Imminent Futurisation of OTC Fixed Income Derivatives Market Forcing Banks to Rethink Structure

• New US trading venues for OTC swaps have not yet resulted in a transfer of liquidity flows into exchange-traded futures markets.
• In the EU, clearing for OTC swaps has been mandated since 2016, but the requirement for them to trade on regulated venues will not kick in until 2018.
• New report exploring the reasons for the lack of manifestation of an OTC swaps trading ‘futurisation’ effect in the EU and the US concludes that it is a delayed rather than a dead concept.

LONDON – 05 June 2017 – A new report from GreySpark Partners, a leading global capital markets consulting firm, finds that while the so-called ‘futurisation’ – or transferral of bilateral swaps liquidity flows into an exchange-traded futures market environment – of the OTC IRS and CDS markets in the EU and the US is not yet occurring, there are signs that the effect may simply be delayed by pending regulatory deadlines in the EU.

The report, Trends in Derivatives Trading 2017, explores the long-running expectation in the OTC swaps marketplace that sellside brokers of OTC swaps liquidity would eventually stop using bespoke, manufactured, cleared or uncleared SEF- or OTC-traded swaps to hedge their positions and, instead, turn more toward the use of the exchange-traded swaps futures as a means of replicating swaps trading flows. This expectation, generally known in the swaps marketplace in 2017 as the onset of the ‘futurisation effect,’ describes the transfer of OTC liquidity flows into listed futures marketplaces. Specifically, G4 OTC IRS and CDS indices – both of which are now SEF-traded in the US – are newly subject to a clearing mandate in the EU and will need to be OTF-traded by April 2018 for certain types of market participants. Despite these regulatory deadlines in the EU, there remains little evidence of futurisation taking hold in either the EU or US marketplaces for the contracts.

Nonetheless, GreySpark Partners believes that the futurisation effect will eventually manifest in both the EU and US OTC IRS and CDS indices swaps markets. As a result, many investment banks will find that their FCM divisions will become responsible for driving the creation of an increasing proportion of fixed income trading revenues from fees charged for clearing brokerage services. Such a shift would surely carry with it a number of cultural and political ramifications that key stakeholders within many banks may struggle to adapt to.

Rachel Lindstrom, GreySpark Senior Consultant, said: “In the world of fixed income, there is still all to play for. While fixed income desks are still being buffeted by major regulatory change and are under pressure from rising costs in a hostile economic environment, the name of the game for many banks in 2017 is business and trading model survival.”