Buy-side swaps costs shrinking under Dodd Frank – BoE

The derivatives industry has seen execution costs for USD swaps contracts fall by as much as $40 million daily since the onset of new trading rules, according to research from the Bank of England.

Buy-side swaps traders have seen execution costs fall between $7-13 million as a result of rules implemented under the US Dodd Frank Act, according to a research paper from the Bank of England.

The paper compiled by BoE staff found that since the introduction of electronic swaps trading and clearing platforms in the US, execution costs for USD mandated contracts (the most liquid contracts) decreased by as much as $20-40 million daily for banks, and by $7-13 million daily for end-users.

Interest rate and credit default swaps are executed on swap execution platforms (SEFs) in the US and Europe is readying itself for similar facilities set to cater for the products under the incoming MiFID II.

“The shrinkage of the intermediation chain and the elimination of associated dealer mark-ups may have been one of the reasons why execution costs decreased after the introduction of SEFs,” the paper said.

The paper says that traders can theoretically bypass interdealer brokers, such as ICAP, in concluding a trade, thus reducing costs.

It also said trading costs have not been dramatically affected by the fragmentation of swaps liquidity pools, despite concerns raised by the International Swaps and Derivatives Association (ISDA).

“Our analysis shows that although US and EU swap markets appear to have become less integrated as a result of Dodd-Frank, this has not had a detrimental effect on trading costs. A fragmentation measure, based on the proportion of trades conducted across versus within geographical regions, is unrelated to liquidity.”

However, it noted that costs may rise for end-users due to fragmented liquidity through higher search costs and limited competition between liquidity providers.