TradeMech: A Method to Multilaterally Net Trades Without Altering Counterparty Exposure

TL;DR

TradeMech is a novel multilaterally netting mechanism for financial networks that maximizes netting efficiency while preserving individual counterparty risk and contractual profits.

Contribution

It introduces a method to transform bilateral contracts into chains and cycles for maximal netting without altering counterparty exposure.

Findings

Maximizes multilateral netting of designated objects.

Preserves each agent's contractual profit.

Avoids creating new counterparty exposure upon default.

Abstract

Financial markets such as bond, derivatives, and repo markets form networks of interdependent obligations. Existing multilateral netting methods typically trade off the extent of netting against preservation of counterparty exposure: central clearing reallocates exposure to a central counterparty, while trade compression may alter bilateral counterparty relationships. TradeMech is a mechanism for markets in which one or two homogeneous fungible objects are traded. The mechanism transforms a network of initial bilateral contracts into chains and cycles, nets the designated object multilaterally on those chains and cycles, and replaces initial contracts with multiparty contracts whose assigned trades remain fractions of the original bilateral trades. The construction achieves maximal multilateral netting of the designated object while preserving each agent's contractual profit and preserving the location of counterparty risk. When a party fails to pre-commit a required object, the affected assigned trade is recovered as a bilateral contract between the same original counterparties and the remaining assigned trades are re-netted on residual chains, so no new counterparty exposure is created.