Buy-side faces cost hike for greater swaps transparency
Greater transparency in the OTC derivatives market is a fundamental aim of regulators looking to decrease systemic risk in this market, but a number of reports have highlighted that achieving this goal will come at a cost for the industry.
The G-20 inspired reforms to OTC derivatives in the US,
Europe and beyond, will, where possible, require swaps to be traded on exchange-like platforms, reported to a
central securities depository and cleared through a
central counterparty. But while greater transparency may help to improve
clarity, it clearly carries a cost. Research firm TABB Group estimates the
extra cost of clearing at US$2 trillion for interest rate
That could be a problem for both buy- and sell-side firms
struggling to balance their books in the face of multiple concurrent global
reforms. A paper by trading technology vendor Fidessa, ‘For whom the bell tolls’,
highlighted some of the difficulties faced by market participants attempting to
comply with the new regulations.
“Coming at a time when Basel III is increasing capital
adequacy ratios anyway, the cost of capital has never been higher,” said Steve Grob, director of group strategy at Fidessa and author of the report. “In fact, it’s
doubtful whether there is enough high-quality collateral available if all the
OTC trading that exist today were to be centrally cleared.”
Collateral costs were also pinpointed by TABB Group as a
potential stumbling block. The TABB paper, ‘Optimising collateral: In search of
a margin oasis’, states that while buy-siders largely expected that their
brokers would assist with any shortfall through collateral transformation
services, this will not happen in practice due to sell-side reluctance to take
the balance sheet hit this would entail. Instead, the research suggests that
collateral will become increasing scarce both in Europe and in the US – forcing
investors to carefully consider how they use their available resources.
Buy-siders will need to invest in collateral optimisation
technology and services, spend on new technology and restructure internal processes to become better organised and more efficient, suggested
TABB. Firms that don’t will be hard pressed to survive.
Meanwhile, Thomson Reuters carried out a survey of buy-side
institutions across 30 countries, titled ‘Bridging the transparency gap’, which
revealed serious concerns about the quality of market data and market
transparency that institutional investors currently have access to.
The Thomson Reuters survey found that nearly half (48.5%) of
respondents want more transparency into the underlying information about the
pricing vendors’ offerings – suggesting that investors are still not satisfied they have the clarity on pricing to ensure they are
getting a good deal on their OTC derivatives transactions. Rated as the top
concern by 75% of respondents, data quality trumped risk management (47.9%) and
cost cutting (29.2%).
vendors need to do a better job proactively by reaching out to their customers
and pushing information to them rather than putting the onus on the client to pull
down information,” said Jayme Fagas,
head of evaluated pricing at Thomson Reuters. “To address transparency, we see
a new information sharing dynamic developing as part of the operational
processes at our clients’ firms.”
the cost of transparency, some investors remain concerned that the shift
to central clearing may disadvantage long-term investors from a risk
perspective in any case. According to Grob at Fidessa, buy-side firms could face increased risk by having to trade with unknown counterparties on centralised platforms.
“Some large buy-sides can prefer the bilateral model,
particularly if they only trade with other large institutions that are similarly
risk averse and well capitalised,” he said. “For them, centralised clearing is
potentially riskier as they don’t know which other firms their margin is being
combined with, or the credit ratings of these firms.”
Some observers also fear that CCP competition could also
prompt a flight to the bottom on margin, reducing the quality of risk control,
while market participants should expect to pay more for smart order routing and
algos as liquidity spreads between multiple venues.