In the 2008 financial crisis two relatively banal words - counterparty risk - became existential problems for all of Wall Street's major banks and their regulators. Even if firms had positioned their portfolios smartly for the looming carnage, they were all linked together in one giant chain of dominoes to a failing firm, for instance Lehman Brothers, AIG or Bear Stearns. After all, what's the point in having an interest rate, credit, or commodity hedge if one side of your trade is in bankruptcy and can't make good on its payments. That's why the Federal Reserve controversially made all of AIG's trading counterparts whole when bailing out the insurer. In the wake of the crisis, banks and regulators rushed to address this risk of falling dominoes, forcing many swap trades once negotiated bilaterally between firms onto independent clearinghouses. Behind the scenes, many major firms have also embraced new technologies to pare down their remaining counterparty risks by identifying overlapping trades and offsetting them. These so-called trade "tear-ups," done in markets such as interest rate swaps, have reduced risk and created new balance sheet breathing room for many of the world's largest banks, perhaps allowing them to increase their lending. That's where a largely unknown, four-person firm called LMRKTS comes in. Earlier this month, the firm made its mark by eliminating $430 billion worth of overlapping foreign exchange exposures across five currencies for six banks including Goldman Sachs Group , JPMorgan Chase , Bank of America , Deutsche Bank and UBS . Lawrence H. "Larry" Summers, former U.S. Treasury secretary. Photographer: David Paul... [+] Morris/Bloomberg New York City-based LMRKTS, founded in 2012 by Lucio Biase, a former trader at Lehman Brothers, Credit Suisse and hedge fund Marathon Asset Management, used its proprietary algorithms to identify 1,182 redundant foreign exchange trades in currencies including the U.S. dollar, British Pound, Euro and Japanese Yen in 25 minutes. (The firm's name is meant to represent a locked market, where buyers and sellers meet at a market equilibrium price.) “Regulations like the Volcker Rule lower the probability of a domino falling because it limits speculation," says Biase. "But they do nothing to lower the impact of that falling domino. What we do is decrease the size of the dominoes, and move them further apart,” he says. LMRKTS' first run is arguably the largest and swiftest compression of foreign exchange risk ever seen on Wall Street. It also comes as quantitative models, new forms of data analysis and artificial intelligence are fundamentally changing the way Wall Street works. The rise of the so-called quants is not only bringing new financial models to investing, it is also creating novel ways for banks, hedge funds and regulators to understand and manage risk. Reducing the potential for systemic risk is the sweet spot for LMRKTS, and it's drawing interest from powerful players on and off Wall Street. On Friday, former Treasury Secretary Larry Summers joined the firm's advisory board, and he praises the its analytic capabilities. “LMRKTS has developed an offering that will help reduce the ‘interconnectedness’ of banks and clearing houses by netting and diversifying counterparty credit risk for cleared and bilateral exposures,” says Summers. The need for a firm like LMRKTS is somewhat simple to explain. As banks like JPMorgan put trades on across Wall Street and offset their various trading risks, their books may end a trading day with flat market risk. But even as the trading books across Wall Street close in relatively neutral position, exposure to one bank or another can stretch into the trillions. That's because they can't see the trading positions of their counterparts to offset them. Banks know these risks exist, but of course they won't open their trading books to each other. So they entrust third parties like LMRKTS and competitor TriOptima to do this work for them by identifying overlapping trades and recommending offsets. It seems LMRKTS may have made a giant breakthrough in using sophisticated algorithms to efficiently find the overlapping trades between parties and clearinghouses that continues to create systemic risk. “What was most striking to me was the incredible efficiency of the LMRKTS algorithm,” says Dan Marcus, head of business development at Tradition, the inter-dealer broker that was used in the compression. “Every single regulator and every central bank should be cheering this on," Marcus adds. Biase's team at LMRKTS includes Hilary Park, a theoretical mathematician and former proprietary trader at Goldman Sachs and Marathon Asset Management, in addition to Sandeep Karkera, a former technology executive at Susquehanna, and Andy Coyne, the former CEO of Traiana. The firm's advisory board includes network theorist Kimmo Soramaki and Andy Brindle, the former head of credit derivatives and structured credit trading at JPMorgan. Already, Biase is working on new foreign exchange compressions, and LMRKTS may eventually ply its services to other markets. “We are trying to provide a market-friendly means to the regulatory mandate of lowering systemic risk." he says. Read More: Banks Promise No Lehman Moment By Relying On Unfinished Derivative Rule Change
The one - person panel at compression provider , LMRKET , recently disclosed $ 430bn of compressed forex exposures for a group of six banks in just 25 minutes . The elimination , by the firm founded in 2012 by a former Lehman Brothers trader , marks the swiftest compression of risk ever seen on Wall Street . The banks benefiting from the compressed exposure across five major currencies were JPMorgan chase , Goldman Sachs plc , global Bank , Bank of America and UBS .