01.03.2014

Commercialization of OTC Markets Expands

01.03.2014
Terry Flanagan

The commercialization of the OTC derivatives sector will pick up steam during 2014, as the Dodd-Frank and Emir regulations take full effect. The three-legged stool of execution, clearing, and reporting of interest rate and credit default swaps will trigger a need for new services and products.

“New instrument types will begin to gain popularity toward the end of 2014 as participants begin to understand the Total Cost to Trade especially around margin and collateral requirements,” said Barry Smith, director of global exchanges and trading venues at Equinix.

The regulation-driven move to electronic trading venues in the Over the Counter (OTC) derivatives market is taking shape inside Equinix. The key components of the market structure – Swap Execution Facilities, Central Counter Party Clearing, Swap Data Repositories and others – are capitalizing on the same infrastructure strategy developed by the architects of electronic trading in other asset classes, such as equities, foreign exchange, futures and options.

Local connectivity to such a wide range of potential endpoints offers badly needed flexibility to firms who must comply with continuously evolving regulation, as the industry sorts through complex new processes and systems.

“The roll-out of Dodd-Frank, EMIR and similar legislation around the world has not come without risk,” said Smith. “From a technology perspective, being able to tap into existing business ecosystems with a high concentration of key market players –including service providers and connectivity providers – has given firms the ability to remain agile throughout the entire process as this market becomes more electronic globally.”

SDRs (Swap Data Repositories) & TRs (Trade Repositories) will begin to offer “commercial products” from their collected data, Smith said, and CCPs (Central Counterparty Clearing Houses) “will continue to thrive–clearing firms are the winners.”

For example, LCH.Clearnet has expanded its credit default swap clearing (CDS) service, CDSClear, to offer single-name CDS clearing.

European members and clients can benefit from significant capital efficiencies through risk offsets between 187 single-names and existing index products through Monte Carlo Simulation VaR based portfolio margining.

Gavin Wells, CDSClear

Gavin Wells, CDSClear

“With the addition of these 187 index constituents we believe the market will benefit from significant efficiencies,” said Gavin Wells, CEO of CDSClear. “As regulations and clearing commitments evolve, we will continue to work collaboratively with market participants to ensure they can clear with confidence.”

The OTC ecosystem inside Equinix is rapidly developing: 16 of 19 Swap Execution Facilities have located key infrastructure inside Equinix (Matching Engines or Access Nodes); three primary Swap Data Repositories have located key infrastructure inside Equinix globally; all registered U.S. CCPs are accessible via access nodes or primary deployments; and three DCMs (Designated Contract Markets) dedicated to futurization of swaps and Central Limit Order Book formation have located their matching engines within Equinix.

Equinix has partnered with industry advisory Aite Group, on a series of three white papers that explore key issues and trends in the OTC space. “Big changes are afoot in the clearing universe,” said Virginie O’Shea, senior analyst at Aite Group. “Current dominant players in the OTC derivatives clearing market are likely to come under pressure to retain their market share as a result of infrastructure changes resulting from Emir. In the meantime, the rest of the world can look to the U.S. market as a precedent for how the clearing space is likely to be altered by regulatory changes.”

New business models will form for OTC execution venues. “Think about the equivalent of an institutional equities market for OTC, or a ‘Single counterparty’ dark pool,” said Smith. “At least three SEFs will form partnerships to aggregate liquidity in 2014.”

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