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Jericho
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Posts: 20
Joined: August 22nd, 2007, 3:14 pm

Internal offsetting OTC trades

March 20th, 2022, 1:46 pm

Hi,
I have a PM who in strategy1 wants to put on a long vega SPX Forward var swap v short listed vix future
In Strategy 2 he wants to put on long NDX forward variance swap v short vega SPX forward variance swap

So net he is short listed vix future and long ndx forward variance swap

He wants to book an internal OTC internal transfer for the long and short vega SPX forward var swap rather than trading with the street.  He will be delta hedging in strategy1 and he feels booking an internal OTC transfer so that he can differentiate his delta hedging and not pay bid/offer on buying and selling in the same market.

Does this present any issues?  Any thoughts on doing a trade like this with no counterparty, just internal contra accounts?

Thanks

J.
 
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bearish
Posts: 4877
Joined: February 3rd, 2011, 2:19 pm

Re: Internal offsetting OTC trades

March 20th, 2022, 2:28 pm

I don’t see anything immoral about the idea, but I suspect it won’t fly, assuming that the “strategies” are separate legal entities. Rule 17a-7 of the ‘40 Act spells out conditions for when direct cross-trades of securities between funds are acceptable, but as far as I know does not address derivatives. There is also the question of documentation. It doesn’t feel like this will fit the standard ISDA template. Of course, if the different strategies are just a way to bucket positions within a fund to facilitate risk management and P&L attribution, then it’s purely an internal systems question. It would indeed be annoying to have to cross a dealer bid/ask spread to compensate for limitations in such systems, but I have seen stranger things happen.
 
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Jericho
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Posts: 20
Joined: August 22nd, 2007, 3:14 pm

Re: Internal offsetting OTC trades

March 20th, 2022, 7:39 pm

Thank you bearish. The strategies are within the traders own book. So i guess that's fine? In terms of isda template and documentation do you mind expanding on that? Appreciate your help and time. Best
 
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bearish
Posts: 4877
Joined: February 3rd, 2011, 2:19 pm

Re: Internal offsetting OTC trades

March 20th, 2022, 11:59 pm

Well, if you were doing these trades with the Street, they would be governed by an ISDA Master Agreement and a Credit Support Annex, and that’s even before the document that specifies the details of the trades. None of this applies when you trade with yourself. A very simple term sheet would probably do, mostly making it clear how to calculate the pay-offs and how to mark to market along the way.
 
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Jericho
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Posts: 20
Joined: August 22nd, 2007, 3:14 pm

Re: Internal offsetting OTC trades

March 30th, 2022, 8:34 am

Many Thanks bearish for your time

Regards
 
Mercadian
Posts: 37
Joined: July 24th, 2020, 4:22 pm

Re: Internal offsetting OTC trades

March 30th, 2022, 7:46 pm

Hey Jericho,

I would agree with the PM, if possible it would be preferable to do an internal risk transfer than an actual trade vs the street, I've seen it done before many times.

To me there are always three key questions with regards to this:

1. Do the strategies or portfolios warrant/require the removal of the exposure? in other words what's the mandate the PM has in each strat? just to make sure that the trade does not represent a cannibalization or "subsidy" of pnl.

2. At what price will the internal trades be booked? same concern as point 1.

3. is it OKed by legal? Bearish point.

Regards,
M