The necessity of increased stabilisation and regulation of financial markets, especially over-the-counter markets, has received increased international attention following the financial crisis of 2007-08.1 Previously, swap markets were largely ‘in the dark’ when compared to exchange traded derivatives. The reactionary regulation, the Dodd-Frank Act, has severely tightened the OTC swaps markets through standardisation, increased collateral requirements and reporting standards and a more refined clearing mandate; to continue our analogy, it has sought to bring the swaps market into the light. Due to this increased regulation and subsequent increased costs associated with trading swaps, large swathes of swap trading migrated onto futures exchanges, in a process known as swap futurisation. This offered market participants regulatory certainty as well as a reduction in some of the more onerous costs and requirements under the Dodd-Frank Act. With eight years of trading under the Dodd-Frank regulation, our investigation into the advantages and disadvantages of swap futurisation will focus on trends seen in American data. Following on we will look more closely at the European Union’s response, namely the Markets in Financial Instruments Directive II and the Markets in Financial Instruments Regulation.
Table of Contents
1. Introduction
2. Futurisation of swaps
2.1 Advantages
2.1.1 Reduced initial margin
2.1.2 Greater transparency
2.1.3 Lower block size threshold
2.2 Disadvantages
2.2.1 Systemic Risk – the downside of Reduced Initial Margin
2.2.2 Could lower block thresholds potentially harm transparency?
2.2.3 Suboptimal Hedging
3. Regulation of OTC markets
4. Conclusion
Objectives and Topics
This paper examines the evolution of derivatives markets following the 2007-08 financial crisis, focusing on the trend of "swap futurisation"—the migration of trading from over-the-counter (OTC) markets to regulated futures exchanges as a response to stringent regulatory requirements like the Dodd-Frank Act. It investigates the trade-offs between regulatory compliance, cost-efficiency, and market stability, while providing a detailed analysis of the European Union's regulatory response through MiFID II and MiFIR.
- The impact of post-crisis financial regulation on OTC swap markets.
- The advantages and risks associated with the shift toward swap futurisation.
- The evolution of European derivatives regulation, including EMIR, MiFID II, and MiFIR.
- The role of transparency, clearing mandates, and systemic risk in global market infrastructure.
- Market reactions to regulatory costs and the search for capital efficiency.
Excerpt from the Book
2.1.1 Reduced initial margin
Margin collateral requirements for cleared swaps and futures, used to protect traders against counterparty credit risk, generally come in two forms: variation margin and initial margin (Smack, 2014). In terms of futures, variation margin is usually based on a one-day charge as a function of the variance in the transactional value from the previous day. Cleared swaps also have to post initial margin to cover the potential future risk exposure. Specifically, the amount of initial margin charged and the liquidation period will vary for different types of cleared swaps, from as much as five days with the exception of some commodities swaps (Gensler, 2012). The use of futures will tie up less collateral in margin accounts that can be put to use generating income elsewhere.
Summary of Chapters
1. Introduction: Outlines the regulatory shift in financial markets following the 2007-08 crisis and introduces the phenomenon of swap futurisation.
2. Futurisation of swaps: Discusses the dual nature of shifting swap trading to futures exchanges, weighing capital efficiency benefits against risks like basis risk and systemic concentration.
3. Regulation of OTC markets: Details the historical regulatory progression in the EU from MiFID I to the implementation of EMIR, MiFID II, and MiFIR to enhance stability and transparency.
4. Conclusion: Summarizes that swap futurisation is a rational market reaction to heavy regulation, while noting that the long-term success of new directives depends on full implementation and compliance.
Keywords
Derivatives, Swap Futurisation, OTC Markets, Dodd-Frank Act, MiFID II, MiFIR, EMIR, Initial Margin, Systemic Risk, Price Discovery, Transparency, Hedging, Financial Regulation, Central Counterparties, Capital Markets.
Frequently Asked Questions
What is the primary focus of this paper?
The paper explores the move toward "swap futurisation," where market participants migrate trading activities from OTC platforms to regulated futures exchanges to navigate increased regulatory costs.
What are the central themes discussed?
The work covers market liquidity, collateral management, regulatory transparency, systemic risk, and the evolution of European derivatives law.
What is the ultimate research objective?
The objective is to evaluate whether the shift toward futurisation provides a net benefit to the market or if it simply displaces risk while bypassing intended transparency goals.
Which scientific methodology is utilized?
The paper employs a comprehensive literature review and comparative policy analysis of major derivatives regulations, specifically Dodd-Frank, MiFID II, and EMIR.
What topics are covered in the main body?
The main body examines the specific advantages (e.g., lower margin) and disadvantages (e.g., systemic risk, suboptimal hedging) of swap futurisation, followed by a detailed review of EU regulatory frameworks.
Which keywords best describe this research?
Keywords include Swap Futurisation, OTC Markets, Derivatives, Systemic Risk, MiFID II, and Capital Efficiency.
How does the author view the "futurisation" trend?
The author views it as a logical, albeit sometimes circumvention-oriented, response by the market to regulatory burdens that are perceived as overly onerous.
What role do "dark pools" play in this regulation?
The text explains that MiFIR article 5 seeks to cap trading volumes in dark pools to reduce information asymmetry and protect market integrity.
Why is the "too big to fail" concern relevant here?
The shift to centralized clearing houses (CCPs) has concentrated systemic risk, raising concerns that these entities become systematically important and potentially require government intervention in extreme scenarios.
- Citar trabajo
- Sabrina Schleimer (Autor), 2018, Futurisation of Swaps & OTC Market Regulation with MIFIR and MIFID II, Múnich, GRIN Verlag, https://www.grin.com/document/437647
