News: NASDAQ’s horizontal fixed income push

26 April 2013: Three separate items which together indicate a concerted strategic move by NASDAQ into fixed income electronic execution partnering with “horizontal” derivatives CCPs:


The future of CDS futures?

The future of CDS futures?

In this article from the Trade News, Peter Barsoom, COO of ICE, advocates their credit index futures product due to come to market shortly.  A few things to highlight:

– Interpreting from the articule, ICE’s proposed contract is a cash-settled credit spread future i.e. a future on each index’s credit spread.

– This does not offer the ability to buy and sell protection and so complements rather than substitutes cleared OTC CDS.  

– ICE has a multi-year exclusive license on iTraxx and CDX indexes (agreed in October 2012) from Markit which calculates and produces the indexes.

– It’s interesting that they haven’t gone with a futurized swap (credit index swap economics in an exchange trades future wrapper) or a deliverable swap future.

How big is OTC really?

(Subtitle: What do the hundreds of trillions mean and how can we compare this with other markets?)

Scarcely a day goes by without a press article or speech mentioning in its introduction the “more $600+ trillion OTC derivatives market”.    Whilst this may liven up the subject, this unnecessarily inflames concern.  Here’s why.


What are the figures?  The quoted figures come from the Bank for International Settlements (BIS) half yearly reporting on OTC derivatives market activity – published on their website.  The latest is: BIS OTC 2012 H1 which notes $639 trillion open notional. 

Why inflammatory?  Because $639 trillion is:

  • bigger than the global aggregate of almost anything (GDP, government debt, global securities issued, … etc. etc.) and
  • is not a measure of the value of OTC trades outstanding.  

Why not?  Unlike bonds where the notional value and market value are close together (one being within a few % of the other), an on-market interest rate swap has near zero market value on trade date whereas notional could easily be $100m or more.   Only through interest rate movements through the swap’s life does it acquire significant value (which can be both positive or negative).  Even then the value will likely remain a very small fraction of the notional value.


How has ISDA tried to help?  ISDA produces companion half yearly figures which eliminate double counting of CCP trades (makes sense) and also all of FX derivatives (not sure I understand the rationale).  The latest is: ISDA OTC 2012 H1 which notes $417 trillion adjusted open notional.   This also emphasizes the point that after netting and collateral the real aggregate exposure is a tiny fraction of the notional.   Whilst helpful, $417 trillion is in practice just as inflammatory as $639 trillion and it is worth further emphasizing the market value and credit exposure numbers produced.  

Are market value and credit exposure available?   Yes.   BIS also collects gross market value as part of the survey which collects notional values.  ISDA combines this with netting and collateralization effectiveness percentages it collects to estimate further credit exposures:

  • $25.4 trillion gross market value[1] – a decent measure of the current value of all gross swap assets held by banks and directly comparable with other financial instruments (see below).  This also implicitly eliminates double counting at CCPs because an in the money trade for one bank will be out of the money for the other.
  • $3.7 trillion gross credit exposure (after netting before collateralization) and $1.1 trillion net credit exposure (after netting and collateralization).  This last figure measures the total counterparty “current” exposure in the market. 

[1] Gross market value is the sum of in the money trade values across all reporting banks – before netting out of the money trades and before collateral

Is that all the risk?  No.  Potential future exposure beyond current market value on OTC products is significant given it is a longer duration product.  Note: market values in other instruments do not measure potential future exposure either.  Initial margin and Basel III capital both aim to buffer against potential future exposure.

So how does OTC compare with other markets?  Comparing global market values at the same point in time i.e. end 2011, we have:

Asset Class

Global Market Value ($trn)







OTC Derivatives


Sources: OTC figures from BIS OTC 2011 H2, Other figures from McKinsey end 2011 global financial stock

I hope that this insight will contribute in some small way to a measured and productive conclusion to the discussions around re-regulation of the swaps market.

Full OTC CCP interoperability

Unlike future exchanges which each clear in a single CCP – often owned by the exchange – OTC CCPs are developing in a way which allows trade executions from multiple channels and venues to clear in one place.  This has promoted a multi-CCP world where CCPs compete to clear the same products – as regulators and legislators hoped.

Full CCP interoperability, however, has remained a background topic as the initial mandates for clearing and trading unfold.  Full CCP interoperability allows two sides of the same executed trade to clear in different CCPs (i.e. each participant can choose their CCP independently of the other)  The diagram illustrates: 
Inline image 2
As set out below, the benefits are clear and the challenges look surmountable but will regulators push this form of interoperability?  So far in the US, Dodd-Frank omitted interoperability entirely though the DoJ has done some preliminary investigations.  In the EU, EMIR includes interoperability but it is not clear (to me at least) whether ESMA intends to push this form.
I am interested in views on the case below for full interoperability and whether ESMA or the DoJ intend to pursue it.
The benefits
1.  Systemic CCP risk de-fragmentation.  CCP fragmentation is a considerable demerit of a multiple CCP world and would largely be eliminated by allowing each participant to directly consolidate it’s CCP risk in fewer chosen CCPs per asset class (ideally one globally) and maximize risk netting benefits in the process.
2.  Simplified / more liquid trading.  DCM / SEF / voice-block participants would not need to specify CCP at the point of trade and would get a single quote rather than a quote per CCP.
3.  Reduced CCP funding and bank capital required.  This is a consequence of reduced risk and possibly the ability to be more selective in CCP membership required.
The challenges
1.  Inter-CCP trade portfolio handling.  These require specific operational processes, legal and regulatory framework (especially if across jurisdictions) and bespoke risk management / margin methodologies.  Whilst this shouldn’t be underestimated, at least for two CCPs within a single jurisdiction this ought to be achievable.
2.  CCP to CCP contagion.  Regulators might fear that the default of one CCP could ripple to other CCPs directly.  Despite considerable notionals in the inter-CCP portfolios, risk netting benefits and the implicit protection of each CCPs existing financial safeguards should keep the level of risk and margin in check.
3.  Persuading rival CCPs to work together.  Likely one or other CCP could see competitive demerits of doing this: hence the need for regulators and market participants to drive this initiative.

DCMs as opposed to SEFs for swap trading

TrueEx has registered as a designated contract market (distinct from a SEF) for interest rate swaps and has signed a clearing deal with CME for IRS clearing.  ERIS, a futures exchange, is also applying to be a DCM in order to be able to execute swap trades.  

I’m interested in views as to where this is headed.  So far I have gleaned the information below.

Firstly, there is some conjecture in the press that SEFs will obselesce in favor of swap DCMs (e.g.

From a quick scan of public documents, the differences are:

1.  Block sizes / intraday reporting: latest SEF proposal contains minimum block sizes which are specific to asset class and other product specific parameters whereas DCMs like futures exchanges are subject to the blanket “85% Centralized Market Requirement” so DCMs must set minimum block sizes which mean that a minimum of 85% of volume goes through the order driven exchange rather than being agreed offexchange and reported to the exchange (as blocks are).  On intraday price reporting.  DCM blocks need to be reported within 5 minutes, SEF blocks need to be reported within 15 minutes.

2.  Order driven protocols / CLOBs.  DCMs are traditionally order driven whereas SEFs may encompass both CLOB (order driven) and RFQ (quote-driven) protocols.  It is not clear to me whether DCMs can offer RFQ or not?  CLOBs need a clearing guarantee to enable anonymous execution (one party doesn’t know the other).  DCMs have a client’s clearing broker / FCM guarantee clearing at the point of execution (taking on the risk that clearing fails).  SEFs don’t have this mandated but any SEF CLOB will need to address it for CLOB protocols to attract banks to providing liquidity to anonymous buy side members.

4.  Open access.  DCMs seem to have stronger rules requiring open access than SEFs.  The details so far escape me.

Finally, it is worth noting that this has a bearing on the swapfutures vs swaps debate.  It has been argued that harmonizing some of the rules for swapfutures with swaps would help to level the playing field so that liquidity for the trading of swap-like economics is established in an unbiased fashion.  Others argue that the economic bias towards swapfutures is beneficial as this will speed along the standardization which some see as inevitable.  

WSJ article: is this the first step towards regionalizing the swap market

WSJ article: is this the first step towards regionalizing the swap market

Barclays and presumably many other non-US headquartered banks are pondering how to respond to the Fed’s proposal to have non-US banks put up US subsidiaries to house their US activities where today many EU banks trade using a single global entity as far as is possible for financial resource efficiency and other reasons.

Is this the first step towards a fully regionalized swap market where e.g. there would be a separate price for the same swap among US entities and among EU entities?