NEW YORK & LONDON--(The New Global Risk Transfer Market: Transformation and the Status Quo,” a benchmark study commissioned by the World Federation of Exchanges (WFE).)--A battle rages across the global risk transfer market, driven by regulatory reform capable of triggering shifts in product selection, says TABB Group in new research published today, “
“The New Global Risk Transfer Market: Transformation and the Status Quo”
Amidst the turmoil, TABB estimates margin shortfall in OTC derivatives trading reached $2.6 trillion at the end of 2011, a cost that could be reduced to several hundred billion dollars based on product selection changes.
“A war is being waged between forces of the status quo and forces of transformation of the global risk transfer market (GRTM),” says E. Paul Rowady Jr., a TABB senior analyst and the study’s author, “It has the potential to shift product selection for hedging and trading purposes, from exotic and bespoke trade structures, to standardized and clearable swaps, futures and new futurized/hybrid swaps.”
The 65-page, 84-exhibit study builds on TABB’s November 2010 Global Risk Transfer Market research, also commissioned by the WFE and conducted by Rowady. This study examines current status and transformation of the global derivatives market, where components of the market ecosystem are in their development and implementation cycles between these two poles. It focuses on many of the primary issues in swaps: clearing, margin, collateral, automated trading solutions, trading costs, trade reporting and repositories and extraterritoriality, juxtaposing them with exchange-traded derivatives (ETD) markets and across multiple regions.
Although dealers and their customers in the US and Europe say they expect the GRTM’s historical growth to resume its former trajectory once reforms are in place, TABB believes the real story to track is the volatility of volumes, liquidity and product selection caused by reform and economic uncertainty.
According to TABB estimates, the OTC derivatives market reached a new all-time high of $709 trillion of notional values outstanding by December 2011, before compression. On the basis of estimated total notional turnover in the GRTM of $4.1 quadrillion as of the end of 2011, representing an increase of $300 trillion over TABB’s 2010 estimate, the ETD market remains larger than over-the-counter derivatives (OTCDs), 55% versus 45%
As much as 40% of notional value outstanding is already being cleared with an additional 39% potentially clearable, says Rowady. “To mandate clearing and margin requirements during an era of deleveraging – when collateral becomes painfully scarce – is a bitter pill to swallow for many financial entities,” Rowady says. “These margin requirements may continue to make exchange-traded and other standardized products more attractive.”
But according to TABB, central clearing is appropriate for correcting long-standing flaws in market structure caused by an over-concentration of exposures among a relatively small number of dealers. “Without central clearing and the mutualization of risks,” Rowady says, “costs are just as great, if not greater, and must often be paid, as in a bailout scenario, by taxpayers.” He adds, however, that the most exotic products are not clearable. “Here, questions remain as to how much new margin and other requirements will make exotics less attractive and whether hedging practices will shift toward greater use of standardized products.”
For OTCD brokers and dealers, the mantra remains the same: Make it up on volume and if mass transformation of the GRTM is expected to alter product selection and trade flows, then all mechanisms to enhance volume levels should be wholeheartedly embraced, including greater access by new market ecosystem players waiting in the wings.
As for finding safe havens to dull the impact of impending rule changes and the potential for extraterritoriality, Rowady says a swaps business isn’t that flexible. “You can’t box it up and roll it onto an airplane, dropping it fully functioning in a new jurisdiction or perceived safe-haven in a heartbeat. These are complex, interconnected, still largely human-centric enterprises and not easily made mobile, particularly in an environment in which operational risk tolerance should be closer to the “batten-down-the-hatches” than the “let-‘er-rip” mode.”
The new study is available to TABB Group Research Alliance Fixed Income clients and qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or more information, visit http://www.tabbgroup.com or write to firstname.lastname@example.org.
About TABB Group
With offices in New York, London and expansion to Asia-Pacific, TABB Group is the only financial markets research firm focused solely on capital markets, based on the proven interview-based research methodology of “first-person knowledge” developed by founder Larry Tabb. For more information, visit www.tabbgroup.com. In January 2010, TABB launched TabbFORUM, the online global capital markets community covering analyses of current issues, tracked daily by nearly 13,000 professionals.