Apr 05, 2012
Swapping out of the swaps market
As the European market infrastructure
regulation (EMIR) edges toward its early-2013 deadline, the transfer of many OTC
derivatives onto central clearing will lead some buy-side firms to adopt
alternative approaches, says Gert Raeves, research director at financial
research firm TowerGroup.
“People will enter and exit the swaps
market based on cost parameters,” he says. “Relatively casual buy-side players,
for whom swaps is not a core part of their investment strategy, or who don’t
support portfolios with a high exposure to these instruments, may just desert
it.”
Raeves estimates that there are some
600-700 regular buy-side participants in the swaps markets in Europe. But he
also identifies a much larger group that has occasional interest and lower
transacted volume. With costs on the rise due to margin and collateral
requirements, he suggests that many firms will be rebalancing their portfolios
and reducing their use of affected instruments.
In Europe, OTC derivatives are being forced onto
centrally cleared, exchange-like trading platforms by EMIR, which seeks to
implement the G20 nations’ commitment to reduce systemic risk. Market
participants that previously entered into bilateral collateral arrangements
with broking counterparties will instead have to post collateral and set aside
margin to be used in the event of a default of one of the parties to a
transaction. The process is intended to reduce the possibility that the default
of one institution could have a catastrophic knock-on effect.
The European Securities and Markets Authority (ESMA) closed submissions
to its consultation on EMIR last week. EMIR was finally voted through
the European Parliament on 29 March. Implementation of EMIR is currently
scheduled for the start of next year.
However, before EMIR can take effect, ESMA
still has to define the technical standards between now and early 2013.
Uncertainty still surrounds the eligibility of contracts for central clearing,
as well as the final number of central counterparties (CCPs) for each asset
class. Raeves suggests that the most likely outcome is two or three CCPs for
each asset class – which he warns may add undue complexity to Europe’s market
structure.
“If there are six or seven main types of
swaps migrating onto exchange-like trading platforms, and each of those has two
or three clearing venues, potentially, you’re easily looking at a few thousand
routing options,” he says. “The main challenge is not that there are new
clearing venues, but that routing orders to the right destination – with so many
centrally cleared and non-centrally cleared instruments and so many different
trading platforms – becomes really complex.”
Products that can automate order handling
and route to the correct venue without human intervention may be a popular
solution. But it is not just a question of routing. Juggling the collateral
requirements across a range of different instruments and platforms can also be
a challenge. Already, firms such as SunGard are offering collateral management solutions that automatically calculate the optimal assignment of assets to collateral
requirements.
Raeves identifies collateral management as
a focus, with many market participants hoping to leverage cross-venue
collateralisation and margin opportunities. But standardised mechanisms that
automatically set margin calls at the CCPs all require rapid allocation of
funds – meaning the cost to the buy-side could continue to rise in the short
term as firms prepare for EMIR.
“Nobody is building infrastructure with
volumes in mind,” he says. “It’s being driven by impending regulation. But it’s
still not clear which counterparties will be most affected by the transfer of
OTC instruments to centrally cleared platforms and what level of choice will be
available to them between the different CCPs.”
Elliott Holley
+44 (0)20 7397 3820
elliott.holley@information-partners.com