PLUS Markets, a UK-based exchange group, has unveiled details of new swap index contracts (SICs) that will be traded on its soon-to-be-launched derivatives exchange and are designed to improve the efficiency of interest rate hedging.
The group's derivatives exchange – PLUS-DX – is scheduled to go live by the end of Q2 and will start by offering a contract based on the full fixed-for-floating US$-based interest rate swap index.
The index contract is designed to reflect the profit and loss of the underlying interest rate swap (IRS) market and will offer 45 different indices covering the US dollar curve for tenors between two and 30 years, including spread and butterfly functionality. PLUS plans to extend the range of SICs to include euro-, sterling- and yen-denominated contracts in the coming months.
Market participants can use a SIC to enter into a short-term interest rate swap with just one single exposure. At present, if an investor wants a short-term hedge against the 10-year IRS curve, he/she would be required to first buy a 10-year IRS swap then enter into another swap in the opposite direction. However, under current regulations, it is not possible to net both transactions, meaning the investor is required to hold the contract for its full duration.
“While it will not be possible to standardise all over-the-counter (OTC) derivatives products so they can be traded on exchange, a lot of the stress in the market stems from the fact that investors have to use long-term contracts to create a short-term exposures,” Clive Connors, managing director, PLUS-DX, told theTRADEnews.com. “This index allows you to hold an exposure for a short timeframe, then sell it with no future commitments.”
Connors added that the method of trading the SIC, which he first designed in 2006 and developed with index operator FTSE, was an important consideration.
“When developing PLUS-DX, it was important to ensure the method of trading is similar to the OTC market to avoid meeting resistance from traditional players,” said Connors. “There is a need and an opportunity to innovate in the OTC market in light of regulatory reforms.”
Following the financial crisis at the end of 2008, leaders of the Group of 20 called for OTC derivatives to be publicly traded and centrally cleared by the end of 2012 to mitigate systemic risk and impose a level of transparency to a market that was worth over US$601 trillion at the end of 2010, according to statistics from the Bank of International Settlements. Of this total, IRS contracts made up US$465 trillion, or 77%, of all swaps traded globally. In Europe, legislators are currently working towards finalising new rules for OTC derivatives via the European market infrastructure regulation and the second iteration of MiFID.