Buy-siders warned of swap future risks

Institutional investors should be wary of the risks involved in swap futures, instruments touted as an alternative means of gaining exposures as OTC derivatives migrate to central clearing, according to speakers at a conference in London.

Institutional investors should be wary of the risks involved in swap futures, instruments touted as an alternative means of gaining exposures as OTC derivatives migrate to central clearing, according to speakers at a conference in London.

Speaking at the OTC Derivatives for Fund Management conference in London today, Patrick Roos, CEO and risk manager at buy-side advisory firm Vanna Capital, raised concerns that many asset managers have not properly identified the risks entailed by use of futurised swaps.

“Central counterparties (CCPs) have been lobbying for people to use swap futures because of the lower margin requirements, meaning they hold less risk. But there can be problems when you change a swap into a future, in particular your risk increases when volatility goes up, ” he said.

The increased costs of clearing OTC derivatives compared to listed futures have been a major point of disagreement between regulators and market participants and operators as regulations come into force that introduce reporting, central clearing and new trading venue requirements on the OTC derivatives market.

Earlier this year, Bloomberg, a financial data provider that launched a US swap execution facility (SEF) in October, took legal action against a decision by the Commodity Futures Trading Commission to require increased margin for centrally cleared swaps executed on SEFs, saying it would hamper new venues. However, the judge ruled that Bloomberg had not been harmed by the rule and thus did not have standing to file a lawsuit.

Vanaja Indra, director of market and regulatory reform at Insight Investment, said, “The benefits of futurisation have been overplayed, and the reason swaps are so popular is because of their highly bespoke nature enabling very accurate hedges.”

Indra said swap futures are either so vanilla that they don’t really give a good hedge or they are highly bespoke and thus should be exposed to higher margin requirements due to a lack of liquidity. Despite being g a future, the products that most adequately fulfill the role of a swap are inherently risky.

Roos believes firms using swap futures could risk regulatory problems in the future as well. “Regulators have already warned that attempts to circumvent the rules to use risky products without suitable margin requirements could be something they look to take action on later,” he said.

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