Co-ordinated global regulation for the over-the-counter (OTC) derivatives markets is creating a dramatically different market for interest rate swaps with central clearing for end-users, the use of organised trading facilities and increased transparency and reporting requirements, according to the Tabb Group.
In its report, ‘The Changing Environment for Managing Interest Rate Exposure’, the Tabb Group says alternative methods of managing exposure will see greater adoption due to regulatory reform, specifically in the US and Europe where efforts will force standardised derivatives onto trading facilities with central clearing. This will create a new trading landscape for OTC interest rate swaps (IRS).
“New central clearing requirements for end-users such as asset managers and hedge funds will require these clients to post initial margin and variation margin, substantially raising the cost of doing business particularly for longer dated instruments,” said Andy Nybo, a Tabb principal, the international advisory and research firm’s head of derivatives and author of the new report. As transaction costs and other expenses associated with margin and capital requirements rise, Tabb believes that market participants will be prompted to search for alternative methods of managing their interest rate exposure.
To date, several exchanges have offered a number of alternative instruments intended to replicate characteristics of interest rate swaps but, Nybo points out, their adoption has been anaemic as structural characteristics have limited their utility.
As final regulations move closer to completion, with the new market structure expected to require swaps to trade on organised trade facilities (OTFs) and swap execution facilities (SEFs), Nybo said that market participants are not yet abandoning traditional interest rate swaps: “Existing interest rate swap markets will continue to be critical for managing global interest rate exposures, especially for large active users in the financial, utilities, technology and industrial goods sectors, big consumers of capital who require significant liquidity across multiple currencies.”
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