The cohesiveness of the swaps and futures markets has increased as a result of regulations such as the Dodd-Frank Act and Emir, bringing with it additional choices for corporations and other users of derivatives to hedge their exposures.
In the United States, most OTC derivatives must now be traded on organized trading venues, either an exchange or a swap execution facility, and must be centrally cleared and reported to a swap data repository. That provides transparency to a large and previously opaque market, but also brings added costs. This could lead to more activity in economically-equivalent swap futures.
“The futurization of swaps is an interesting development, but the root of that is really providing a more cost-effective way for end users of these swaps to get the same kind of financial exposure from the derivatives, but with the benefit of having it under the futures regulatory and margin framework,” said John Omahen, vice president of post-trade derivative solutions at SunGard, at the Futures Industry Association conference in Boca Raton, Florida. “On the regulatory side, futures regulations are pretty well understood and have been around for a while. There's a degree of comfort from that perspective. Also, swap futures have a clearing certainty in contrast to an OTC instrument.”
While FX swaps and forwards received exemptions from trading and clearing requirements imposed on derivatives in other asset classes, they will still feel the impact of trade reporting requirements, anti-evasion authority, business conduct standards and Basel III capital requirements, according to Kevin McPartland, head of the market structure and technology advisory service business at Greenwich Associates. “These influences are likely to encourage a shift of some FX swaps and forwards business to futures,” he said in a report.
Non-deliverables forwards and FX options didn’t escape the grasp of trading and clearing requirements and the high margin rates they bring.
“Once these rules set in, trading these products will become more expensive. Financial users of these products, which drive most of the volume, require less customization than corporate users, making it likely that they will shift some of their flow to less expensive futures,” McPartland said.
He added, “On the surface it would appear the reasons for choosing FX futures over cleared FX swaps would be the same as those in credit and rate markets—lower margin and a more certain regulatory structure. But the reasons for selecting futures in lieu of cleared NDFs or options are even more compelling.”
Swap futures also have disadvantages, however, including the cost of clearing. “There has been an overall trend toward mandatory clearing, which brings with it additional costs both to the sell-side providers who are between the customers be the clearinghouses, and also the customers themselves in the form of having to put up collateral and having to pay higher margins on their open positions,” said Omahen.
For some end users, a futurized swap may be a more economically viable way to organize a portfolio. But it may not be for everyone. “The big question is how narrow or broad is the band of the market where swap futures can be offered,” Omahen said. “That's something everyone is looking at very closely.”
