Amidst a threatened margin hike for cleared interest rate swaps (IRS) and the prospect of US default, buy-side demand will remain strong, says a derivatives expert who nevertheless expects other hedging techniques to emerge.
CME Clearing, the central counterparty (CCP) operated by derivatives exchange operator CME Group, on Tuesday announced it would increase margin requirements for IRS trades by 12.5%. But, by Thursday, with a last-minute deal secured in Congress, the CCP announced it would repeal the initiative.
Despite the deal, financial markets may face a similar situation in January, when the US government is required to pass another appropriations bill, the passing of which could be halted by Congressional Republicans. Uncertainty caused by this possibility alongside the willingness of clearing houses to increase margin requirements could dramatically increase buy-side IRS trading costs.
“The events of the last few weeks have created some uncertainty in the market, including amongst the buy-side, but they will not have a major impact on investment decisions or the use of OTC derivatives,” Zohar Hod, global head of sales for SuperDerivatives, a market data and trading technology firm, told theTRADEnews.com.
Hod believes institutional investors will not trend towards a wholesale reevaluation of swaps trading, but will look to new hedging instruments, such as swap futures, and the opportunity to trade more standardised swaps on swap execution facilities (SEFs).
He said the new era of OTC derivatives trading – ushered in by the Dodd-Frank Act in the US – opened new options about which instruments to trade, where to trade them, and how they should be cleared.
“The future for asset managers will include a combination of IRS trades, swap futures and bilateral OTC derivatives as opposed to a drastic migration away from certain instruments,” he said.
Swap futures products, exchange-traded instruments that mimic certain OTC derivatives, may not witness the rate of increase many have predicted, adds Zod.
“Despite higher margin requirements, OTC derivatives like IRSs are still seen as the most efficient way to hedge and the buy-side has and will continue to show a strong willingness to use these products. Although generally less expensive, a swap future simply does not have the flexibility of an equivalent swap instrument.”
Shutdown effects
Overall, however, despite causing uncertainty, the US government shut down and narrowly-avoided default will have a limited effect on institutional investors an expert from US buy-side trade body the Investment Company Institute (ICI) said.
The Commodity Futures Trading Commission (CFTC), which reduced staff headcount from 680 to 28 during the 16-day period, will have a backlog of work to deal with, but the ICI believes it will not pose any major challenges to market stability.
“The limited operational capacity of the CFTC during the US shutdown has delayed key guidance requests from the investor community,” Jennifer Choi, senior associate counsel at the ICI, told theTRADEnews.com, citing compliance questions with commodity regulations.
Choi said cross-border rules the CFTC must deliver by 21 December will prove particularly difficult to form given the two-week absence, but believes the Commission would be able to meet the deadline.
“The CFTC’s work on cross-border issues, due in coming months, alongside delays to SEF registrations, means this will be a busy period of the Commission, but our members don’t anticipate any long-term detrimental effects,” she said.