In a commentary article, Eurex Clearing’s Byron Baldwin explores if futurisation will take hold of the European swap markets in the near future. You can hear more of his views on OTC Clearing in a webinar June 29th.
EMIR OTC IRS Clearing Obligation Timetable
- 21 February 2016 start of Frontloading for Category 1 participants;
- 21 May 2016 start of Frontloading for Category 2 participants;
- 21 June 2016 start of OTC Clearing for Category 1 participants;
- 21 December 2016 start of OTC Clearing for Category 2 participants;
- 21 June 2017 start of OTC Clearing for Category 3 participants; and
- 21 December 2018 start of OTC Clearing for Category 4 participants.
With the European Swaps market now fully in the grip of the EMIR Mandatory OTC Clearing Timetable for the central clearing of OTC IRS, what is next for the development of the European swaps market? What about exchange traded Swap Futures as an alternative to Cleared IRS? Currently Eurex offers a Euro Deliverable Swap Future and GMEX IRS Constant Maturity Futures.
Tod Skarecky, Clarus FT, in ‘Swap Futures:2016 Progress’ outlined several bullet points in favour of the adoption of Swap Futures as an alternative to Cleared IRS:
- They replicate Vanilla OTC swaps nicely
- They are exchange traded in an order book, complete with the ability to do block trades off-exchange
- As such they fit into every Bank, HFT, PTG, CTA etc technology stack today
- Margins are typically lower than the OTC swap equivalents, hence leverage can be larger
- There should be some capital advantages to firms impacted by the leverage ratio. The PFE notional addon for futures is 0.5% while OTC variants go up to 1.5% for IRD and 5% for Credit.
- And even if you are not impacted by the leverage ratio, your FCM is, and you are paying for it
The main benefit of Swap Futures over Cleared IRS is the lower Initial Margin requirement 1 day margin period of risk (MPOR) for US exchange traded derivative products (currently 2 day MPOR for European exchange traded derivative products) against 5 day MPOR for US and European Cleared IRS.
How does this difference in MPOR between Swap Futures and Cleared IRS translate into actual margin requirements? As the tables below show, the lower MPOR for Swap Futures generates significant initial margin savings compared to their Cleared IRS equivalent…
Margin Comparison of Cleared IRS & Eurex Euro Swap Future
Margin Comparison of Cleared OTC IRS & GMEX IRS CMF
With Eurex Euro-Swap Futures being margined within the Fixed Income Liquidation Group of Eurex Clearing’s innovative PRISMA portfolio margining system that includes Bond Futures, OTC IRS and Zero Coupon Inflation Swaps, further margin efficiencies are generated when creating synthetic Euro Asset Swap trades via spreads between Eurex Euro-Swap Futures versus Eurex Bond Futures:
Synthetic Euro Asset Swap – DV01 Neutral Eurex Euro-Swap Futures vs. Eurex Bond Futures – Margin Savings
Other DV01 neutral relative value trades such as swap yield curve flatteners / steepeners and butterfly trades using Swap Futures will also generate significant margin efficiencies under Eurex Clearing’s PRISMA portfolio margining system….
Greenwich Associates in their paper, ‘Total Cost Analysis of Interest Rate Swaps vs Futures’, produced analysis of the cost, over time, of Cleared IRS versus Swap Futures (and Bond Futures):
Total Cost Analysis – Cleared IRS versus Swap Futures
The Greenwich Associate analysis above clearly shows that Futures are a much cheaper alternative to Cleared IRS with the cheapness between the two products widening the longer the holding period. The above analysis also asks the question as to whether Bond Futures are an alternative to using Cleared IRS and undoubtedly there was some switching to Treasury Futures as mandatory OTC Clearing was introduced into the US in 2013 under the Dodd Frank Act. However, using bond futures to hedge swap exposure introduces basis risk and this can be potentially significant – as evidenced if you had bought Bond Futures to create a synthetic receive fix swap position with US swap rates falling below US Treasury yields….
The futurisation of Swaps in Europe will depend on the ability to execute both in the futures order book and off exchange to meet the needs of the liquidity providers in OTC IRS. Eurex’s Trade Entry Services’ Block Trade Facility (BTF) allows for the bilateral off exchange execution of Eurex listed derivative products, including Euro Swap Futures – the BTF has a minimum trade size:
Block Trade Facility – Minimum Block Trade Size
The Exchange for Physical (EFP) Facility can then be used in conjunction with the BTF to create off exchange synthetic Euro asset swap trades between Eurex Bond Futures and Eurex Swap Futures – the Euro Swap Futures leg is executed via the BTF and then becomes the reporting transaction in the EFP facility and the duration weighted DV01 equivalent of Bond Futures is created as the transaction creating a position:
EFP Facility – Eligible Product Combinations
In the new capital constrained world of Basel III and Leverage Ratio, there is room for the co existence of both Cleared IRS and Swap Futures – Cleared IRS gives a bespoke solution to LDI and Pension Fund Managers to hedge a specific asset / liability profile, Swap Futures give a cheaper and more capital efficient access to swap market beta and a leveraged vehicle by which to generate alpha for the Buy Side…..
Links and Further Reading:
Tod Skarecky, Clarus FT, ‘Swap Futures: 2016 Progress’: https://www.clarusft.com/swap-futures-2016-progress/
Eurex Deliverable Swap Futures: http://www.eurexchange.com/exchange-en/products/int/eur-swap
GMEX Constant Maturity Swap Futures: http://www.eurexchange.com/exchange-en/products/int/gmex
Link to Eurex Fixed Income Futures Products: http://www.eurexchange.com/exchange-en/products/int
Link to Eurex Trading Entry Services – Block Trade Facility, Exchange for Swaps (EFS) and Exchange for Physicals (EFP) – Fixed Income: http://www.eurexchange.com/exchange-en/products/eurex-trade-entry-services/block-trades and http://www.eurexchange.com/exchange-en/products/eurex-trade-entry-services/exchange-for-swaps and http://www.eurexchange.com/exchange-en/products/eurex-trade-entry-services/exchange-for-physicals
Link to overview of Eurex Clearing’s PRISMA – portfolio risk-based margining: http://www.eurexclearing.com/blob/294792/9c0910e525ecde02b50cf0dd3574cc35/data/eurex_clearing_prisma_brochure.pdf
Byron Baldwin, LinkedIn Pulse, ‘Cross Margining at Eurex Clearing – Default Fund & Capital Efficiencies’: https://www.linkedin.com/pulse/cross-margining-eurex-clearing-generating-margin-default-baldwin?trk=mp-author-card
Byron Baldwin, LinkedIn Pulse, ‘Creating Synthetic Euro Asset Swaps – Eurex Bond Futures vs Eurex Swap Futures’: https://www.linkedin.com/pulse/creating-synthetic-euro-asset-swaps-eurex-bond-futures-baldwin?trk=mp-author-card
‘The ‘Missing Link’ in Todays Interest Rate Derivatives Markets for LDI Strategies’ by David Bullen & Gavin Dixon: http://www.theotcspace.com/2016/04/27/%E2%80%98missing-link%E2%80%99-today%E2%80%99s-interest-rate-derivatives-markets-ldi-strategies?utm_source=dlvr.it&utm_medium=linkedincompanies
Greenwich Associates, ‘Total Cost Analysis of Interest Rate Swaps versus Futures’: https://www.greenwich.com/fixed-income-fx-cmds/total-cost-analysis-interest-rate-swaps-vs-futures
GreySpark, ‘Trends in Fixed Income Trading’ by Frederic Ponzo & Russell Dinnage: http://research.greyspark.com/2016/trends-in-fixed-income-trading-2016/
SIFMA’s Asset Management Group (AMG), working in collaboration with the International Swaps and Derivatives Association (ISDA), has helped to develop a new interest rate swap (IRS) contract structure with pre-defined, market-agreed terms. These Market Agreed Coupon (MAC) contracts should promote liquidity and enhance transparency in IRS trading. The MAC Contract is voluntary and is meant to compliment bespoke IRS and deliverable interest rate futures.
The establishment of CUSIP numbers, a standardized method for identifying MAC contracts, will also serve to facilitate trading and transparency in the IRS marketplace.
- Press Release: SIFMA AMG Helps Develop New Market Agreed Coupon for Interest Rate Swaps (April 23, 2013)
- Press Release: SIFMA AMG and ISDA Announce that CUSIPs are Now Available for MAC Contracts (December 12, 2013)
- MAC Term Sheet
- MAC Rationale
- MAC Swap Confirmation
