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A New Swaps Platform PDF
A New Swaps Platform PDF
A New Swaps Platform PDF
Dodd-Frank Requirements
Standardized swaps must be
SEF (Swaps Execution Facility) traded Cleared
Swap Volumes
Report on Trading Derivatives (IOSCO Technical Committee, February 2011):
The International Swaps and Derivatives Association (ISDA) and others have stated that there are less than 2,000 standardised interest rate swaps executed globally on an average day. The most liquid swaps (10-year dollar interest rate swaps) trade about 200 times per day, while most swaps trade less than 20 times per day.
Implication
Aggregate trading volume too low to
Achieve liquid markets Obtain scale economies
TO
Design an order type for executing trades that establish swap-equivalent exposures
Example:
Three-year vanilla interest-rate swap for $120M Equivalent to 12 orders for 12 contracts ($1M notional each) expiring on successive settlement dates over next 3 years Total number of contracts: 144
Margin for DCM positions expected to be lower than for SEF positions
t ,t k
rt k
rt k r
Technical Aside--continued
Equivalence of a swap with a strip of forward contracts implies that r is the present-value weighted average of the
rt ,t k
and deviations of rt k from r for the fixed rate payer and the rt ,t k for a short forward strip will be well correlated. Hence, a swap paying fixed and receiving floating (variable) can be approximated by a strip of short futures contracts and a swap paying floating (variable) and receiving fixed can be approximated by a strip of long futures contracts.
20 years of MBA training established a cadre of mid-level managers who understand swap-futures equivalence
Unlike now, when swaps established derivatives expertise was scarce Dealers provided needed advisory and execution services Advisory services less needed today for standardized products Automating execution services can shift a sizable portion of swap business to an order-submission platform for futures
Connect interface to clearing system to determine collateral needs Make parser an order entry route into electronic order book Sizable marketing effort
Additional Needs
Parser will need correct for convexity Legal, tax and accounting issues:
Is proposed facility a SEF or DCM? Meet FASB 133 hedge requirements? Tax considerations?
Potential needs
At start up compensation for market making services Encourage use of algorithmic trading in options trading Specialized membership category
Potential Benefits
Trading volume
Market Potential
2,000 contracts daily (IOSCO Technical Committee) Assume average contract is $120M notional, 3-year tenor, 4 settlement dates per year Implies daily volume of 288,000 contracts
Ability to offer greater liquidity in back-month futures and option contracts attracts participants