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OTC Derivatives Markets Face up to Government Regulation

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OTC Derivatives Markets Face up to Government Regulation Q4 2009 Sponsored by In this issue: Page 2 and 3 Tradeweb’s CEO and President give their take on the latest news. Page 5 Looking for liquidity? Electronic trading offers an effective way to increase market transparency. Page 6 As the Asia market sees a higher demand for offerings, Tradeweb consistently expands. Page 11 Tradeweb’s Deposits market goes global with its electronic trading. Page 14 Tradeweb establishes Smart IOIs™ for the Equities market. Page 18 Q&A with Stephen Engdahl of Charles River Development. Treasury Market Shows Resilience he U.S. Treasury market rebounded in the first half of T the year, after liquidity had OTC Derivatives Markets Face Up dried up at the end of 2008. Clients traded 13% more in Q4 2009 than to Government Regulation in the prior quarter, a signal that some stability had returned. With he most recent Bills proposed in the U.S. pave the way for centralized clear- an extensive government fund- ing and electronic trading on either exchanges or alternative swap execution ing program in place, dealers are facilities (such as Tradeweb) for derivatives that can be cleared. There are looking anxiously for any signs of T many details to be negotiated during the remaining legislative timetable and the inflation or drying-up of demand by foreign central banks for U.S. ensuing regulatory phase, but the proposed legislation from the Administration, debt. Despite the difficult environ- House, and Senate as they stand would result in significant changes in the way ment, Tradeweb’s average trade size that swaps are traded. European legislation seems headed in the same direction, a grew to $6.1 million in Q4 2009, necessary condition if jurisdictional arbitrage is to be avoided. and more than 35% of business The language in the various Bills in relation to trading requirements is still in flux, executed on Tradeweb during this but the consistent policy message relating to trading is troubling to many mar- period was represented by trades of $100 million or greater. At the ket participants. Most concerning to the buy-side would be a shift to traditional same time, the customer hit rate exchange trading of OTC derivatives, which would likely suck the liquidity out of the improved to 72% and the percent- swaps market and limit the scope of available derivatives contracts. This could be age of trades executed at or better problematic. For example, insurance companies and pension funds with long-term than Tradeweb’s composite price assets and liabilities may not be able to accurately hedge their positions. This increased by 7% to 75%, all signals would likely result in increased costs for the end-users. of an improving market. Continued on page 2 For more information on Tradeweb contact (800) 541-2268 or [email protected] emarkets • Q4 2009 • 1 Lee Olesky Talks About The Regulatory Environment View From he decisions taken over the next few months in Wash- with clients over the telephone and through regulated ington DC and Brussels will have a profound effect on electronic platforms, such as Tradeweb. It has been well doc- T the long-term health of the OTC derivatives market. umented what happens when these primary institutions do At stake is a multi-trillion dollar industry which provides not—or are not able to—provide liquidity. important hedging tools to a wide array of end-users. While By contrast, exchange trading models have been effective regulation is an important step towards rebuilding confidence for a relatively small number of highly-liquid instruments. The in the banking sector, it is important that in the rush success rate for newer, less liquid products has been to address systemic risk, legislators don’t inadver- disappointing. There is a long list of unsuccessful tently restrict competition or limit access to the exchange trading initiatives over the years, in- OTC markets. cluding the failed launches of CDS on Tradeweb supports the broad goals of Con- Eurex, and Liffe (which has not yet cleared a gress, in particular the adoption of central single CDS trade). Evidence of effective counterparties and the benefits of electronic ongoing competition between exchanges in trading. Electronic markets provide an similar products has not been encouraging. increased level of transparency, help improve Indeed, the monopolistic characteristic of efficiency, and provide the ability to monitor exchanges was one of the key factors leading to markets and prevent trading abuses. MiFID reform in Europe to create more competi- While central counterparty clearing and enhanced tion for exchanges. transparency are eminently sensible goals, there is under- Captive clearing mechanisms linked to exchange trad- standable widespread concern about any move towards ing further exacerbate this problem, and have led to exten- exchange trading, as it would overlook the many benefits of sive regulatory examination and investigation of these ar- the current market structure. Furthermore, there is no logical rangements over the past decade. The benefits of exchange reason to tie clearing or central counterparty functions to trading—transparency and centralized digitized recording of an exchange. trades—are also readily available in a range of non-exchange The proper solution for the OTC derivatives market lies in regulated electronic OTC trading platforms. By keeping creating central counterparty clearing mechanisms that of- derivatives on a centrally-cleared OTC market, and open to fer equal access to multiple regulated trading platforms. This multiple regulated trading platforms, much-needed reform would strike the right balance between addressing systemic can be brought about, without sacrificing the innovation problems and encouraging market innovation. and competitive drive for efficiency that delivers continuing The OTC model supports a wide range of instruments, real benefits to end-users, investors, and debt issuers. many of which trade relatively infrequently. Issuing new and refinancing existing debt requires a market structure predi- cated on the willingness and desire of institutions to support Lee Olesky the underwriting, distribution, and the provision of secondary Chief Executive Officer, market liquidity for each new issue. This is done both directly Tradeweb OTC Derivatives… Continued from page 1 There are signs that industry lobbyists are having an im- as early as Easter 2010. The devil is then in the details, and pact. In recent weeks, a number of end-users have appeared it is expected that the CFTC and SEC will be in hearings on on Capitol Hill on behalf of the derivatives industry, and this the proposed regulation for 12 months or more following is apparently making an impression. President Obama’s signing of the final Bill. During this time, Final regulation from the SEC and CFTC is some way off— there will be intense pressure to craft rules that preserve the perhaps 18 months or more—but in the meantime there will core benefits of OTC derivatives trading—flexibility, access to be plenty of work for governmental affairs personnel. In the dealer liquidity, and a fully-disclosed marketplace—while pro- next few months, the House and Senate will be negotiating viding transparency, efficiency, and the prevention of market a common Bill for presidential sign-off, which could come abuse that Tradeweb currently provides. 2 • Q4 2009 • emarkets Billy Hult Speaks The Top On Interest Rate Swaps he OTC markets have a history of innovation, which has Electronic trading of swaps is likely to further accelerate enabled governments, agencies, and corporations to when some of the “manual” aspects of the swaps T better manage their assets and liabilities. The current market, such as signing ISDA agreements with new clients debate on the regulation of derivatives has, to date, failed and the process for enabling clients with dealers, become to focus on the benefits of OTC markets in general, and on more streamlined. Standard ISDA agreements can still take electronic trading in particular. No more striking example can six to 12 months to complete and while some dealers enable be seen than in the growth of the interest rate swap clients in a couple of days, there are others who can market, which has provided an invaluable hedging take months to enable new clients as swap coun- tool to many major global institutional clients terparties. While both of these processes can be over the last 20+ years. completed electronically, the market will only While the swaps market is relatively young, reach its full potential for streamlined elec- many other over-the-counter markets have tronic trading when dealers and their custom- developed over decades. What they all have ers take advantage of these efficiencies. in common is that when electronic trading There is little doubt that the OTC markets has been introduced, volumes have invariably are here to stay. The opportunity now is to increased—usually sharply. In tandem, trans- increase the efficiency of these markets, parency has grown dramatically, with the visibility which will benefit both customers and dealers, of real-time pricing now taken for granted in the OTC while satisfying the demands of the regulators. markets. The benefits of electronic swap trading are numerous, and mirror those for other e-markets, including: Billy Hult Access to Deep Pools of Liquidity E-trading provides President, Tradeweb the buy-side with direct contact with sell-side trading desks simultaneously, even in volatile markets; Real-time Auctions In fast-moving markets, e-trading allows clients to place dealers in real-time competition, impossible to do effectively on the telephone; The Value in Electronic Swaps Trading: Most Customers go to Straight-through Processing Some of the biggest risks 3 Dealers revolve around fat fingers and failed trades. E-trading solves Percentage of 1,720 Total Inquiries this with seamless electronic trade capture, trade allocation, on Tradeweb in 2Q09 confirmation, and processing; Sent to 1 Dealer 4% Compliance E-trading not only provides the ability to Sent to 2 Dealers 32% extract the best price from a market by placing dealers Sent to 3 Dealers 64% in competition, but it lets you prove it with a permanent elec- tronic audit trail.
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