The system used to calculate fees for trades on the credit indices is throwing up discrepancies when dealers determine the price of credit options, the majority of which are bets on iTraxx or CDX. And as the volume of credit options that expire on quarterly dates increases, it's becoming more of a pressing issue.
On hundreds of options, trade counterparties are computing different cash settlement figures, which can vary by up to GBP100, (USD176). This is creating headaches for middle and back office staff who settle and process the transactions.
Greg McEneny, legal counsel in credit derivatives at the Royal Bank of Scotland, said there is inconsistency at almost every option expiry and settlement prices can vary by up to USD2000. "It's like a storm in a teacup," McEneny said, adding, "Although the discrepancies are quite small, each one has to be manually looked at." Dealers are looking to stamp out variations by holding discussions to clarify settlement pricing methods across the market. "We need to agree on a benchmark before we can go forward," said one legal official. No formal talks have yet been held, but groups including the International Swaps and Derivatives Association and the International Index Company are expected to be involved.
Differences in settlement prices are arising because of inconsistencies in the method which determines them. When an index is formed, a spread level for the index is calculated and then frozen. The difference between this frozen spread and the spread at expiry creates the cash settlement fee. Dealers get the current spread from a Bloomberg page called CDSW, which references a floating interest rate benchmark. Counterparties are not referencing this benchmark at the same time and therefore receiving varying settlement figures. "Unless it's calculated at exactly the same time, which is hard, there will be differences," said a trader.
