Patent Publication Number: US-2010125518-A1

Title: System and method for facilitating exchange of credit default swaps

Description:
CROSS REFERENCE TO RELATED APPLICATIONS 
     The present application claims priority to Great Britain Application No. 0820925.6 filed Nov. 14, 2008. The entirety of the application is incorporated herein by reference. 
     FIELD OF THE INVENTION 
     The present invention relates to a system and method for facilitating exchange of credit default swaps, in particular the exchange of credit default swaps between a tender device and a client device. 
     BACKGROUND OF THE INVENTION 
     A credit default swap (CDS) is a contract in which a buyer of the CDS agrees to make a series of payments to a seller and, in exchange, receives a payoff if a credit instrument, for example a bond or loan, goes into default or a specified credit event occurs, for example bankruptcy or restructuring. Credit default swaps can be bought by a professional investor and traded amongst a group of well-established investors; it is not necessary for a particular buyer to own the underlying credit instrument. Currently, credit default swaps are traded directly between buyers and sellers which limits the availability and ease of trading amongst the group of investors who are typically large financial institutions. In the context of this application, an institution is an individual or organisation (e.g. a bank or fund) which carries out CDS trading. Large financial institutions are generally content to trade credit default swaps amongst each other because there is awareness amongst the investors of the credit worthiness of the counter party. However, this limits the availability of CDS trades to direct trades between institutions who have detailed knowledge of the credit worthiness of the individual institutions; that is the ability of an individual institution owning a particular CDS to be held to the payoff of the credit instrument on the occurrence of the specified credit event. Generally, this means that individual investors, who are not well-known or visibly involved in CDS trades, cannot trade in CDS. 
     It would be desirable to improve the ease and availability of trades in defaults swaps employing electronic trading platforms. 
     SUMMARY OF THE INVENTION 
     The present invention is defined by the appendant claims and aims to solve the aforementioned problems. 
     The system and method of the present invention increases the availability and ease of access to credit default swap trades amongst individuals whilst ensuring that CDS trades are only effected when the credit worthiness of the individuals can be verified to an acceptable level; that is a level at which it is presumed the buyer will not default on the trade subsequent to its completion and the seller will not default on a payout if the credit event covered by the CDS occurs. 
    
    
     
       BRIEF DESCRIPTION OF THE DRAWINGS 
       The present invention will now be described by way of reference to the accompanying drawings in which: 
         FIG. 1  shows a credit default swap trading system that exists in the prior art; 
         FIG. 2  shows a credit default swap trading system according to the present invention; 
         FIG. 3  shows a workflow of the credit default trading system of  FIG. 2 ; 
         FIG. 4  shows a user interface generated at a client processing device of the credit default trading system of  FIG. 2 . 
     
    
    
     DETAILED DESCRIPTION OF THE DRAWINGS 
       FIG. 1  shows a conventional CDS trading system  100  of the prior art. A first processing device  101  and a second processing device  102  are connected via a conventional network connection  103 , such as a LAN and the Internet, to each other and can communicate with each other over the network connection  103 . A server processing device  104  is also connected to the network connection  103  and is accessible to both the first and second processing devices  101 ,  102 . In one example of the prior art, the first processing device  101  may be accessed by a first user (acting for a given institution) who is a buyer of credit default swaps and the second processing device  102  may be accessed by a second user (acting for a given institution) who is a seller of one or more credit default swaps, but the opposite is also true and the first user may also be a seller of credit default swaps and the second user may be a buyer of credit default swaps. In essence, the first and second processing devices  101 ,  102  are interchangeable in that each can operate as both a sales and purchase platform for credit default swaps. 
     The first processing device  101  is connected to a first display screen  101   a  and first user input means  101   b.  The second processing device  102  is connected to a second display screen  102   a  and second user input means  102   b.    
     The server processing device  104  comprises memory  104   a  storing a database  104   b  of the credit default swaps which are tendered for sale or purchase by the second processing device  104 . For each credit default swap which is tendered by a given processing device, the database  104   b  comprises an offered sale price and an offered purchase price for a unit value of the CDS. 
     The second processing device  102  is configured to transmit sale and purchase prices of credit default swaps to the server processing device  104  for storage in the database  104   b.  In essence, a user of the second processing device  102  has agreed to sell a given CDS at a particular unit sale price and purchase a given CDS at a particular unit purchase price. 
     When a user of the first processing device  101  wishes to instigate a trade of a CDS, the first processing device  101  is directed (using the first user input means  101   b ) to access the server processing device  104  and a request for available credit default swaps from the second processing device  102  is transmitted. The server processing device  102  receives the request and transmits the purchase and sale prices for the credit default swaps. The sale and purchase prices are received by the first processing device  101  and displayed in a user interface on the first display screen  101   a  or vice versa. The server processing device  104  acts merely to receive, store and pass on sale and purchase prices of credit default swaps. The user of the first processing device  101  may decide to proceed with a trade (either sale or purchase) based on the received purchase and sale prices. The trade is then effected using the first user input means  101   b  through the first processing device  101  which initiates communication directly with the second processing device  102  corresponding to the CDS which it is intended to trade. An electronic swap contract is exchanged directly between the first and second processing devices  101 ,  102 . In the prior art, the server processing device  102  acts merely to pass on the sale and purchase prices of credit default swaps agreed by a particular institution through the second processing device  102 . The institution will only permit a user of the first processing device  101  to trade with it when it has accepted that the user (or related institution) has sufficient available credit with the counter party and vice versa. In the prior art system  100 , this is achieved by the second processing device  102  being configured to restrict access to a group of accepted users receiving direct connections from the first processing device  101 . 
       FIG. 2  shows a trading system  200  according to the present invention and  FIG. 3  shows a workflow performed by the system  200  of the present invention. The invention is now described by way of example only, with regard to  FIGS. 2 and 3 . 
     A client processing device  201  and a tender processing device  202  are connected via a conventional network connection  203 , such as a LAN and the Internet, to each other and can communicate with each other over the network connection  203 . A server processing device  204  is also connected to the network connection  203  and is accessible to both the tender and client processing devices  201 ,  202 . The client processing device  201  is accessible by a user who is a buyer of credit default swaps and the tender processing device  202  operates with or for an institution (such as a market maker) who is a seller of one or more credit default swaps. The opposite is also true and the user may also be a seller of credit default swaps and the institution may be a buyer of credit default swaps. The institution is commonly known as a market maker and the user is commonly known as a trader. In both cases, the tender processing device  202  supports tenders to buy or sell credit default swaps and the client processing device  201  serves as a platform to respond to the tenders, rather than providing its own tenders. That is to say, the client processing  201  is not accessible by any other device to view credit default swap prices, whereas the tender processing device  202  transmits and receives sale and purchase prices for credit default swaps across the network connection  203  to the server processing device  204 . 
     The client processing device  201  is connected to a client display screen  201   a  and client user input means  201   b.  The tender processing device  202  is connected to a tender display screen  202   a  and tender user input means  202   b.    
     The server processing device  204  comprises memory  204   a  storing a CDS database  204   b  of the credit default swaps which are tendered for sale or purchase by the tender processing device  202 . For each credit default swap which is tendered by a particular processing device  201 , the CDS database  204   b  comprises an offered sale price and an offered purchase price for a unit value of the CDS. 
     The memory  204   a  also comprises a user database  204   c  of user information containing a record for each registered user of the system  200 , a value representing cash credit available to the user and a credit rating for the registered user; that is a value representing the credit worthiness of the user and the ability of the user to make payments required under the terms of a credit default swap. 
     The aforementioned cash credit can be an amount that the supplier of the system  200  is willing to loan on margin in addition to a user&#39;s personal credit contained in a margin account. A user has to have a minimum amount in the margin account for the purchase of a particular CDS. This deposit is known as the minimum margin. From the account, the user can borrow from the system provider up to a specified percentage (e.g. 60%) of the notional purchase value of the credit default swap. On completion of a purchase of a CDS, the margin loaned to the user by the system provider is secured against the CDS so that, on sale of the CDS by the user, the amount of the margin is first repaid to the system provider before the remainder of the value from the sale of the CDS is credited to the user into the margin account. The server processing device  204  determines the margin available to the user for the purchase of a given CDS based on the specified percentage defined by the supplier and a minimum margin required by the supplier. The margin account is held at payment clearance server  205  which also holds the system provider&#39;s account for providing the margin as determined and approved by the server processing device  204 . The payment clearance server  205  is connected to the server processing device  204 . 
     The minimum margin and specified percentage are specific to a particular user and values for each user are stored in the user database  204   c.    
     The tender processing device  202  is configured to transmit sale and purchase prices of credit default swaps to the server processing device  204  for storage in the database  204   b.  In essence, the institution represented by the tender processing device  202  has agreed to sell a given CDS at a particular unit sale price and purchase a given CDS at a particular unit purchase price. Tendered data is transmitted from the tender processing device  202  to the server processing device  204  comprising: sale and purchase prices along with an identifier for the particular CDS and credit conditions which must be satisfied by the buyer or seller for a trade to be completed. This information is displayed in a user interface generated by the client processing device and displayed on the client display screen  201   a.  For example, the credit conditions may stipulate that the seller must have a particular value or range of credit worthiness values. 
     In step  301 , the user accessing the client processing device  201  with client user input means  201   b  directs the client processing device  201  to connect to the server processing device  204  and identifies itself to the server processing device  204 , for example by logging in with a username and password to the server processing device  204 ; that is the client processing device  201  receives input of the username and password from the client processing device  201  and transmits the username and password to the server processing device  204 . If, following step  302 , the user is identified in the user database  204   c,  then in step  303 , the tendered prices stored in the CDS database  204   b,  and received from the tender processing device  202 , are streamed and updated in real-time to the client processing device  201 . The server processing device  204  is configured to transmit only the ‘best’ sale and purchase prices for a particular CDS to the client processing device  201  from amongst a plurality of values of a particular CDS received from different institutions and tender processing device  202   s.  In a particular embodiment of the invention, the ‘best’ price is defined as the lowest sale unit sale price for a given CDS or the highest purchase price for a given CDS. Thus, the server processing device  204  transmits sale and purchase prices for different available credit default swaps which are received from a plurality of different tender processing devices (only one tender processing device is shown in  FIG. 2 ). 
     In step  304 , the user of the client processing device  201  may decide to proceed with a trade (either sale or purchase) of a given CDS from the counter party based on the received purchase and sale prices. Using the client user input means  201   b,  the trade is initiated by the client processing device  201  initiating communication with the server processing device  204  to transmit a trade request for a quantity of sale or purchase of the selected CDS. 
     In step  306 , the server processing device  204  receives the trade request and determines the value of the trade; that is the total purchase or sale cost to the user of the client processing device  201 . In step  307 , the server processing device  204  is configured to access the client database  204   b  and determine whether the identified user has sufficient credit margin and satisfies the credit conditions specified in the tendered data previously transmitted from the tender processing device  202 . 
     In the case of purchase of a CDS by a user, the server processing device  204  communicates with the payment clearance server  205  to determine whether sufficient margin credit exists for the trade. In doing this, the server processing device  204  determines that:
         (i) sufficient personal credit is available to the user in its margin account;   (ii) sufficient margin (provided by the system provider) is available in addition to the user&#39;s personal credit above the user&#39;s specified maintenance margin; and   (iii) the margin being supplied is below the maximum specified percentage available to the user for the trade of the particular CDS.       

     If sufficient margin credit exists and the credit conditions for the particular CDS trade are satisfied, then the tender processing device  202  which offered the sale or purchase price for the tendered processing device is notified, along with the client processing device  201  which instigated the trade (step  308 ). In step  308 , the notification gives the user of the client processing device  201  a further opportunity to cancel or accept the trade. If the conditions are not satisfied or insufficient credit does not exist then the tender processing device  202  and client processing device  201  are notified accordingly. 
     If, following step  309 , the trade is to be accepted, then the server processing device  204  generates an electronic swap contract for the trade (i.e. either a sale or purchase by the client processing device  201 ) in step  310  and submits an electronic payment request to the payment clearance server  205  in respect of the institution corresponding to the tender processing device  202  (in the case of sale by the institution) or in respect of the user identified at the client processing device  201  (in the case of sale by the user). 
     In the case of purchase of a CDS by a user, the server processing device  204  signals the payment clearance server  205  in the request to transfer credit from the user&#39;s margin account to the institution&#39;s account along with any margin credit required and approved from the system provider&#39;s account. In the case of sale of a CDS by a user, the server processing device  204  signals the payment clearance server  205  in the request to transfer credit from the institution&#39;s margin account to the system provider&#39;s account in respect of margin previously utilised by the user for its purchase of the CDS, and to further transfer any remaining credit owed (having been deducted from the margin owed to the system provider) into the user&#39;s margin account. 
     In addition, in step  311 , a trade margin or trade fee is deducted by the server processing device  204  and credited to the system provider&#39;s account. 
     The swap contract is completed during step  310  by being electronically signed by the server processing device  204  on behalf of both the user and institution and transmitted to both the client and tender processing devices  201 ,  202 . 
     The electronically signed swap contract represents agreement that the seller receives a payment if the credit instrument specified in the swap contract goes into default or a specified credit event occurs. 
       FIG. 4  shows a user interface  400  of the trading system  200  generated by the client processing device  201  on the client display screen  201   a  based on the tender data received from the server processing device  204 . 
     It will of course be understood that the present invention has been described above purely by way of example and modifications of detail can be made within the scope of the invention.