New studies highlight uncertain future for swaps trading
Market participants gearing up
for widespread changes in the OTC derivatives market are likely to favour
exchange-traded products to manage risk because of onerous margin requirements
for exotic instruments.
The predictions are part of
new research from consultancy TABB Group commissioned by the World Federation
of Exchanges and suggest that a margin shortfall for swaps that reached US$2.6
trillion at the end of 2011 could be reduced to several hundred billion dollars
based on product selection changes.
“A war is being waged between
forces of the status quo and forces of transformation of the global risk
transfer market,” says Paul Rowady, senior analyst at TABB and author of the
study. “It has the potential to shift product selection for hedging and trading
purposes, from exotic and bespoke trade structures, to standardised and
clearable swaps, futures and new futurised/hybrid swaps.”
The research focuses on the
core changes that will result from the new OTC derivatives regulation such as
clearing, margin, automated trading, costs, reporting and extraterritoriality
and compares them with global exchange-traded derivatives markets.
The reforms will standardise
OTC derivatives where possible so they can be traded on exchange-like platforms
and cleared by central counterparties, thereby subjecting them to more formal
margin requirements. Exotic products that are not suited for exchange trading
will be subject to higher margin costs.
TABB estimated that the OTC
derivatives market reached a record US$709 trillion of notional values
outstanding at the end of December 2011, but added the exchange-traded
derivatives market remains larger, accounting for 55% of the overall risk
“To mandate clearing and
margin requirements during an era of deleveraging – when collateral becomes
painfully scarce – is a bitter pill to swallow for many financial entities,” said
Rowady. “These margin requirements may continue to make exchange-traded and
other standardised products more attractive.”
But he added that enforced
clearing and the mutualisation of risk are more desirable than the consequences
and costs that could arise if a major derivatives player collapses.
Trading venues take shape
from capital markets research firm Greyspark examined the environment for the
newly-created derivatives trading venues that will emerge as a result of the
In the US, the
Dodd-Frank Act included the creation of the swap execution facility, while in
Europe, MiFID II will likely introduce derivatives trading venues via the new organised trading facility category of trading platform.
With over 50
firms planning or launching trading venues for derivatives, liquidity
aggregation – particularly in a low volume environment – will be key.
According to the
report, aggregation must include an accurate valuation process for products, a reliable estimate of the size of
firm and executable liquidity available, and an optimisation of the trading
The report also
highlights the differences that face buy-side firms as they opt to either
connect to trading venues themselves – which potentially increases costs
through the need to set up market access and clearing infrastructure – or access
derivatives venues using existing relationships with dealers.