Are swap futures the future of swaps?
Eurex yesterday became the first European exchange to offer swap futures. The Deutsche Borse-owned group offers 6-month contracts on 2, 5, 10 and 30 year swaps denominated in EUR from 1 September 2014. Globally, it joins US exchanges CME group, ICE and Eris in marketing the simple, but innovative, derivative on a derivative. Eurex’s product specification references patent numbers owned by Goldman Sachs, listing GS managing director Oliver Frankel as the inventor; their per contract share is unspecified. Pioneered by ICE in 2001, the products have some superficially attractive features, potentially lower and therefore cheaper time-horizons for margining[1], combined with portfolio netting against other future positions[2]. The cost vs. customisation calculation is becoming increasingly difficult to calculate. Against the “OTC to OCD” background of EMIR reporting imperatives, standardised swaps futures may offer a useful means to gain the majority benefit of their underlying market, while circumventing a large portion of recently-imposed regulatory overload; the imposition of commoditisation on a bespoke market has blurred the boundaries with “off the peg” products. It may, for example, be cost-effective to nearly-replicate a CMS swap by rolling the nearly-relevant futures-swap contract- convenience becomes basis risk. The contracts have had a slow start[3] in their birthplace, having been primarily marketed at lighter-volume end-users. Laurent Paulhac, CEO of ICAP’s SEF, told Risk magazine in June that he saw little threat to the wholesale market from the futures variant. He’s probably right, although in the admittedly-Jurassic era of the mid-1980’s, interest rate swaps themselves were fairly niche exotica. Four other European exchanges including Nasdaq OMX and the LSE are looking to develop similar products.
[1] Swaps are generally subject to a five-day holding period, futures to one-day. Simple square root of time equates to a 2.23 swaps vs. futures margin ratio. Difference is (somewhat) mitigated by VaR vs. portfolio margin calculation methods respectively.
[2] LSE is developing products which will cross-margin against the SwapClear liquidity pool.
[3] ERIS open interest all tenors on 29\08\2014- 123,351 contracts. CME Group open interest on 28/08\2014 – 111, 000 contracts. Both $ denominated contracts. Both notional size $100,000. ICE reached a daily record on 12 June 2014 with a volume of 70, 480 in its EUR 2yr. Swapnote product, open interest was 54,992.