracts” by Brouwer which is hereby incorporated by reference in its entirely.

However, because of the volume of trade, it is often possible that the counterparties involved have off-setting trades which, if “ripped up” prior to the confirmation process, can result in reduction of costs to the counterparties such as reduction in economic and regulatory capital usage; and reduction in counterparty risk exposure. As can be appreciated, offsetting bi-lateral trades between just two counterparties is a simple process. However, offsetting or netting trades between a plurality of individual, segregated counterparties to provide for multi-lateral netting is more complex.

Thus, there remains a need for a new and improved electronic netting system which provides netting of bilateral trades while, at the same time, is operable to provide optimized, multi-lateral netting among a plurality of individual, segregated counterparties.

The present invention is directed to an electronic netting system. The system may include: (a) a plurality of individual, segregated counterparties for providing bilateral trades, (b) a multi-lateral transaction hub, and (c) a trading system in communication with the transaction hub. The multi-lateral transaction hub may be for (i) providing an aggregation of trades between the counterparties, (ii) providing for multi-lateral netting of selected and authorized bilateral trades, (iii) apportioning the accumulated trade values among the counterparties according to pre-determined netting parameters including a weighted distribution selectable by at least one of the counterparties; and (iv) including the selection of a preferred counterparty credit exposure.

In a preferred embodiment, the individual, segregated counterparties are financial institutions. The financial institutions may be banks. The banks may include investment banks.

Also in a preferred embodiment, the bilateral trades are OTC derivatives. The OTC derivatives may be credit derivatives. The credit derivatives may be credit indices.

Preferably, the transaction hub may include: (i) a trade processing system (ii) a netting system in communication with the trade processing system for providing for the optimized, multi-lateral netting of selected and authorized bilateral trades and apportioning the accumulated trade values among the counterparties; and (iii) a trade confirmation matching service.

The trade processing system may include an input of the bilateral trades and a database for storing the input and an output of the trades. The input may include the parties, the instrument, the price, the size, and the upfront fee. The input may further include additional trade details. The input may also include data from E-trading. The trade processing system may further include external trade input. In a preferred embodiment, the output may include trade confirmations.

In an embodiment, the trade processing system may further include a trade verification module. The trade verification module may be bilaterally verified.

Preferably, the netting system may include an input of trades (T₁, T₂, . . . T_N), a recursive application of the optimization algorithm of the optimization engine, and an output of netted trades. The recursive optimization engine may further include a first netting interval. The recursive optimization engine may also include at least one subsequent netting interval for netting the remainder of unnetted and netted trades from the preceding netting interval. In an embodiment, the netting system may further include an input of additional netting parameters. The additional netting parameters may include at least one counterparty trading limit.

In one embodiment, the output of netted trades may further include a payment output. The payments may be netted. The payments may also be collected by a central party.

The output of netted trades may also include a reconciliation output. Preferably, the additional netting parameters may include netting constraints. The netting constraints may be selected from the group consisting of limits of trades; limits of notional and combinations thereof. The additional netting parameters may include netting objectives. In an embodiment, the netting objectives may be selected from the group consisting of total gross notionals; number of trades; variance of the notional; distribution of netted trades by counterparty (i.e. the counterparty credit exposure distribution); and combinations thereof.