Jun 29, 2012
Beyond swaps reform
Once OTC derivatives reforms
are in place, the creation of a collateral repository could be next in
achieving the minimisation of systemic risk, says Ted Leveroni, executive
director of strategy at post-trade processing firm Omgeo.
“With better data collection
a core tenet of OTC derivatives reform, the creation of a collateral depository
is a logical next step,” says Leveroni. “It will get regulators closer to where
they want to be – full transparency and a greater understanding of risks in the
market.”
The spike for demand for
collateral is just one of the myriad potential unintended consequences of
impending reform to global OTC derivatives markets. The new rules, mandated by
the G-20 and due in place by end-2012, will encourage swaps to be transacted on
trading venues, cleared through central counterparties and reported to data
repositories. This means that buy-side firms will have to ensure they have the
sufficient amounts and quality of collateral to secure exposures, a process that
was handled informally under bilateral deals.
While it is difficult to
identify the exact scale of the challenge that will be faced by the industry,
estimates suggest that an extra US$2-6 trillion worth of collateral will be
required, with the number of collateral calls – the demand for extra margin
based on prevailing market events – increasing up to eightfold.
A repository for collateral
would require market participants to report the amount and type of assets they
hold against OTC derivatives trades, allowing regulators to identify shortfalls
or potential bubbles.
Existing framework
Leveroni points out that the
development of swap data repositories (SDRs) could offer a framework for a
collateral repositories. Omgeo is part-owned by US post-trade utility
Depository Trust and Clearing Corporation, which is seeking approval by the
Commodity Futures Trading Commission to become a SDR for OTC derivatives
instruments.
SDRs also form part of the
new swaps rules, and will hold responsibility for collecting and maintaining records of financial market
transactions.
“The truly global nature of
the swaps markets mean that regional SDRs have to be harmonised across
regions,” he said. “Regulators are keen to ensure that reported exposures are
not double counted and provide a view of the whole market, so global
co-ordination is a must. Once you can solve these issues, you can use them as a
basis for collateral repositories.”
The next stage would be to identify
the potential operator of a collateral repository and establish how it could be
constructed, Leveroni adds.
Buy-side firms will need to
conduct a cost-benefit analysis on the cost of trading OTC derivatives
following the new legislation. Institutional investors that use swaps as
hedging tools may find that the cost of offsetting risk becomes uneconomical.
This will of course be
contingent on the trading model of individual buy-side firms, but Leveroni
believes there is an opportunity for new solutions to help investors manage
this shift.
Assessing the cost of trading
“There is a need for
pre-trade analytics that help the buy-side to accurately assess the costs of
trading swaps, depending on the workflow a firm wants to follow,” explains
Leveroni, adding that pre-trade analysis would include how costs vary depending
on choice of clearing broker, instruments chosen, choice of CCP and trading
venue fees. “These are decisions that need to be made pre-execution and an area
that is ripe for change and innovation.”
But he admits that such
solutions will rely on the finalisation of regulations as well as greater
clarity of the final shape of trading venues for OTC derivatives – termed swap
execution facilities in the US and organised trading facilities in Europe.
However, Leveroni insists that buy- and sell-side firms will soon be looking
beyond simply complying with the new rules.
“Whenever there is a big
shift in market structure, firms first look at how they will comply with the
new regulations, then how to maximise efficiency and finally, how to use the
new environment to their advantage,” he says. “Everyone is focused on the first
two right now, but the focus will soon be on how to thrive in the new swaps
world.”
Anish Puaar
+44 (0)20 7397 3817
anish.puaar@thetrade.ltd.uk