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Industry Unprepared For The New World Of OTC Derivatives Trading

By Ganesh Iyer, IPC Systems

It is still early days in the trading of over the counter (OTC) derivatives on swap execution facilities (SEFs) and organised trading facilities (OTFs). Even though it has been over four years since the G20 first proposed initiatives to mitigate systemic risk and promote transparency in the global OTC derivatives market, practitioners believe the industry is still in the throes of a revolution and remains unprepared to face a rapidly evolving marketplace. The Dodd-Frank Act in the US and European Markets Infrastructure Regulation (EMIR) in Europe represent a paradigm shift in the global financial regulatory environment. The impact of these regulations is being felt around the world, particularly the mandate of executing all derivatives subject to a clearing obligation on a regulated market, SEF or OTF. This is a significant change as it is one that alters how the market operates as well as how market participants conduct business.

Industry Unprepared For The New World Of OTC Derivatives Trading

Industry Unprepared For The New World Of OTC Derivatives Trading

In order to get a comprehensive temperature check of the industry’s opinions about OTC derivatives regulation, IPC recently interviewed individuals from both the business and technology sides of trading operations at investment banks, broker/dealers, hedge funds, exchanges and other financial institutions. The results were quite intriguing.

Survey respondents (60%) said that they believed the industry was not on track to meet the regulatory deadlines covering OTC derivatives trading. This is of concern given the vital role played by OTC derivatives in the global capital markets and the benefits the asset class brings such as aiding price discovery, managing risk, adding to liquidity, improving market efficiency for the underlying asset and reducing market transaction costs. However, the survey also uncovered some good news with 61% of respondents stating that their own firms were ready from a regulatory perspective.

It also appears that regulation has become the catalyst for the “futurization” of swaps with 61% of survey respondents expecting to see a shift of OTC derivatives trading to the futures market. Trading venues and clearing providers are increasingly offering futures contracts that mimic swaps. Trading a listed or “futurized” swap instead of an OTC contract means lower margin requirements, greater transparency, more choices for clearing as well as regulatory certainty.

The survey also found that in order to be compliant and take advantage of the opportunities presented by the growing OTC derivatives market, market participants are aggressively investing in voice recording and communications, electronic connectivity, data archiving and networking technologies. It was also clear that the key players in the OTC derivatives trade lifecycle – buy-side firms, major swap participants, swap dealers, liquidity venues, central counterparties, and trade repositories – need to connect to one another. Not surprisingly, the survey revealed that market participants were choosing to connect to multiple SEFs and OTFs with the most popular choices being CME Group (53%), TeraExchange (50%), Bloomberg (44%), Eurex (34%) and ICE (32%). The connectivity landscape, particularly in the US, has become quite complex with the large number of players, the vast size of the market, the number of derivative asset classes being traded (interest rates, currencies, credit, commodities, equities and energy) and variations in trading models – adding to the challenges in getting prepared for the changing marketplace.

The warning signs that preparations for the new world of OTC derivatives trading were not as far along as they could have been were seen in an earlier survey conducted by IPC at TradeTech in 2013. Over half the compliance professionals who took part in the survey said that they believed their own departments didn’t fully understand the new regulations.

Ready or not, the impact of mandatory trading on a regulated market, SEF or OTF is going to be felt. Three-quarters of the latest survey respondents said it will have an impact on trading volumes and sizes, while a quarter expect the importance and value of the OTC derivatives market to grow. Global reforms will bring profit opportunities to be capitalised on by any market participant that can adapt itself to the transformed world of OTC derivatives, a market with a gross value of $20 trillion and notional amounts outstanding totaling about $700 trillion.

About Ganesh Iyer

Ganesh Iyer is Director of Financial Markets Network Product Marketing at IPC Systems, a leading global provider of specialised communications solutions for the global capital markets. IPC provides customers with integrated solutions that support traders and market participants across the entire trade lifecycle. Ganesh is responsible for spearheading global product marketing initiatives, building brand awareness and growing the business. The full report from the survey – ‘Market View 2014: OTC Derivatives Regulations and Swap Execution Facilities’ is available on the IPC website.

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