Significant percentages of participants say the global swap market has fragmented and liquidity has deteriorated, but they still need the risk management tools, according to a survey by the International Swaps and Derivatives Association (ISDA). Much of the fragmentation has been attributed to US regulators’ intent to extend new US swap regulations to virtually any entity transacting with market participants registered in the US.
A plurality of the 376 of respondents to the survey, the results of which were issued in late April, were financial institution end users, including banks, insurers and finance companies (31.38 percent), followed by asset managers (23.94 percent). Non-financial corporates made up a significant 22.07 percent of respondents, with government entities, energy companies, others making up the rest. Nearly half of respondents were from North America and close to 40 percent from Europe.
As a result US regulatory reach, many swap market participants outside the US have stopped trading with US entities or on US trading platforms. Regulators are discussing how to hammer out those differences, but no solution appears imminent.
Among survey respondents, 54.49 percent said the market is fragmenting, and the same percentage said it is fragmenting along geographic lines because of the regulatory framework being put in place in key jurisdictions, while only 7.87 percent said it is not fragmenting.
More than 56 percent of those saying fragmentation is occurring believe it has a negative or strongly negative impact on their ability to hedge risk. A sizable percentage, 24.08 percent, said fragmentation has no impact on their hedging, while 4.19 percent said it actually has a positive impact.
Swap market fragmentation has been anticipated to lessen market liquidity, and 36.23 percent of market participants said liquidity has deteriorated, while 22.61 percent said liquidity remains unchanged, and 6.09 percent said it has improved.
The cost of hedging also appears to have gone up, according to respondents, with 40.47 percent saying there’s been a small increase and 12.61 percent saying the increase has been substantial. Meanwhile, a number of respondents, 34.43 percent, said fewer dealers are willing to offer a price, somewhat higher than the 30.54 percent who reported there’s been no change.
“This survey shows that inconsistent application of derivatives regulations across borders is having an impact on the ability of end users to hedge their risk. Most think markets are fragmenting and costs are rising,” Scott O’Malia, ISDA’s chief executive officer, said in a prepared statement. He added that constraints on bank balance sheets are also being felt, with roughly a third of respondents pointing to fewer dealers and a reduction in liquidity.
“This is now starting to have an effect on the ability of end users to hedge their risk effectively,” O’Malia said.
Among the respondents who said liquidity has deteriorated, 64.75 percent said that has had a negative impact on their ability to manage risk, and 22.13 percent said there was no impact. More than 89 percent of respondents said derivatives, whether cleared or uncleared, are important to their risk management strategies, while 5.69 percent said they’re not important.
Managing exposures to currencies, commodities and credit to improve pricing, operating expenses and returns was the top reason for derivative use, checked off by 66.67 percent of respondents. Hedging exposures in international markets to maintain and enhance competitiveness was number two, at 41.74 percent. And reducing financing costs and managing the cost of capital the company borrows to invest in its business was number three, at 37.84 percent
The biggest concern amount respondents regarding their companies use of derivatives to manage risk was the increased cost of hedging, at 61.52 percent. The uncertainty about regulations was checked by 44.85 percent, followed by the scope of cross-border derivatives regulations at 39.70 percent, and fewer dealers to transact with, at 38.48 percent.
Despite their increased concerns about costs and liquidity, however, corporate treasurers still appear to view derivatives as essential tools to manage those risks. The vast majority of respondents, 67.07 percent, said there derivative use would stay the same in 2015, followed by 15.31 percent saying it would increase. Only 6.34 percent saying it would decrease.