Swap Clearing Deadline Anticlimactic

By Valerie Bogard, TABB Group

Originally published on TABB Forum 

The Category II swap clearing deadline came and went Monday. But contrary to expectations, swap futures did not see a jump in volume. 

Yesterday marked a new era in derivatives trading. June 10 was the deadline for the Dodd-Frank Category II swap clearing mandate, which requires over-the-counter swaps to be centrally cleared. For those who missed the deadline, the question is: What to trade now?

The first wave of the clearing regulation, which hit on March 11, mandated that Category I firms – which consists of swap dealers, major swap participants and active funds – start clearing certain interest rate and credit derivatives products. Yesterday marked the beginning of the second phase, which now regulates Category II firms. This includes commodity pools, private funds other than active funds and entities engaged in banking activities, which means, by TABB Group’s estimate, 500 buy-side firms are now subject to the new rules.

Last month, TABB Group estimated that 75% of these firms would fail to meet the June 10 deadline. The process of moving over to the new legislative requirements – which includes establishing clearing broker relationships, meeting legal and operational demands, and completing training and testing – takes about three months to complete. While waiting to complete this process, traders must continue to trade where products are available. The options for these firms include swap futures, interest rate futures, bespoke OTC uncleared swaps, or simply not trading at all.

Contrary to some expectations, CME Group and Eris Exchange swap future products did not see a dramatic increase in activity yesterday. CME Group did see a slight increase in its swap future volume last week; however, it is difficult to attribute that solely to new client activity. 

Neal Brady, CEO of Eris Exchange, said, “We didn’t have a record volume day, and we didn’t expect that either.” He did add, however, that the exchange expects volume to pick up over the next few months. Just as completing the necessary requirements to clear OTC swaps takes time, traders must also prepare for trading a new product.

CME reported that its interest rate futures did in fact see growth in the past month with a broader client base, including Category II firms such as asset managers and hedge funds. CME said part of this could be attributed to the increased interest rate volatility seen over the past few weeks, but analysts will have to wait for more data to come in to see if traders are choosing this product in lieu of OTC swaps as they wait for their clearing processes to be set up. It could be that traders are choosing interest rate futures over swap futures, as they are more comfortable them.

Although it might seem strange, there surely is a percentage of traders who decided not to trade yesterday because they were not familiar enough with the alternative products. CME stated that it did not see a significant uptick in volume yesterday for OTC cleared swaps, although there was an increase last week. Given this, and the fact that swap futures also did not see a huge increase, one can assume that traders either turned to interest rate futures or did not trade. Those not comfortable trading interest rate futures really only have the option of not trading at all, at least for the time being. These market participants might have bet that the CFTC would push back the clearing deadline; the fact that the regulators stood firm in their decision has now put those firms behind. 

In the coming months, market participants will have a more complete view of how the mandate affected the derivatives market. We will also get a broader picture of which products traders are using while they become operationally compliant for OTC swaps; and even with their clearing systems in place, traders may decide to stick with either interest rate futures or swap futures.

All in all, yesterday was, for the most part, rather anticlimactic. Laurent Paulhac, senior managing director for OTC products at CME, said, “There was so much written about June 10thand so much anticipation, that it’s actually not tremendously surprising that there wasn’t much activity.”