Futures Exchanges Eye Swaps Market

Terry Flanagan

With firms looking for new ways to bring OTC products to market in response to regulatory mandates including Dodd-Frank in the U.S. and Emir in Europe, firms with deep derivatives industry expertise are assisting market participants at converting existing and new OTC interest rate swap products to the clearing house model.

Morgan Stanley plans to make “a strategic equity investment” in Eris, a U.S. futures exchange, which offers interest rate swap futures. Morgan Stanley also plans to participate on the exchange as a provider of liquidity and clearing services.

Swaps and futures have much in common. Both are used to hedge risks although futures have standardized terms to facilitate liquid trading and price discovery and are almost always traded on exchange. Swaps, though, which are privately negotiated, grew out of a commercial need in the 1980s to customize these trades and have grown rapidly in popularity.

However, as swaps have become more integral to the financial system, they have become more standardized and are now like futures contracts in many instances. And this is why exchange operators such as CME Group, IntercontinentalExchange, Eris Exchange and NYSE Liffe are all beginning to offer swap-like products as futures contracts in a bid to tap into the vast $700 trillion OTC market, much of which is being shoehorned by regulators through centralized clearing and on to exchange-like venues for the first time in a bid to reduce risk and increase transparency.

“Futures operate within a known regulatory framework, and there’s a lot of efficiency in the way futures are processed and margined,” Neal Brady, chief executive of Eris Exchange, told Markets Media. “Once the swaps market is required to be cleared in 2013, and as people compare a cleared swap to a futurized swap, it becomes clear that futures are more efficient with wider access and less documentation.”

As part of the arrangement, which is expected to close in early 2013, Morgan Stanley will join the board of directors of the exchange holding company.

“As the traditional OTC rates swap market undergoes significant structural, economic and regulatory changes, Morgan Stanley believes that Eris Exchange and its futurized swaps are ideally suited to provide our clients with flexible alternatives,” said Patrick Haskell, head of liquid flow rates in the U.S. for Morgan Stanley, in a statement.

Morgan Stanley has initiated its integration with the Eris SwapBook electronic trading platform and will commence providing electronic and block trade liquidity for both Eris Standards, which are benchmark futures, and more customizable futures, known as Eris Flexes, in early 2013.

Morgan Stanley’s commitment to stream two-sided markets across the yield curve in quarterly Eris Standards and daily Eris Flexes ensures that end user clients will benefit from the institutional liquidity of Morgan Stanley’s leading rates trading team, and complements Morgan Stanley’s set of existing liquidity providers, according to Brady.

“It’s a great sign of the market’s embrace of Eris and getting serious about changes that are about to occur in the swaps market,” Brady said. “There has been a lot of discussion as Dodd-Frank rules have gone through system. It’s a clear sign that firms are committing to venues that will be able to comport with those rules.”

Eris Exchange embeds the cash flows of OTC interest rate swaps into a futures product cleared by CME Clearing and settled to the CME OTC interest rate swap curve. It allows contracts to be traded as though in an OTC environment while integrating into existing futures clearing and back-office systems, assisting with regulatory compliance and enabling faster time to market.

Eris Exchange recently launched Eris Standards, an interest rate swap futures contracts with quarterly effective dates and pre-determined fixed rates that currently provide margin savings of 40%-80% compared to cleared OTC interest rate swaps.

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