The buy-side may reduce its risk hedging activities as a result of clearing requirements for OTC derivatives under the Dodd-Frank Act, which will capture asset managers for the first time in June, an expert has warned.
The second wave of client clearing under the Dodd-Frank Act, which takes effect on 10 June, will require most buy-side firms to centrally clear swaps trades. Chris Perkins, global head of OTC clearing for Citi, said the development of swap futures products offered asset managers more options to hedge risk, but that the higher price of clearing more bespoke swaps could lead some buy-side firms to take on more risk.
“The markets will ultimately find an equilibrium and there will be a price point where it makes sense to clear for those clients, or those clients will find ways to hedge risk, possibly via futures, or they may simply take on more risk,” Perkins said.
Despite this, Citi’s OTC clearing chief suggested that more market participants may engage in cleared OTC derivatives products as the market will be regulated and there will be more liquidity.
Citi has stepped up efforts to prepare buy-side clients for the June client clearing deadline under Commodity Futures Trading Commission rules governed by Title VII of the Dodd-Frank Act, although a great number of asset managers began centrally clearing swaps trades in advance of the regulatory deadline to ensure systems, processes and agreements with clearing houses are in place.
Extraterritoriality concerns also persist among market participants, as final rules and an implementation date for the European market infrastructure regulation (EMIR) – expected in Q1 2014 – are yet to be finalised.
Perkins said differences between these two regimes may lead to a fracturing of transatlantic clearing agreements, and the possibility of some arbitrage techniques for selected products.
“If we can’t get extraterritoriality right between EMIR and Dodd-Frank we could see the regionalisation of derivatives trading with European market participants clearing with European clearing houses and vice versa,” said Perkins.
Clearing for the largest users of swaps came into force in March, while the June deadline – known as the ‘category two’ deadline – will capture most buy-side firms. The third phase of these rules will come into force on 9 September with the extension to all market participants.