The CME’s new deliverable interest rate swap futures contracts could offer OTC swappers a better deal than either dealing with a clearing house or paying to transact bilaterally. While corporates have ostensibly received an exemption from central clearing, the extra capital that dealers will have to set aside for non-cleared transactions means that many OTC derivatives could become prohibitively expensive.
The swap futures will have the underlying economics of a swap but will not be considered such under Dodd Frank. End users will be able to avoid clearinghouse initial and variance margin requirements, which some believe will be prohibitive for swaps, in favor of those requirements for futures, which are less onerous. Futures contracts require only one-day variance margin, while swaps require five-day variance margin.
End users will also be able to net their exposures with other futures contracts, which will provide operational and cost advantages. And unlike the soon-to-be-transparent swap market, the swap futures market will allow end users to keep block trades of 3,000 contracts or more out of the public’s view.
Of course, the CME has tried to launch swap futures in the past with little success. Some dealers say they froze out those products because they competed with their plain vanilla swaps business, leaving the CME contracts with no liquidity to speak of. This time, dealers and end users may find the contracts, and others like them, more compelling. In fact, four dealers have agreed to provide liquidity: Citigroup, Goldman Sachs, Morgan Stanley and Credit Suisse. Goldman will receive a royalty on the product, which uses a patent that it owns.
The new contracts start trading in mid-November.