A synopsis of the headlines in the derivatives industry from the last week
Global news
According to a new report from Greenwich Associates – Systemic Risk and the Impacts of Central Clearing – the new derivatives regulations are delivering the goods with 80% of institutional investors believing that mandatory central clearing has reduced systemic risk in global financial markets.
However, there still needs to be more work done on the understanding of the default management processes undertaken by clearinghouses. This lack of clarity is contributing to a widespread belief that additional measures are needed to mitigate risk.
The study shows that while almost 70% of institutions feel the major clearinghouses have adequate financial resources to handle a major multiple bank default, fewer than one in five have a strong grasp of the default management waterfalls at the central counterparties (CCPs) that clear their trades.
Respondents believed that providing clearinghouses with access to central bank liquidity and requiring them to have more “skin-in-the-game” could be two helpful measures to help them reduce the possibility of a bank failure.
Throughout last year, Greenwich Associates interviewed 4,036 global fixed-income investors about their dealer relationships and use of various fixed-income products, including interest-rate derivatives. In the fourth quarter the research firm conducted an additional 72 interviews with key research participants to more deeply understand their views on systemic risk, the impacts of central clearing and their expectations for the interest-rate derivatives market.
US
Futures to overtake swaps
In a separate report – “Total Cost Analysis of Interest-Rate Swaps vs. Futures,” Greenwich Associates revealed that buy-side firms were opting for futures over swaps due to their cost effective nature. They were seen as the least expensive alternative for expressing views on interest rates in nearly every scenario analysed with liquidity costs as the largest contributor to the gap.
In addition, the research firm, which canvassed 40 US market participants, noted that while the impact of higher margin requirements for swaps has had limited impact on product selection to date, it will move the needle in the coming years as clients have less eligible collateral on hand.
The death knell though should not be rung for either cleared or bilateral swaps. They will continue to have their place and those markets will remain robust, albeit on a smaller scale than previously.
TrueEX volumes could start to bite
Year old trueEX Group upset the derivatives apple cart by capturing almost 20% of the trades in exchange-traded interest rate swaps in the US for the week ending 20 Feb. Although it has not matched those numbers since, its 9% market share to date is a significant milestone for a start-up which is jostling for position against the weighty investment banks.
Many of the top derivatives dealers have declined to use trueEX. Other new exchanges have also struggled to get traction with major banks.
TrueEX offers trading features, such as anonymous trading, that regulators and traders at fund management firms believe will encourage smaller banks and other players, such as hedge funds, to enter the market as dealers. The theory is that this will help increase competition, reduce prices for customers, and decrease risk in derivatives markets.
Although it is unlikely to pose a serious threat, if the fledgling venue continues to build market share, it could start to make a small dent in the profitability at the top banks which combined earn $3 bn-$4 bn a year dealing US dollar interest rate swaps on exchange-like platforms, similar to trueEX’s, according to research from the Boston Consulting Group.
Europe
ISDA calls for changes to derivatives transparency rules
The International Swaps and Derivatives Association (ISDA) warned that derivative markets are in danger of a liquidity shortage if impending European regulations are not refined. The trade body is concerned that the European Securities and Markets Authority (ESMA) proposed definition for liquidity may encompass instruments that are actually illiquid.
MiFID II recommends widespread improvements to transparency, obliging prices and volumes for trades in multiple asset classes to be publicly reported, if the products are classified as liquid. The trade body though believes ESMA’s definition of what constitutes continuous buying and selling in a derivative – a key determinant of liquidity under the new rules – is incorrect at its current level of one trade per day, and a notional trade value of €50 m. Instead, it believes a more realistic threshold would be 15 trades per day, with a notional threshold of €500m.
