A study by Paul Rowady, analyst at research house Tabb Group, says that under new clearing rules, buyside firms that use derivatives to hedge market risks, such as a rise in interest rates, will face some unpalatable choices when they are forced to clear swap trades for the first time.
Central counterparty clearers stand between buyers and sellers in a securities trade, guaranteeing completion in case of default. In return, both parties must post margin against their side of the trade as a form of surety. But margin payments for cleared bilateral swap trades are likely to be more onerous than those products traded on exchange because of a perceived higher degree of risk.
For many buyside firms, posting large amounts of cash against swaps as intraday margin is not feasible. Final rules from US regulator the Commodity Futures Trading Commission last month set the seal on which firms will be caught in this clearing dragnet. All firms with a “substantial position” in swaps, calculated on the basis of a firm’s gross market exposure, will be forced to register with regulators as a “major swap participant”, or MSP, and sign up to a swathe of new trade reporting requirements and business conduct standards. This will not only catch the buyside but non-financial corporations, such as drillers and pipeline providers in the energy markets, which currently use swaps to hedge commodity price risks.
Every entity facing being defined as an MSP will not only have to pay a $15,000 registration fee, but employ a team of lawyers, compliance executives and trade support staff too. But dealers say choosing on-exchange futures as a substitute for a swap brings its own headaches. Mark Croxon, global product manager for OTC clearing at Nomura, said the firms choosing such an alternative would have to grapple with a potential increase in basis risk – the danger that a product used as a proxy does not move in the direction expected.
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