NYSE Liffe Eyes Riches of OTC Swaps Market

Terry Flanagan

NYSE Liffe, the European derivatives arm of exchange operator NYSE Euronext, is making a move to capture some of the vast over-the-counter swaps market as it plans to start offering a service for three of its most popular fixed income products.

Following the financial crisis, the G20 group of nations mandated that much of the previously opaque $700 trillion OTC derivatives market be forced through centralized clearing and on to exchange-like venues from 2013 in a bid to reduce systemic risk.

Exchanges are looking to capture much of this business—the OTC markets are 10 times the size of the exchange-traded derivatives sector—and are trying to circumvent ways of having to set up as registered swaps dealers, as mandated by the new regulations, and avoid the extra costs involved by offering previously bilateral swap agreements as futures contracts.

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, grew out of a commercial need in the 1980s to customize these trades and have grown rapidly in popularity. Swap counterparties are negotiated privately and bilaterally and were thought to be bulletproof and without the need for regulation.

However, the financial crisis changed all of that. U.S. investment bank Lehman Brothers was a big user of swaps and its demise caused a near unravelling of the financial system.

But as swaps have become more integral to the financial system, they have also become more standardized and are now like futures contracts in many instances.

In the U.S., for example, exchange operators CME Group and IntercontinentalExchange are planning to convert cleared energy swaps to futures and the move by NYSE Liffe across the Atlantic is similar.

From next week, NYSE Liffe will begin clearing a trio of fixed income futures—three month euro (euribor), three month sterling (short sterling) and long gilt futures—through Bclear, the exchange’s trade confirmation, administration and clearing service.

NYSE Liffe will be extending its Bclear service, which already covers equity derivatives and commodities, to accommodate market participants seeking to execute large size interest rate products. The exchange says its Bclear solution reconciles the processing and regulatory implications posed by large off-exchange transactions.

“With the regulatory environment moving towards greater use of central counterparty clearing services, NYSE Liffe is leading the way in supporting the fixed income trading community with a new service through its Bclear franchise, which is an innovative alternative for processing products currently traded off-exchange,” said Finbarr Hutcheson, chief executive of NYSE Liffe.

The fixed income products will be available through NYSE Liffe’s existing central order book. Business submitted to NYSE Liffe via Bclear must meet a minimum volume threshold and be priced at fair value. Bclear OTC contracts will be fully fungible with the existing exchange-traded contracts, and will contribute to a single pool of open interest for the relevant contract.

“From 2013 onwards, the OTC move to clearing is widely expected to create a significant growth opportunity for the listed markets: if a contract is sufficiently standardized to be cleared, then why not list it for trading?” said David Morgan, marketing director, trading and client connectivity at SunGard’s global trading business, a trading and technology firm, in a recent white paper.

It is also thought that this move to electronic trading will further standardize the swaps market and will see more volume in benchmark swaps, thus encouraging new entrants to the market.

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