Liquidity and Capital Rules Set To Widen Cost Gap Between Futures and Cleared Swaps

Futures products will gain traction among global investors in coming years at the expense of more standardized cleared swaps according to new research from Greenwich Associates.

“Our quantitative model used in this research identifies generally favorable liquidity cost dynamics for futures in many cases as the regulatory headwinds impacting the swaps market will not die down,” says Greenwich Associates Managing Director Andrew Awad. “In fact, impending derivatives regulations in Europe, in tandem with changes to risk-weighted asset calculation requirements, will only make trading swaps more costly as time goes on.”

A new report released today, Total Cost Analysis of Interest-Rate Swaps vs. Futures, based on deep quantitative modeling and interviews with over 40 U.S. market participants, found futures to be the least expensive alternative for expressing views on interest rates in nearly every scenario analyzed with liquidity costs as the largest contributor to the gap.

While the impact of higher margin requirements for swaps has had limited impact on product selection to date, it will move the needle in the coming years as clients have less eligible collateral on hand.  In addition, the liquidity cost gap between swaps and futures demonstrated in the research will likely widen as banks find it more difficult to make money trading cleared swaps with new regulations.

Swaps Not Going Away
While the use of interest-rate futures is set to grow, the research also reveals that swaps, both cleared and bilateral, will continue to have their place and those markets will remain robust, albeit on a smaller scale than previously.

“Many market participants are willing to pay up for customization that the swaps market allows and our models show that the cost differentials will benefit those in this camp,” says Kevin McPartland, Head of Market Structure and Technology Research at Greenwich Associates.

The study also examines roadblocks, both perceived and actual, for further adoption of futures despite the cost savings.  Among the biggest roadblocks cited by investors were concerns about liquidity for trading large blocks in certain products, operational changes required and cultural barriers that exist within certain investment organizations.