Omgeo and European Central Counterparty (EuroCCP) have launched joint development of a pan-European equities central counterparty (CCP) service for hedge fund transactions.

The service should mitigate counterparty risks and reduce inefficiencies in the hedge fund/prime broker/executing broker processing chain.

The processing solution will be based on Omgeo Central Trade Manager (Omgeo CTM) which services trades from execution through to settlement. Omgeo and EuroCCP expect to pilot test of the system model this year and aim for a 2010 launch of the service.

Currently the settlement of hedge funds' trades between their executing and prime brokers occurs as OTC transactions without any CCP guarantee. All parties, including the underlying hedge funds, are exposed to counterparty risk.

The introduction of a CCP in the settlement chain substantially reduces counterparty risk between the prime and executing brokers and substantially reduces the exposure of the hedge fund to their executing brokers.

A CCP also enables more efficient operations by netting down the number of transactions that need to be settled.

The profitability of the prime broker/executing broker business is under pressure because of costly and excessive trade repair procedures and frequent manual intervention in what could be an automated process.

The information flows resulting from unmatched trades and trade allegations in the market have strained capacity in the middle and back offices. This has added risk for all counterparties, particularly prime brokers. These uncertainties have led to higher than acceptable levels of costly settlement failures.

Omgeo and EuroCCP will use an institutional trade processing model that will route hedge fund/prime broker equity trades as well as other OTC transactions from trade matching through central counterparty netting and onward to settlement finality.

The model will enable a prime broker to authorise locked-in trades and release them to EuroCCP, where the trades will be guaranteed, netted and routed to the proper European central securities depository (CSD) for settlement on a netted basis.

The Omgeo/EuroCCP processing solution initially will cover equities in 15 European markets and seven currencies. By netting customers' gross obligations, EuroCCP will be able to reduce the number of settlement transactions.

Due to stamp tax regulations netting is unlikely to occur in the near term in the UK and Ireland.

EuroCCP is a UK-incorporated, UK Financial Services Authority (FSA)-regulated recognised clearinghouse. It is the European subsidiary of the Depository Trust & Clearing Corporation (DTCC). EuroCCP was formed to provide clearing and settlement services for a wide range of trading venues across Europe.

Through its subsidiaries DTCC provides clearance, settlement and information services for equities, corporate and municipal bonds, government and mortgage-backed securities, money market instruments and over-the-counter derivatives.

DTCC is also a processor of mutual funds and insurance transactions.