Buy-side firms must prioritise the selection of clearing houses they want to use after the implementation of new OTC derivatives legislation, or risk falling behind, according to new research.
With only weeks before elements of the Title VII rules under the Dodd-Frank Act come into force, market participants must act now in order to successfully transition to the new environment, consultancy Woodbine Associates has foreshadowed in its readiness assessment report published this week.
Under Dodd-Frank, OTC derivatives must be traded on exchange-like platforms where possible, centrally-cleared and reported to newly created swap data repositories.
For the buy-side, a key concern surrounds securing agreements with central counterparties (CCPs). According to Woodbine, the buy-side’s choice of central counterparties will be led by the efficiency that can be gained through offsetting the margin posted against swaps exposures.
Netting initial margin across cleared swaps, futures and cash instruments through one CCP will allow the buy-side to reduce costs under the new rules.
Rather than forging direct agreements with CCPs, the Woodbine report suggests institutional investors will instead access clearing houses through futures commission merchants to avoid additional requirements in the event of default.
“Clearing customers will need to move quickly if they have not already done so. Negotiating documentation, implementing technology, onboarding portfolios and testing communications and middleware is an involved process and can take from six to 12 weeks or longer,” the report, compiled by Sean Owens, director, fixed income and derivatives at Woodbine, reads.
Mandatory swaps clearing will kick in on 11 March for some interest rate swaps and credit default swaps, for swaps dealers and major swap participants.
The study also identified pre-trade analysis as another area the buy-side need to invest in to lower the cost of hedging and risk transfer. This includes implementing new methodologies and technology to automate margin daily and intra-day margin calculations in real-time, which will require increased analytical capacity within firms.