The Chicago Mercantile Exchange’s deliverable swap futures (DSFs) have seen a noticeable if not major increase in volume since the first round of market participants required to clear swaps began doing so earlier this month, indicating the new product’s viability as a replacement for cleared and over-the-counter (OTC) swaps.
Average daily volume in March was 4,707, compared to February’s 3,225, January’s 1,584, and 1,355 in December, when the contracts were launched.
The CME’s interest-rate DSFs provide benefits typically associated with OTC swaps, such as no block surcharges, lower thresholds and longer reporting times. At the same time, they have significantly lower margin requirements than both OTC and cleared swaps, and they can be traded from a desktop screen, although their standardized terms tend to make them less useful hedges.
Market observers have anticipated trading in swap futures, listed by the CME as well as other futures exchanges, to pick up as the first of three deadlines to begin clearing swaps arrived on March 11. Volumes did in fact increase, and Mathew Simon, an analyst at Tabb Group, noted that DSF’s volumes picked up a bit after that deadline, if not by a “staggering” amount. The trade volume increase, and the liquidity it indicates, is nevertheless a positive sign for end users of swaps who may be considering an exchange-traded version.
“It’s not a surprise that some market participants have started to make the switch over. As mandates are passed and alternatives present themselves in the market, end users will have to monitor trading costs and trading objectives,” Simon said, adding, “Liquidity remains a primary component of that evaluation process.”
The first of three clearing deadlines applied to the most active users of interest-rate and credit-default swaps, including dealers and major swap participants. The second deadline, on June 10, applies to a much wider net of market participants, including commodity pools and private funds, and the final Sept. 9 deadline impacts all other counterparties including third-party subaccounts and ERISA plans.
Jack Callahan, Executive Director of OTC products and services at CME Group, noted that in addition to the DSF volume increase, the new product experienced two other “watershed” events in March. One, clients who chose to roll their March contracts into June contracts, a common strategy, were able to do so without complications. And two, clients who choose to take physical delivery were successfully delivered into CME cleared interest-rate swaps on March 19.
Callahan said some market participants have been waiting on the sideline to see how the new contract performed these essential functions.
“The combination of a successful role and a seamless delivery are things that make market participants much more comfortable in trading a new product like this,” Callahan said.
As more institutions are required to clear, executives at the CME as well as the Intercontinental Exchange and the Eris Exchange anticipate volumes for swap futures to increase further, as market participants seek the cost savings and lesser regulatory burden stemming from exchange-traded products. Only two firms are sufficiently active in the swap market to have been designated major swap participants (MSPs) so far, requiring them to comply with burdensome rules that are similar to those applied to swap dealers. End users on the cusp of the MSP designation, however, may switch to swap futures to remain below the threshold.