Patent Publication Number: US-7904377-B2

Title: System for settling over the counter trades

Description:
RELATED APPLICATIONS 
     This application is a continuation of U.S. patent application Ser. No. 10/444,324 filed May 23, 2003, which claims priority from U.S. Provisional Application No. 60/385,337 filed May 31, 2002, the contents of which are hereby incorporated by reference. 
    
    
     BACKGROUND OF THE INVENTION 
     1. Field of the Invention 
     The present invention relates to an electronic trading system. Particularly, the present invention is directed to a system for trading instruments, such as over the counter instruments or futures contracts, on an electronic exchange wherein trades are settled either bilaterally or cleared based on participant preferences. 
     2. Description of Related Art 
     The present invention relates generally to the trading of instruments such as over the counter instruments and futures contracts. Generally, such trades are arranged through bilateral contracts, i.e., the exchange of written agreements between counterparties. Recently, electronic markets have arisen to facilitate the trading of these instruments. In some circumstances, the trades may be consummated automatically if each counterparty informs the exchange of predetermined credit limitations, and the counterparties satisfy each other&#39;s respective limitations. While this method has generally been effective, the increased popularity of trading in these instruments (especially electronically) has created a need for more conventional trading method involving clearing trades through a third party clearinghouse. 
     Each method of trading, bilateral and cleared, has its own advantages. Bilateral trades are often favored where the parties have a pre-existing bilateral netting agreement, or where clearing a trade may be more expensive. On the other hand, it may be preferable to clear trades through a clearinghouse when one of the parties has reservations concerning the other party&#39;s credit worthiness and wishes to have the trade guaranteed by a third party. Current electronic exchanges have not accounted for these preferences. Therefore, there is a need for a system on an electronic exchange in which participants may set preferences to trade either bilaterally or cleared depending upon the circumstances. There is also a need for a system in which the exchange will automatically default to a preferred trading method. It is also desirable to show the products being traded in a single price stream, regardless of how the trade is settled. Thus, the details of the trade (e.g., price, quantity, etc.) should not be affected by the method of settlement. The method of settlement will only be determined at the time of trade confirmation. This system will streamline electronic trading of the products being traded. 
     SUMMARY OF THE INVENTION 
     The purpose and advantages of the present invention will be set forth in and apparent from the description that follows, as well as will be learned by practice of the invention. Additional advantages of the invention will be realized and attained by the methods and systems particularly pointed out in the written description and claims hereof, as well as from the appended drawings. 
     To achieve these and other advantages and in accordance with the purpose of the invention, as embodied and broadly described, an embodiment of the invention includes a trading system for trading financial instruments on an electronic exchange involving bilateral and cleared trading, the system comprising:
         receiving respective trading preferences from a first participant and a second participant relative to each other, wherein said trading preferences comprise bilateral only, cleared only, preferred bilateral, preferred cleared, or closed;   receiving respective bilateral credit limits from the first and second participants relative to each other if bilateral trading is possible between the first and second participants, the bilateral credit limits comprising daily dollar limits and tenor limits;   establishing a first and second clearing account between each of the first and second participants and one or more clearing firms, respectively, if cleared trading is possible, wherein each clearing account has a clearing account setting of open or closed for each of the first and second participants relative to each other; and   effecting a cleared trade between the first and second participants if:
           (a) the first participant has a trading preference for the second participant as cleared only or preferred cleared and the second participant has the second clearing account open with respect to the first participant, or   (b) the first participant has the first clearing account open with respect to the second participant and a trading preference for second participant as preferred bilateral and the second participant has a trading preference with respect to the first participant as cleared only or preferred cleared with the second clearing account open;   
           refusing a trade between the first and second participant if:
           (a) the first participant or the second participant has a trading preference of closed with respect to the other,   (b) the first participant has a trading preference of cleared only and the second participant has a trading preference of bilateral only or preferred bilateral with the second clearing account closed, or   (c) the first participant has a trading preference of bilateral only and the second participant has a trading preference of cleared only; and   
           effecting a bilateral trade between the first and second participant if the trade is not refused or cleared and the trade satisfies the first and second parties&#39; respective bilateral credit limits.       

     Embodiments of the foregoing system have the advantage that they can be embodied in a user interface able to facilitate electronic trading, as described herein below. 
     It is to be understood that both the foregoing general description and the following detailed description are exemplary and are intended to provide further explanation of the invention claimed. 
     The accompanying drawings, which are incorporated in and constitute part of this specification, are included to illustrate and provide a further understanding of the method and system of the invention. Together with the description, the drawings serve to explain the principles of the invention. 
    
    
     
       BRIEF DESCRIPTION OF THE DRAWINGS 
         FIG. 1  is a schematic representation of the components of an embodiment of the system in accordance with the invention. 
         FIG. 2  is a schematic representation of a procedure for setting up an account to trade in accordance with an embodiment of the present invention. 
         FIG. 3  is a schematic representation of another procedure for setting up an account to trade in accordance with an embodiment of the present invention. 
         FIG. 4  is a schematic representation of a procedure for setting up accounts to trade cleared in accordance with an embodiment of the invention. 
         FIG. 4A  is a user interface used in connection with an embodiment of the invention. 
         FIG. 4B  is a user interface used in connection with an embodiment of the invention. 
         FIG. 4C  is a user interface used in connection with an embodiment of the invention. 
         FIG. 5  is schematic representation of a trading pathway in accordance with an embodiment of the invention. 
         FIG. 6  is schematic representation of a further trading pathway in accordance with an embodiment of the invention. 
         FIG. 7  is schematic representation of clearing account checks in accordance with an embodiment of the invention. 
     
    
    
     DETAILED DESCRIPTION OF THE PREFERRED EMBODIMENT 
     Reference will now be made in detail to the present preferred embodiments of the invention, an example of which is illustrated in the accompanying drawings. The method and corresponding steps of the invention will be described in conjunction with the detailed description of the system. 
     The methods and systems presented herein may be used for electronic trading of financial instruments, such as over the counter instruments or futures contracts. The present invention is particularly suited for electronic trading of such instruments wherein a participant on an electronic exchange has predetermined preferences concerning settlement with specific counterparties. 
     Electronic over the counter trading systems are shown generally in  FIG. 1 . Such a system  100  generally includes an exchange server  101  operated by the exchange. One such exchange, for exemplary purposes, is provided by the Intercontinental Exchange, Inc. In electronic communication with the exchange server  101  are multiple trading parties operating through party terminals  102   a  through  102   d . Although only four party terminals are herein depicted, it should be clear that the system  100  is not limited to four party terminals and will usually have hundreds, if not more, party terminals  102 . Indeed, the more parties trade on the exchange, the more successful the exchange will be. Finally, the exchange server  101  may be linked to one or more clearing firms  103   a  through  103   c . Again, the system is not limited to the number of clearing firms  103  depicted in  FIG. 1 , but instead should be understood to comprise as many or as few clearing firms as have agreed to clear trades made on the exchange. Other computers or terminals may be included in the system  100  for performing a variety of other functions desirable in an electronic trading system (such as trade matching). It should also be understood that the trading system  100  will be operational regardless of the methods by which the various parties or clearing firms are linked to the exchange server  101 , such as by modem, serial cable connection, wireless connection, or other telecommunications link known in the art or hereafter developed. 
     The present embodiments of the invention require first that the parties be set up to take advantage of the exchange. This process is described generally at  FIGS. 2 through 4 . It should be noted that the process for setting up the parties can vary depending upon the business needs of the exchange and are not necessarily related to the settlement logic which is at the heart of the present invention. 
       FIG. 2  represents the set-up process  200  for a participant on the exchange who is involved in trading. The participant first completes a Participant Agreement and New User Enrollment Form  210 . These forms are typically legal documents by which the participant agrees to the terms and conditions governing use of the exchange. The documents (which may be executed on line or in paper form) may also identify the various persons or entities having responsibilities or obligations, such as the participant&#39;s Administrator, contact information, or subsidiary companies that will be trading on the exchange under rights granted to the participant. For example, therefore, a company may execute a single Participant Agreement to allow trading for multiple subsidiary companies whose accounts will be managed by a single participant employee (e.g., the Administrator, or a Risk Manager, to be explained further below). In the second step  220 , the Administrator gives the participant access to markets in which the customer will be trading. In practice, the exchange may have multiple markets relating to the types of instruments traded, such as energy markets, commodity markets, equity markets, etc. In the next step  230 , the Administrator sets up each particular user. The user may be an individual or an entity with rights under the Participant Agreement. In this step, the Administrator identifies to the exchange what each user may or may not do. For example, some users may have trading privileges, others may have viewing privileges. A particular user may also be identified as the Risk Manager, whose role is defined further in reference to  FIG. 4 . Finally, the Administrator gives the users permissions  240 . Thus, for example, some users will be permitted to trade in one market, but not others. 
       FIG. 3  represents the set-up process  300  for a participant on the exchange who is involved in trading by clearing trades, that is, for participants that are clearing firms. In addition to the process  200  set forth in  FIG. 2 , the clearing firm goes through the process  300  required to establish a clearing relationship with the participants on the exchange. The process is similar to the process for setting up a trading participant  200 , except the process  300  is focused on setting up clearing permissions. Thus, after a clearing firm has executed the necessary agreements  310 , the Administrator tells the exchange that the participant is a clearing firm  320 . The Administrator will set up users  330  who will have authority to clear trades, and will finally give users their specific clearing permissions (e.g., market or value specific criteria for clearing trades)  340 . 
       FIG. 4  and associated  FIGS. 4A-C  represent the process by which a Risk Manager and Clearing Administrator establish clearing accounts for particular traders, counterparties and markets. It should be understood that the screen shots depicted in  FIGS. 4A-C  represent preferred embodiments of the user interfaces of the present system. 
     According to the method  400 , the Risk Manager logs into a counterparty filter  410 . The counterparty filter is depicted in  FIGS. 4A-4C . In  FIG. 4A , the counterparty filter identifies the market which the Risk Manager has selected in Market Type tab  401 . The Risk Manager selects his company&#39;s role in that market, i.e., buyer or seller, from tab  402 . It will be understood that one skilled in the art might use drop down menus for each of the required tabs. For the selected market type and role, all of the participants are listed in the Participant column  403 . In the Market Type selected in  FIG. 4A , clearing is not available, and thus the clearing button  404  is disabled. Because clearing is unavailable, trades must be settled bilaterally in this Market Type. Accordingly, the counterparty filter identifies whether the company has identified the participant as a participant with which the company will trade bilaterally in this market (see “My Bilateral” column  405 ). Similarly, the “Their Bilateral” column  406  identifies whether the applicable counterparty permits bilateral trading with the Risk Manager&#39;s company. In the preferred embodiment, the term “open” is used to denote available bilateral trading, and “closed” is used when such trading is unavailable. Bilateral trades can only be executed when each party&#39;s bilateral preference is “open” with respect to the other. In addition, bilateral trading will occur when the parties are able to meet each other&#39;s respective credit limits. Thus, the counterparty filter identifies the tenor limits (i.e., Max Days) for the instrument being traded  407 , and the Daily Dollar Limit  408  for trades with that counterparty. In the case depicted in  FIG. 4A , a trade between Test Company and Adidas for an instrument having a term exceeding 10,000 days or a notional value exceeding $99,000,000 will be rejected. Also, because the Daily Dollar Limits  408  are cumulative for the trading day, a trade having a notional value of, for example, $50,000,000 will be rejected if the two parties have already traded in excess of $49,000,000 in notional value that day. 
     In  FIG. 4B , the Risk Manager selects another Market Type from the menu  401 . In  FIG. 4C , the Risk Manager has selected a Market Type where clearing is available. Thus, the counterparty filter additionally identifies each party&#39;s clearing preference with respect to the other  411 ,  412 . Based upon this screen, it can be seen whether trades will be executed bilaterally, cleared, or not at all. If both parties prefer cleared trades with respect to each other, the trade will default to cleared. If both parties have clearing capabilities, and if one party prefers cleared but the other party prefers bilateral, the trade will default to cleared. In the preferred embodiment, the trade will default to bilateral in the event both parties have clearing capabilities only if both parties prefer bilateral. 
     In the next step  420 , the Risk Manager requests clearing accounts from the clearing firms of his choice. This process is preferably accomplished through an electronic interface. The Risk Manager will send a request to the Clearing Account Manager requesting access to one or more of the company&#39;s clearing accounts with the clearing firm. The Clearing Account Manager may access a screen which identifies all of the requests for accounts and may respond by making one or more of the accounts available for trading. Typically, the company has a pre-existing relationship with clearing firms for trading, and one or more of those pre-existing accounts is used. Once access has been given to a clearing account, the Risk Manager may edit and view trader profiles (i.e., trading profiles for users under the Risk Manager&#39;s authority). This may include assigning accounts to particular traders. 
     The trading process according to the preferred embodiments of the present invention is depicted in the flow charts shown in  FIGS. 5-7 . In  FIG. 5 , it is determined first whether trading is available between counterparties, P 1  and P 2 . If trading is available between P 1  and P 2 , the trading logic is depicted in  FIG. 6 . The clearing account checks are depicted in  FIG. 7 . 
     According to  FIG. 5 , in the preferred embodiment, the first party, P 1 , floats an order to the exchange  510 . In the preferred embodiment, this involves selecting a market the party wants to trade in, navigating to an order entry screen, entering the economic details of the transaction, selecting a clearing account, and floating the order (either bid, offer or both). The order is received by prospective counterparty, P 2 , who decides to attempt to consummate a trade on the terms of the order floated by P 1 . The first determination  520  is whether P 1  permits bilateral trading with P 2 , i.e., is bilateral trading “open” or “closed” with P 2 . If bilateral trading is open with P 2 , the next inquiry  530  is whether P 2  has bilateral trading open or closed with P 1 . If both P 1  and P 2  have bilateral trading available with each other, trading is available (at least on a bilateral basis) and the process proceeds to the trading logic  600  to determine whether the actual trade floated by P 1  can be consummated between P 1  and P 2  based on credit limits. 
     Referring back to  FIG. 5 , if P 1  has bilateral closed with respect to P 2 , the inquiry is then whether P 1 &#39;s order is floated with a clearing account  525 . If P 1 &#39;s order is floated with a clearing account, the order is passed to clearing account checks  700  to determine whether the order passes clearing credit account checks  540 . If P 1 &#39;s order is not floated with a clearing account, trading is unavailable with P 2  and the order will show up as unavailable to P 2  on the trading screen. That is, if P 1  does not have a clearing account for that order, and bilateral trading is closed with P 2 , then there is no pathway through which a trade may occur, and trading is unavailable. If P 1 &#39;s order passes clearing account checks, the next step is to determine whether P 2 &#39;s order has an account  535 . If not, and bilateral trading is closed with P 1 , trading is unavailable. If so, then the order is passed to P 2 &#39;s clearing account checks logic  700  to determine whether P 2 &#39;s order passes clearing account checks  545 . If the order passes clearing account checks, then P 1  and P 2  may trade cleared and trading is available pursuant to trading logic  600 . If P 2 &#39;s order does not pass clearing account checks, trading is unavailable. Thus the trading availability scheme is summed up as follows. Trading is available (assuming credit limits are met) if: (1) both P 1  and P 2  have bilateral open with respect to each other, or (2) either P 1  or P 2  have bilateral closed but both parties have a clearing account open for the order and the order passes clearing account checks. If either P 1  or P 2  has bilateral closed with respect to the other, and does not have a clearing account available, there is no trading pathway (bilateral is closed and clearing is unavailable). 
     Assuming trading is available between P 1  and P 2 , the trading logic  600  determines whether the trade is settled bilaterally, cleared or not at all. The first inquiries  610 ,  615  are whether the order is floated with a clearing account. If not, the trade can only proceed bilaterally, if at all. Thus, the system determined  620  whether P 1 &#39;s order passes P 1 &#39;s bilateral credit checks, i.e., tenor limits and daily dollar: limits. If not, there is no trade. If P 1 &#39;s order passes its bilateral credit checks, the next inquiry  630  is whether the order will pass P 2 &#39;s bilateral credit checks. If not, there is no trade. If the order satisfies the tenor limits and daily dollar limits for both P 1  and P 2 , and one or both does not have a clearing account for the order, the trade will be consummated bilaterally. 
     Assuming both P 1  and P 2  have an open account in which to clear the order, the order must pass the clearing account checks  700  for both P 1  and P 2 ,  625  and  635 , respectively. Such clearing checks include, for example, the order size, the credit line available in the clearing account, maximum net long and short limits, and a net trade position balance (calculated from all cleared trades in a trading day) to determine maximum long and short thresholds per trade opportunity. These checks are described in  FIG. 7 . If clearing account credit checks cannot be met for either or both P 1  and P 2 , the trade will pass to the bilateral credit checks,  620 ,  630  to determine if the trade can nevertheless proceed bilaterally. 
     If clearing account credit checks are satisfied, the trade may still be settled either bilaterally or cleared depending upon the parties&#39; preferences. If P 1  will only trade cleared with P 2   645 , the trade will automatically proceed as a cleared trade. If P 1  will trade either way, but simply has a preference for one or the other  655 , the trade will trade cleared if P 1  prefers cleared, but will depend on P 2 &#39;s preferences if P 1  prefers bilateral. If P 1  prefers bilateral, but P 2  will only trade cleared  665 , the trade will be settled through clearing. Similarly, if P 2  will trade either way but prefers cleared  675 , the trade will be settled through clearing. If both P 1  and P 2  prefer bilateral trading  655 ,  675 , the trade will settle bilaterally even though cleared trading is available to them. Thus, if cleared trading is available based on clearing account credit checks, and either party prefers cleared trading or mandates cleared-only trading, the trade will settle through clearing. If cleared trading is unavailable, or if available but both parties prefer bilateral trading, the trade will settle bilaterally if both parties satisfy bilateral credit limits. 
       FIG. 7  depicts the credit account checks pathways for P 1  or P 2 , respectively. It should be understood that the checks will proceed along different lines as one party will be making a bid and another party will be making an offer. The clearing account checks are therefore described herein generically. The first step  705  is to determine whether the applicable party has set his clearing account to limit trading such as, for example, suspending or closing the clearing account. This is typically done by a risk manager and may not be known to the trader at the time the order is floated. If the account is suspended or closed, the trade fails the clearing account checks. If the account is open, the next step  710  is whether the clearer has suspended or closed to account. If so, the order fails account checks. If the account is not suspended or closed (either by the party or the clearer), the next step  720  is to determine whether the clearer has set the account as open or liquidate. 
     Assuming first the account is set to open, the next inquiry is whether the party is making a bid or an offer  730 . If it is a bid, it is determined whether the lot quantity exceeds lot size limitations placed on the account  732 . If the lot size is not under the limit, the clearing account is unavailable and the order fails clearing account checks. If the lot size is under the limit, the next inquiry  734  is whether the bid exceeds the net account balance. If the bid is not less than the maximum trade long position minus the net account balance, the order will fail the account checks. If the bid is within range, clearing is available on that account. 
     If the party is making an offer instead of a bid, the inquiries are similar. The first inquiry is whether the lot size meets lot size limits  736 . If not, the order fails. If so, the system determines  738  if the offer exceeds the max trade short position plus the net account balance. If not, the trade fails clearing accounts. If so, trading may proceed on a cleared basis with this account (assuming the remaining trade logic is satisfied). 
     If the clearer has the party set to liquidate, the first inquiry  740  is again whether the party is making a bid or an offer  740 . If it is a bid, and the account net balance is long  742 , the trade will fails account checks. If the account net balance is short  742 , the clearing account checks proceed as described above in steps  732  and  734 . If the order is an offer, and the account net balance is short  744 , the order fails account checks. If the account net balance is long, the clearing account checks proceed as described above in steps  736  and  738 . 
     It will be understood the present invention can be adapted to other types of clearing account checks. 
     Another aspect of the system according to preferred embodiments is a user interface that displays parties&#39; trading preferences and settings with respect to each other. In the preferred embodiments, the counterparty filter (see  FIG. 4C ) illustrates this functionality in a market where clearing is available. For each product in the market relative to the particular counterparty, the filter will identify whether the first party permits bilateral trading with the counterparty (see “My Bilateral”) and whether the counterparty permits bilateral trading with the first party (see “Their Bilateral”). In addition, the counterparty filter identifies whether clearing is possible for a particular product. In the “My Clearing” and “Their Clearing” columns, the first party&#39;s and counterparty&#39;s preferences (i.e., Bilateral or Cleared) are displayed, respectively. It should be noted in this embodiment that even if cleared trading is available, if a party is set to “Preferred Bilateral,” it will be displayed as a “Bilateral” setting in the “Clearing” column. Thus, if the first party prefers cleared trades and the counterparty prefers bilateral trades, but nevertheless has a clearing account available for the product, the trade will proceed cleared. 
     Although the counterparty filter identifies the possible trades that can be made with a specific counterparty for specific products, in the preferred embodiment trading is done anonymously and whether the trade is settled through clearing or bilaterally is not decided until actual trade execution. Thus, the first party may float on offer for a particular product on which both bilateral and cleared trading is available. Whether the trade will be settled bilaterally or through clearing will depend on the preferences of the party to accept the offer. If the party making the offer, for example, has bilateral trading closed with a particular counterparty and at least one of the party or counterparty does not permit cleared trading of the product, the product will show up as red on the trading screen. If trading is possible, the product offer will show up as white. The color coding acts as the means for indicating whether trading is possible. The color coding may also be tied to the particulars of the trade (e.g., notional amount or tenor limits) and those trade particulars compared to a counterparty&#39;s bilateral credit limits to determine if trading is possible. Accordingly, if the two parties have bilateral trading open with respect to each other, but the trade would exceed bilateral credit limits, the product offer might still show up as red. 
     It will be apparent to those skilled in the art that various modifications and variations can be made in the method and system of the present invention without departing from the spirit or scope of the invention. Thus, it is intended that the present invention include modifications and variations that are within the scope of the appended claims and their equivalents.