The Future of OTC Derivatives:
Swap Execution Facilities and the New Dealer
Executive Summary
It is different this time. The swaps market is actually going to change. Relationships will still drive trading and banks will still make billions as dealers (albeit through an affiliate), but the dealer count in the US will jump to at least four times its current level and real point-and-click trading will emerge for a variety of contracts.
But all of this change is much easier said than done. |
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Despite the inevitability of sweeping market structure reform, the final rules are still in flux and the path taking us to the regulators’ vision of a utopian market—transparent with fair access for all—remains quite blurry. To that end, existing swaps dealers are spending millions to ensure they emerge from OTC derivatives reform with their profits intact despite an onslaught of new competition and regulations designed to break up the long-running oligopoly. Some will succeed; some will look for business opportunities elsewhere.
Much of that competition will come from swap-execution facilities. The last decade has seen exchanges and dealers compete for liquidity where they once acted as partners. Mandated execution on a registered venue of all clearable swaps will create a similar situation in this decade. Clients once looked to the dealers for liquidity, and the dealers in turn to other dealers and interdealer brokers. Just one year from now regulations will ensure that everyone looks only to SEFs and exchanges for that same liquidity, kicking dealers off their current perch for all but the most unclearable of swaps.
The way forward hinges heavily on the rules now being written by the regulators. These rules must be in place by July 15, 2011, but it is likely full market compliance will not be required until roughly that same time in 2012. Existing dealers, new dealers, interdealer brokers, swap-execution facilities, clearinghouses, the buy side and every other market participant have and will continue to change their market strategy despite this lack of regulatory clarity, all with the hope of starting off this new era in swaps trading with their best foot forward.
Regardless of where the chips fall, the OTC derivatives market is in for revolutionary rather than evolutionary change. The opportunities created far outweigh the negatives and the resulting environment will much more fairly enable the smartest participants to win as opposed to the biggest and most connected. Phones will not go away and high-frequency swaps trading will not be born overnight, but the area in between will see these markets grow and innovation abound.
The TABB Group Vision Note The Future of OTC Derivatives: Swap Execution Facilities and the New Dealer is based on conversations with major swaps dealers, aspiring swaps dealers, interdealer brokers, exchanges, soon-to-be swap execution facilities, legislators and regulators. This study examines the open issues to be debated between market participants and regulators, and pinpoints winners and losers based on what form the final rules take. It also examines how market participants are preparing for the new world even though so many questions remain unanswered.