A significant proportion of buy-side traders expect a reduction in OTC derivatives volumes following the introduction of swaps rules, with many also expecting a substantial shift to equivalent futures, according to research from UBS.
The Swiss bank’s report quizzed buy-side traders on their outlook for swaps activity as new rules under the Dodd-Frank Act begin to take hold. The report showed 69% of buy-side respondents thought the new rules would cause volumes and liquidity in OTC derivatives markets to decrease, although none thought it would cause a ‘significant’ decrease.
“It is increasingly likely that the impact of higher margin requirements at clearing houses will more than offset some of the benefits that would come from increased transparency,” the report, authored by Alex Kramm, analyst, UBS, read.
Half of respondents also stated they were likely to direct more swaps business to futures markets, driven by lower capital and margin requirements, lower execution costs and better liquidity.
Specifically, 23% of respondents said moving OTC derivatives activity to futures was ‘more likely’ and 26% of respondents said the move would be ‘likely’, but there were currently not enough substitutes’ for contracts they traded, due largely to the customisable nature of swaps.
The appeal of futures has grown since October, when new reporting rules part of Dodd-Frank implementation drove derivatives venues to create futures instruments that mimicked OTC derivatives.
Under the Title VII of the Dodd-Frank Act, swaps will be traded on exchange-like venues known as swap execution facilities and must be cleared through central counterparties, which will require the buy-side to post higher margin against their exposures. In Europe, similar rules will come into force through a combination of the European markets infrastructure regulation (EMIR) and MiFID II.
Buy-side desks from asset managers, hedge funds, banks, insurance companies, and government sponsored enterprises were interviewed for the report, with 58% of respondent based in the United States. Also, 34% of respondents conducted more than 40% of their overall business in OTC derivatives markets.
In the US, mandatory swaps clearing will begin on 11 March for some interest rate and credit derivatives contracts for market participants classified as swaps dealers and major swap participants. In Europe, EMIR rules will come into force later this year after formal agreement is reached in Brussels over the details of the regulation.