New Greenwich Report Shows Dealer Focus Shifts Away from Corporations

Use of derivatives is growing in anticipation of a hike in global interest rates.  The increased demand for hedging instruments is placing a strain on dealers, which face rising derivatives trading costs as a result of recent regulation.

A new report, Corporate Derivatives Use Continues to Grow — Dealers Say Not So Fast,  released today by Greenwich Associates examines the results of a study of nearly 400 corporate treasurers globally and finds that corporate use of derivatives has climbed since the financial crisis with the annual interest-rate derivatives trading volume of the typical big corporate user growing to $3 billion in 2014 from $2 billion in 2006. The vast majority of these users—87% of study respondents—say new regulations have had no impact on their use of derivatives.

The story is much different for the dealers which companies rely on to execute these trades. While Dodd-Frank exempted corporate “end users” from its trading and clearing mandates, dealers executing bilateral trades with these clients are subject to much higher capital costs than those imposed on cleared trades for other clients. “Banks will be, and in some cases already are, passing these new costs down to the client,” says Kevin McPartland, Head of Market Structure and Technology Research at Greenwich Associates.

Over half the corporations participating in the study are paying credit charges to their dealer as part of the initial transaction to offset the dealer’s cost of capital under Basel III.  

Dealers Cutting Back
These new cost dynamics have caused some banks to cut back their focus on corporate customers. As a result, corporates are increasing their counterparty lists to ensure they have access to the liquidity and services they need. The biggest beneficiaries have been second-tier dealers with large balance sheets and high credit ratings. HSBC, RBC and Wells Fargo all fit in this camp and saw strong growth over the past year.

“Even with these moves, corporate derivative end users won’t be able to continue on as if it’s 2007 forever,” McPartland says. “Rates will eventually rise, and Basel III will start to make its mark on dealer-provided pricing and service, both causing a further adoption of central clearing.”

Corporate end users—often referred to as bona fide hedgers—need customization in their swaps more than most, a big factor in their choice to stay away from the more standardized derivatives encouraged by global financial reform. As the cost of that customization rises and clearinghouses begin to clear more customized contracts, a move away from bilateral transactions is inevitable.