August 11, 2014
There is a perception among some commentators that only a small fraction of derivatives activity relates to hedging that benefits the ‘real economy’. This analysis challenges that assumption. Publicly available data published by the Bank for International Settlements reveals that 65% of over-the-counter interest rate derivatives market turnover involves an end user on one side and a reporting dealer on the other. These participants, comprising non- dealer financial institutions and non-financial customers, use derivatives primarily to hedge risks and reduce volatility on their balance sheets. The remaining 35% of derivatives turnover activity relates to dealer market-making and the hedging of customer transactions – vital for market liquidity and the facilitation of client trades. Without this, end users would be unable to put on risk-reducing and cost-effective hedges, potentially leading to less hedging and more balance-sheet volatility.
July 24, 2014
Evidence has emerged that over-the-counter derivatives markets have fragmented along geographical lines since the start of the swap execution facility (SEF) regime in the US on October 2, 2013. That trend has been especially notable for euro interest rate swaps, with European dealers opting to trade with other European parties. This development has accelerated since the start of mandatory SEF trading in the US from February 2014, and the market for euro interest rate swaps is now clearly split between US and non-US counterparties. This research note provides evidence of this further fragmentation since February, based on an empirical analysis of cleared derivatives data.
January 8, 2014
Years after the first G-20 summit and Dodd-Frank’s passage, swaps may be made available to trade early this year, finally heralding the SEF era. Remaining issues include unfinalized rules in the United States and possible regulatory inconsistencies among major global economies. However necessary the regulatory mandates, they are the polar opposite of organic market development and have the potential to drastically disrupt global OTC markets. In other words, though Dodd-Frank’s execution mandate has certainly resulted in a great blossoming of SEFs, all is not a bed of roses: SEFs must consolidate before liquidity can thrive and SEFs can eventually blossom once more.
Bank for International Settlements
December 8, 2013
This feature analyses the market for OTC interest rate derivatives using data from the Triennial Central Bank Survey. Low and stable interest rates after the financial crisis went hand in hand with low but still positive turnover growth in most currencies. The increase was entirely driven by a larger volume of contracts with financial institutions other than dealers. The share of inter-dealer trades has shrunk to 35%, the lowest since the survey’s inception. Despite rapid growth in emerging market currencies, trading remains concentrated in major currencies and financial centres. Changes in regulation have led to more contracts being centrally cleared.
After growing rapidly prior to the financial crisis, activity in the market for over-the-counter (OTC) interest rate derivatives, such as swaps and forward rate agreements (FRAs), has since expanded at a more moderate pace. Even so, daily turnover averaged $2.3 trillion in April 2013, 14% higher than three years before (Graph 1, left-hand panel).
Activity in this market remains opaque. Admittedly, transparency has improved from the mid-1990s, when central banks expanded their regular survey of activity in foreign exchange markets to also cover turnover and amounts outstanding in OTC interest rate derivatives. And data warehouses and clearing houses provide some data on the transactions they process. Even so, the Triennial Survey remains to date the most comprehensive source of information.
This special feature uses data from the latest Triennial Survey, covering April 2013, to shed light on the structure of the OTC interest rate derivatives market and to analyse the main drivers for activity. We find that low and stable interest rates after the financial crisis have gone hand in hand with low but still positive turnover growth in most currencies. A larger volume of contracts with financial institutions other than dealers coincided with declining inter-dealer activity, causing the share of inter-dealer trades to shrink to 35%, the lowest since the inception of the Survey. The volume of transactions with non-financial firms also declined. Despite rapid growth in emerging market currency activity, trading remained concentrated in major currencies and financial centres. Changes in regulation have resulted in more contracts being centrally cleared.
August 7, 2013
Research from Deutsche Bank highlights the differences in the Dodd-Frank Act and EMIR, which the group says, raises the risk involved in regulating the OTC derivatives market.
The report is published as the US Commodity Futures Trading Commission (CFTC) proposes rules for derivatives clearing organizations to align with international standards.
The Deutsche Bank report reveals:
- The exact definition of standardised derivative contracts, the treatment of cross-border trades, and CCP access to central bank liquidity have yet to be clarified.
- The decrease in volumes in derivatives markets can largely be explained by trade compression.
- Despite a notable shift from dealer to CCP trades for interest rate derivatives, the actual capacity of the clearing market is much higher.
- Regulatory pressure to encourage standardisation seems to have created little urgency for greater standardisation, and the utilization of exchange platforms has remained limited.
- Even though collateral practices would become more expensive for all market participants, non-financial corporations as counterparties are more likely to be affected by collateralisation obligations in the future.
July 11, 2013
Research from Deloitte highlights how the US and EU regulatory regimes for over-the-counter derivatives markets are highly aligned.
The report is published as the US Commodity Futures Trading Commission (CFTC) meets to agree how its rules will apply to EU banks operating in America.
The Deloitte report reveals:
- The regulatory objectives in the EU and US are aligned across all 15 regulatory categories identified by the CFTC.
- Overall, regulators are adopting a similar approach to reducing systemic risk and improving transparency.
- The categories where there is the greatest degree of variance are swap data reporting and clearing and swap processing.
- Despite differences in approach both regimes lead to broadly similar outcomes.
Davis Polk has developed a series of monthly reports with statistical data and graphical illustrations of the Dodd-Frank rulemaking process. The analysis in the Progress Report is largely derived from our Davis Polk Regulatory Tracker, an online subscription service designed to help market participants, particularly their in-house legal and compliance departments, effectively navigate the Dodd-Frank Wall Street Reform and Consumer Protection Act and the regulatory phase of financial reform.
Financial Services Regulatory Practice
The CFTC issued three final rules that will move bilaterally traded swaps onto execution platforms that offer many-to-many trade functionality. These rules create the standards for registering and operating swap execution faciliations (“SEFs”). This brief describes this new regulatory environment for mandatory electronic swaps trading and highlights considerations for the buy-side and sell-side.
Impact and Analysis of the CFTC’s Final Rule Relating to the End-User Exception to the Clearing Requirement for Swaps
This alert focuses on the recent approval by the Commodity Futures Trading Commission (“CFTC”) of the final rules relating to the end-user exception to the mandatory clearing requirements, what the rule means for end-users, and the effects that the final rule has for various swaps and entities. Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) provided non-financial end-users that use derivatives to hedge or mitigate their commercial risks an exception from the Dodd-Frank Act’s clearing requirements. While Title VII of the Dodd-Frank Act provides and the CFTC’s final rule implements an exception for qualifying non-financial swap end-users with respect to clearing and trading requirements, regulators have not provided definitive guidance with respect to inter-affiliate swaps, centralized hedging units, and margin. Additionally, non-financial end-users will still be responsible for other requirements under the Dodd-Frank Act, including recordkeeping obligations. Gibson Dunn can assist derivatives end-users that want to learn more about the end-user exception and other rules that may affect end-users.
This report focuses on fundamental reform of over-the-counter (OTC) derivatives markets, and the profound impact on how these instruments are used. The core objectives of the reforms, which
include the Dodd-Frank Wall Street and Consumer Protection Act (the Dodd-Frank Act) in the US, European Market Infrastructure Regulation (EMIR) and similar measures throughout Asia, are to centralise and manage counterparty credit risk and increase transparency.
This paper describes a risk reduction practice, portfolio compression, which is conducted in the interest rate swap (IRS) market. Compression enables swaps dealers with substaintial two-way (pay and recieve) swap activty to terminate substantial amounts of swap contracts before they expire by their terms. The benefits of compression include reductions in counterparty credit exposure, operational risk and cost, as well as lower legal and adminsistrative expenses in the even of a default of any participating dealer.
Bank of England
As part of a G20 commitment to improve transparency and mitigate systemic risk in derivatives markets, many OTC derivatives will be required to be traded on exchanges or electronic platforms by the end of 2012. It is important that liquidity on the new trading platforms is resilient, both
during normal and stressed market conditions. This article discusses how liquidity is provided in different trading models and how liquidity resilience can be achieved. The article shows that liquidity provision depends on many factors, including the willingness of dealers to provide continuous prices, their ability to manage the inventory risk arising from their role as market makers, and the ability of customers to execute large or sensitive trades with minimum price impact. The article also suggests that conceptually, liquidity resilience can be achieved in a variety of trading models.
December 1 2011
According to new research released publicly today, “SEF Industry Barometer: Fall 2011,” skepticism is rising across the swaps markets concerning the benefit of implementing SEFs, says Kevin McPartland, report author, a TABB principal and director of fixed income research. Thereport’s analysis is based on responses from over 200 buy-side and sell-side market participants in the US and Europe, including dealers, SEFs, interdealer brokers, asset managers, proprietary traders, hedge funds, commercial end users, G14 and non-G14 global investment banks and agency brokers, futures commission merchants (FCMs), IT providers, exchange/clearinghouses and consultants.
November 30 2011
In a new report, Swap Execution Facilities and Organised Trading Facilities: A New Market Structure Emerges, Celent offers key insights into the likely future direction of SEF/OTF markets and critical factors setting this direction. Based on these insights, Celent believes that there are multiple scenarios for the market structure to reach the SEF/OTF future state. However, because of fragile liquidity, industry feedback, and cautious regulators, a dominant scenario emerges as the most likely outcome.
The Macrofinancial Implications of Alternative Configurations for Access to Central Counterparties in OTC Derivatives Markets
The G-20 leaders’ commitment that all standardised over-the-counter (OTC) derivatives will be centrally cleared by the end of 2012 is intended to increase the safety and resilience of the global financial system. Achieving these objectives depends importantly on the arrangements through which market participants obtain access to central clearing. Such arrangements could include increased use of existing global CCPs; the establishment of domestic CCPs in a number of jurisdictions; and the possible construction of links between CCPs. This report analyses the potential implications for financial stability and efficiency of these alternative access arrangements to CCPs.
November 1, 2011
This paper examines in considerable detail the likely costs and benefits of mandating the execution of interest rate swaps on designated contract markets (“DCMs”) or on swap execution facilities, (“SEFs”). The “Electronic Execution Mandate” or the “EE Mandate” is not related to issues of safety or soundness of the derivatives marketplace. These issues are properly covered in rules regarding clearing and reporting of transaction data to regulators. Regulation affecting market structure rather than risk should be justified by rigorous cost-benefit analysis as required by law. Since there has been no such justification, the International Swaps and Derivatives Association (“ISDA”) decided to conduct a comprehensive cost benefit study and retained NERA Economic Consulting to assist in the research and analysis. The study indicates that the EE Mandate, in all likelihood, will bring little benefit to the market while adding significantly to the costs of using derivatives.
October 18 2011
In a new report, EMIR and OTC Derivatives Clearing in Europe: Tough Times Ahead, Celent looks at the main features of the regulation, along with its impact on the market participants. EMIR is expected to be implemented by January 2013. It is going to be voted upon by the European Parliament in Q4 2011. Once implemented, it will be flexible in its orientation and further changes could be made with regard to issues such as the definition of eligible derivatives and the threshold levels for nonfinancial users.
June 15 2011
In September 2009, the leaders of the G-20 stated that “All standardized OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.”
August 15 2011
New initial margin requirements are going to have a huge impact on which OTC derivative products become more popular and which are abandoned. For example, like a sin tax, the proposed level of initial margin requirements for uncleared trades will render certain trade structures extinct. Initial margin levels for even the most vanilla trades will still be a huge drag on capital given that they are starting from zero today. Even small margin requirements attached to huge notional values outstanding have the potential to wreak havoc on product selection.
July 22 2011
Davis Polk & Wardwell LLP today released a report analyzing the rulemaking and implementation progress of the Dodd-Frank Wall Street Reform and Consumer Protection Act following its one-year anniversary. The Progress Report contains a wide range of statistical data and graphical illustrations of the Dodd-Frank rulemaking process and takes into account the scores of rulemakings that had a July 21, 2011 deadline.
July 14 2011
Whereas before automated swaps trading was both improbable and impractical, OTC derivative reform efforts are setting the stage for some long-overdue market innovation. Automating the trade confirmation process by launching Deriv/SERV in 2004 was a great first step, but that evolutionary change pales in comparison to the changes that are upon us now. Principal trading groups (PTGs) are known as firms that flourish in highly liquid and highly electronic markets. The manual and bilateral nature of the swaps market has kept PTGs on its sidelines for years.
June 23, 2011
The exchange landscape for interest rate futures is changing dramatically as exchanges launch new products and a new entrant emerges. A new report from Aite Group examines the state of the interest rate futures market. It explores the products available and highlights changes at and new offerings from the three major U.S. exchanges in the space.
Authored by Craig Pirrong, Professor of Finance at the Bauer College of Business at the University of Houston, “The Economics of Central Clearing: Theory and Practice” is the first in a series of discussion papers by ISDA covering key topics in OTC derivatives, public policy and financial regulation. This report is particularly timely given the current regulatory proposals to expand the role of central clearing, and the active debate about the rules that should apply to it.
May 19, 2011
The OTC derivatives markets represent a $600 trillion marketplace with broad participation from banks, institutional investors and corporate end-users around the world. The marketplace is in flux however, as coordinated global regulation is creating a dramatically different market for trading interest rate swaps. Central clearing for end-users, the use of organized trading facilities and increased transparency and reporting requirements are all being mandated through these global regulatory efforts. The impact of these changes will shape the future of interest rate swaps trading and is forcing many market participants to reexamine their interest rate hedging and exposure strategies.
April 28, 2011
A new report from Aite Group addresses the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (aka FinReg) on over-the-counter (OTC) derivatives, and discusses outstanding issues associated with its implementation.
April 12, 2011
With the comment period behind us and the final rules only a few months away, there is still a lot of uncertainty in the market about what final OTC derivatives market rules will look like. In this report, TABB Group provides answers to critical questions, such as: who will be the winners and losers, how will liquidity be impacted and what will the market look like when the dust settles.
October 28, 2010
This study examines the open issues to be debated between market participants and regulators, and pinpoints winners and losers based on what form the final rules take. It also examines how market participants are preparing for the new world even though so many questions remain unanswered.
October 12, 2010
Interest rate swaps have served as important risk management and financial engineering tools for many years. New regulations will be far-reaching, but their full impact remains up in the air.
October 2, 2010
The Dodd-Frank Wall Street Reform and Consumer Protection Act is a vital piece of legislation that will come into full effect over the next few years. Its impact will be far-reaching, and it is expected to be as important for the financial services industry as the Glass-Steagall Act of 1933.
During July and August 2010, Adsatis consultants interviewed approximately 40 senior individuals from financial organisations to elicit opinion on the likely impact of the legislation that has been passed in the US and the likely direction in European regulation given recent draft legislation. We had a particular focus in our research on the impact on the OTC derivatives markets, although discussions inevitably extended into the wider areas of financial stability and risk management. The interviewees were based in the US, London and mainland Europe and represented investment banks, investment organisations, clearing houses, exchanges, brokers and market infrastructure companies.
June 22, 2010
Poised for growth, the OTCD Market Must Overcome Challenges In Order to Realize its Full Potential.
A new report from Aite Group, LLC focuses on current issues in the over-the-counter derivatives (OTCD) marketplace, the makeup of the OTCD market, issues surrounding counterparty risk management, and the impact of pending legislation and regulation.
February 10, 2010
This report provides interesting insight into the ongoing debate over OTC derivatives reform. In particular, the report details why and how electronic markets will play an important role in increasing efficiency and transparency for market participants.
This report portrays an important perspective regarding derivatives reform. The study indicates that many traders and executives are still unclear about how the proposed OTC derivative legislation will influence them, and that regulators should more fully consider how this legislation will affect corporate hedging practices.