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▲ Executive Summary.…………………………………………3
▲ Market Sizing….…………………………………………….. 9
▲ Trading Cost Analysis………………………………………24
▲ Collateral…………………………………………………..24
Collateral 24
▲ Clearing and Exchange Fees…………………………..31
▲ Bid-Ask Spreads………….………………………………38
▲ Conclusions……………….………………………………40
Conclusions 40
▲ Regulatory Update and Survey Results .. ………………46
▲ Appendices………………………………………………….58
pp
▲ InterestRate Derivatives……………………...………...59
▲ Credit Default Swaps…………………………………….66
▲ Other Major
j Asset Classes……………………………...74
60
US$ Trillions
US$ Trillions
400
50
300
40
U
U
Tracking the siblings
200 30
A visual and quantitative correlation of
growth confirms that OTCDs and ETDs
are two sides of the same coin. 20
100 Both components of the Global Risk
Transfer Market are simultaneously 10
complementary and competitive.
- -
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e
38 score.
Interest rate products dominate both OTCD
28
25 and ETD markets, together representing 75%
of 2009 notional outstanding; short term
24 23 products ((<1 yyr)) dominate within ETD rates at
p
95% of notional open interest; OTCD rates
are 40% of notional values outstanding.
80
OTCD equity exposures represent 49% of
1998 2000 2002 2004 2006 2008 2010e total global notional equity exposures.
Notional turnover in ETD equity and interest rate
OTCD asset classes account for ETD’s notional turnover
size advantage vs. OTCDs. Unlike OTCDs,
Notional Values Outstanding 1,840
1,690 however, high levels of turnover in ETD are caused
Notional Turnover
by both structural and strategic activity:
ons
Turnover Frequency
US$ Trillio
St i
Strips: tto formulate
f l t longer
l term
t exposures
4.2 from short term instruments
3.4 3.1 Rolls: to move from front expiring months to
625
3.0 2.7
future months
TABB Group p estimates the p
proportion
p of structural
trading in ETDs is no more than 5% of volume; high
turnover strategies account for 40% and are
1998 2000 2002 2004 2006 2008 2010e growing quickly.
Source: BIS, WFE, TABB Group Dashed points are interpolated estimates
TABB Group The Global Risk Transfer Market | Nov 2010 5
Executive Summary:
Collateral Leading Concerns
Percentage of Collateralized 75% Collateral Costs Increasing
70% OTC Trade Exposures ▲Increasing collateral costs remains remain the theleading
leadingconcern
concernOTCD
among amongparticipants,
OTCD participants,despite collateralized
despite OTC
60% collateralized
trades increasing
OTC trades
g 2.4x increasing
to nearly y 70% g 2.4x
and the
to nearly
number
y
70%
of collateral
and theagreements
number of collateral
increasing agreements
3.1x to 172,000
50% increasing
since 2003.3.1x to 172,000 since 2003.
49% ▲The level of collateral for OTCD trades is still widely
▲The level of collateral for OTCD trades is still widely
40% believed
believed to to be
be too
too low.
low.
▲Based on comparisons with ETD markets, gross
30% ▲Based
credit on comparisons
dit exposure (GCE) iin with
OTCDETDmarkets,
markets,
markets
k t and gross
d currentt
credit exposure (GCE) in OTCD
data from CCPs for OTC credit derivatives, TABB markets, and current
20% data
Group from CCPs for
estimates thatOTC credit derivatives,
the additional collateralTABB
required
Group
in OTCD markets is about $2 trillion, globally. required
estimates that the additional collateral
10%
▲in
DueOTCDto end markets could be about
user exemption $2 trillion,
contemplated in globally.
current
29% 52% 55% 63% 59% 65% 66% 69%
0% ▲Due to the end user exemption contemplatedthis
regulatory reforms and several other factors
factors, in level
of collateral
current impactreforms
regulatory may never and be actualized.
other factors, this level
2003 2004 2005 2006 2007 2008 2009 2010e
▲TABB Group estimates that the
of collateral impact may never be actualized. near term collateral
OTCD FX Metals
Energy Equity Interest Rates impact of moving additional standardized OTCD
▲TABB Group estimates that the near term collateral
interest rate and credit exposures to CCPs is
impact of moving
approximately $240 additional
billion. standardized OTCD
Collateral Agreements i t
interest t rate
t and d credit
dit exposures tto CCPs CCP iis
150 ▲The increasing and pervasive use of collateral in
approximately $240 billion.
Thousands
sis Points
30y IR Swap Future
og Scale
3,125
OTC CDS Single (HY)
1,600 OTC 10y IR
OTC CDS Single (IG)
Swap
Lo
Bas
$1 000
$1,000 5y IR Swap Future
600
OTC CDS Index (HY)
469
og Scale
on liquidity?
usage/focus
Reform Impacts
Firm’s view on e-
by/of yyour firm?
requirrements?
View on Trade
missions?
ositories?
OTCD reform’s primary
pact on
focus continues to be:
Participants
reducing systemic risk
Impact o
comm
% OTCD
Imp
Impact o
OTCD u
Repo
and increasing overall
market transparency for
both price and
Top-Tier Dealers positions.
There is consensus on
“Emerging” Dealers tactics – centralized
clearing for
Traditional Buy-Side standardized
instruments, tighter
Hedge Funds requirements on
collateral, and cleared
Corporate End Users contracts on a
registered execution
Exchanges / Clearinghouses venue – but
implementation will be
Inter-dealer Brokers / OTC
Execution Venues slow for end users,
coming online in 2011
through 2013.
Data Providers / Aggregators
Increase Decrease Same Positive Negative Indifferent
TABB Group The Global Risk Transfer Market | Nov 2010 8
Market Sizing
60
US$ Trillions
US$ Trillions
400
50
300
40
U
U
Tracking the siblings
200 30
Standard deviation of OTCD growth is 9%
as compared to over 22% for ETD (or 2.5 20
times that of OTCD)
OTCD), which is easily visible
100 from the chart. Before the credit crisis,
OTCD growth was extremely consistent, 10
with a standard deviation of 6%.
- -
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e
Rates
89%
ETD ($73 trillion) OTCD ($615 trillion)
Notional Turnover 38
Turnover Frequency
4.2 28
25
3.4 3.1
625 24 23
3.0
2.7
80
1998 2000 2002 2004 2006 2008 2010e 1998 2000 2002 2004 2006 2008 2010e
Source: BIS, WFE, TABB Group Dashed points are interpolated estimates
TABB Group The Global Risk Transfer Market | Nov 2010 15
Turnover frequency (TOF) points to the structural makeup of a market as well
as the strategies participants implement within those markets
TOF
600
Limited participants and low process
automation limit turnover frequency, and
40
400 therefore, market liquidity.
As large market segments like OTC
interest rate derivatives trade and clear
200 20 more like futures, the market will realize
significant cost savings and greater
liquidity.
0 - The impact of doubling TOF for OTC
interest rate swaps – from roughly 1 to 2
- would yield an additional $350 trillion of
global annual trading activity.
0%
Equity- Rates Commodity Other * FX Credit
Linked
* Other includes ETF Options (ETD)
OTCD ETD and unallocated exposures (OTCD)
Source: BIS, WFE, TABB Group
TABB Group The Global Risk Transfer Market | Nov 2010 17
OTCD market exposures originate primarily in Europe while ETD shows
waning dominance in North America; Regional dynamics changing slowly
which will accelerate with growth in APAC markets
OTCD – Notional Turnover Achieving
Achieving regional
regional balance
balance
2,000
Europe remains the epicenter of OTCD
US$ Trilllions
15%
16% dealing due to London’s dominance in
1,500
interest rate dealing
dealing. However
However, it is
slowly ceding its dominance as US and
1,000 64% APAC activity grows.
61%
14%
The concentration is less pronounced
500 64% when viewed by underlying currency.
21% 23% Single-currency OTC interest rate
22% derivatives and Euro-denominated
-
2004 2005 2006 2007 2008 2009 2010e trades edge out US-dollar-
denominated trades, 39% versus 34%
Dashed points are interpolated estimates in 2009.
Source: ISDA * Includes Latin America, Eastern Europe, and Africa; ** includes Hong Kong, Singapore and Australia
TABB Group The Global Risk Transfer Market | Nov 2010 19
Dramatic change in OTCD demographics is direct link to search for multi-asset
alpha by hedge funds and prop desks; ETD influenced primarily by high
frequency trading strategies
Corporate Use of OTCD Futures End User Breakdown
2009 % of Contract Volume OTCD demographics
All 94% 16% 17% 18% 19% CDS and other complex structured
20%
Rates 88% products, like CDOs, had a major
28% 26%
i
impactt on OTCD d demographics
hi iin
FX 83% 39% 35% 25%
the past 5 years.
Commodity 49% Alternative asset managers and
Equity 29% proprietary trading desks of large
54% 55% 55% financial companies flocked to
Credit 20% 45% 48% th
these new products.
d t
Hedging
H d i primary,
i iinvestment
t t and
d ttrading
di IInvestment
t t and
d trading
t di primary,
i hedging
h d i
Strategy Types secondary; Limited annual turnover range: secondary; Broad annual turnover range:
1 –20x 1 – 100x
Outstanding Notional $625 trillion (2010e) $80 trillion (2010e)
Notional Turnover $
$1.7 quadrillion (2010e) $
$2.0 quadrillion (2010e)
Contract Open Interest NA 1.02 billion (2009)
Contract Volume NA 22.4 billion (2010e)
Annual Transactions / Trades ~16
16,000,000
000 000 (2010e) ~3
3 billion (2009)
Average Trade Size / Value NA / $105 million (2010e) 5.9 contracts / $103,000 (2009)
Regional Breakdown (2010e) N. America: 23%; APAC: 16%; EMEA: 61% N. America: 48%; APAC: 12%; EMEA: 40%
TABB Group The Global Risk Transfer Market | Nov 2010 23
Trading Cost Analysis:
Collateral
10%
Collateral Agreements
150
Thousands
al Commitment to GCE
40% other words,
words, it measures
it measures
nettednetted
credit credit
exposureexposure
between
between counterparties”,
counterparties”, accordingaccording
to ISDA. to ISDA.
4,000 ▲ Using GCE as a benchmark, the OTCD collateral
35% ▲ Using GCE as a benchmark, the OTCD collateral
3,520 requirement was over $3.5 trillion
forfor 2009.BasedBased
ns
requirement
q is over $3.5 trillion 2009. on
US$ Billion
on th
the ISDA M
Margin i S
Survey
the 2010 ISDA Margin Survey, TABB Group 2010
2010, TABB G
Group
30%
estimates
estimates that that $1.6
$1.6 trillion
trillion of
of collateral
collateral -– 45% or 45%of of
3,000 GCE
GCE -- is is already
already committed
committed in in OTCD
OTCD markets
markets;(82%
25% (82% of collateral is cash in major currencies with
of collateral is cash in major currencies with another
another
10-15% 10-15% of collateral
of collateral posted inposted in government
government
20% securities
securities.)
securities).
iti ) )
% Collatera
2,000 ▲ A note on single-counting versus double- counting:
1,576 ▲A noteMargin
ISDA on single-counting
surveys do not versus
adjust double- counting:
for double-
15%
ISDA Margin surveys do not
counting – i.e. both collateral delivered andadjust for double-
counting
collateral –received
i.e. both–collateral
because delivered
its goal isand to measure
10% collateral
1,000 the usage g of collateral and not the valuetoofmeasure
received – because its goal is assets
the usage of collateral and not the value of assets
posted as collateral.
5% posted as collateral.
▲ However, for centrally cleared trades, both
counterparties
▲ For centrally cleared must posttrades,collateral
however, as initial
both and
- 0% variation margin,
counterparties generally
must in an amount
post collateral estimated
as initial and
1999 2001 2003 2005 2007 2009 to cover amargin,
variation 5-day loss, with 90%
generally in anconfidence.
amount estimated
Gross Credit Exposure (GCE)
Therefore, TABB Group believes
to cover a 5-day loss, with 90% confidence. that using aTABB single
Collateral Commitment (Single Counted) counting
Group methodthat
believes for using
the ISDA a singlemargin estimates
counting method
% of GCE offers
for thetheISDA most accurate
margin reflection
estimates offersof the
wheremost the
Source: BIS, ISDA ,TABB Group value of collateral
accurate reflectionisoftoday.
the current value of collateral.
TABB Group The Global Risk Transfer Market | Nov 2010 27
ETD margin levels represent an alternate method to estimate the total
collateral benchmark for OTCDs; Margin levels vary widely by asset class, but
are based mostly on volatility
Interest Rate Futures Alternate OTCD collateral benchmark
5% Effective Margin and Average Volatility Samples 12
▲Outright margin levels for fornaked
“naked” positions
positionsreflect
reflect
Volatility
4% 10
Margin
Average V
Effective M
Maintenance Margin (%) a fraction of outright margin levels, and often therefore,
reflect
Avg Volatility (2010 YTD) 6
2% minimum
often reflect margin
minimum
requirements
margin requirements
due to limiteddueandto
4 finite
limitedrisks.
and finite risks.
1% 2 ▲Key factors that influence outright margin levels
▲Key factors that influence outright margin levels
include volatility, duration, liquidity and complexity of
0% - include volatility,
volatility duration,
trade structures. duration liquidity and complexity of
trade structures.
▲Liquidity premiums can sometimes cause
margin requirements
▲Liquidity premiums can to sometimes
double. cause
▲Cross-margining, portfolio margining
margin requirements to double.and other
netting techniques, which will continue to become
Equity Index Futures ▲Cross-margining,
more common in both portfolio
ETDmargining
and OTCD and other can
markets,
Effective Margin and Average Volatility Samples netting
result intechniques will continue
additional reductions in to become more
margin
15% 25
e Volatility
common
requirements.in both ETD and OTCD markets, resulting
Effectivve Margin
Notional
400 ▲Based on total margin levels
ons
0.61% 0.75%
reported to the CFTC and OCCOCC,
o of Margin to N
US$ Billio
Ratio
nearly $450 billion, or 0.6% of
- 0.00% notional open interest. ($134b +
2005 2006 2007 2008 2009 $78b / 47% = $449b; $449b / $73t
ETD notional = 0.61%)
US Options Margin (OCC)
US Futures / Options on Futures Margin (CFTC) ▲ Applying this level as a
Global ETD Margin Estimate benchmark for OTCD collateral
Margin as % of Notional Outstanding
requirements yields an expected
level of nearly $3.8 trillion for
Applying ETD Margin Benchmark to OTCD 2009.
Percentage of Notional Values Outstanding 4,699 2.0%
5,000
ns
Ratio of Margin to
3 776
3,776
US$ Billion
4,000 3 508
3,508 1 5%
1.5%
Notional
3,000 2,014 1.0%
0.61%
2,000 1,545
0.5%
1,000
- 0.0%
R
2005 2006 2007 2008 2009
Collateral Requirement (ETD Benchmark)
ETD Margin Benchmark (%)
Source: CFTC, OCC, TABB Group
4,000 Comparison of the 3,508 proportion of collateralized transactions, TABB Group estimates
ETD and
d GCE Margin
M i that the total collateral commitment in OTCDs today is too lowlow.
Benchmarks 3,520 Applying the previously defined GCE and ETD benchmarks,
3,000 3,256 the additional collateral requirement could be as high as $1.9 -
$2.2 trillion based on a move of all OTCD exposures to CCPs
1,900 2,036 today (assuming total est. OTCD collateral for ‘09 was $1.6t).
2,000
GCE B
Benchmark
h k ▲The current collateral levels at ICE Trust US and ICE Clear
2,014
ETD Benchmark Europe for credit derivatives further confirm the range of the
1,545 GCE and ETD benchmarks; the combined guaranty funds in
1,000
2005 2006 2007 2008 2009 the US and Europe yield a collateral benchmark of 0.5%.
OTCD Margin Requirement ▲The next tranche of OTCD exposures, which are among the
5,000 4,555 most likely to be migrated to CCPs,
CCPs are vanilla swaps at the top
C
Current versus
Additional Collateral 14 dealers currently not already cleared. According to the trade
4,000 3,520 repository for OTC IR derivatives, these swaps total $42 trillion,
$ Billions
1 900
1,900 2,193
2,000 to ever be levied. Factors that contribute to reductions in
1,235 1,368 collateral include: 1) Not all OTCD exposures will move to
1,000 1,979 CCPs, 2) high likelihood of end-user exemption, 3) extremely
1,576
1,063 short term exposures, like a majority of FX, will require little or
665 668
- no collateral, and 4) innovations in cross-margining.
cross margining.
2005 2006 2007 2008 2009
▲Factors that increase collateral requirements include:
Current Margin (Single Counted) increasing volatility, decreasing liquidity, increasing duration,
Additional Margin Requirement increasing complexity, and lack of netting efficiencies.
Source: BIS, ISDA ,TABB Group
TABB Group The Global Risk Transfer Market | Nov 2010 30
Trading Cost Analysis:
Clearing and Exchange Fees
nds
ons
Thousan
US$ Trillio
IRS Clearing (two-sided) Monthly Trade Registrations ▲ Services for customer clearing are
in the works, as well as clearing
150 SwapClear Market Share 89% 100%
for vanilla forwards and options
$ Trillions
40%
50 exotic – will ultimately be centrally
25 20% cleared.
- 0%
▲ Customer-to-dealer (C2D)
transactions still remain largely
bilateral, in part, awaiting
guidelines on collateral
IRS Clearing (one-sided) Reporting Dealers - IRS Mkt Share - Dealer IRS requirements.
Source: LCH SwapClear
250
nds
8 dealers moved existing positions into the CCP to meet their
Thousan
200 regulatory commitments. Following the commitment date of
6 Dec 15, 2009, open interest in index CDS at ICE Trust US
150
have a compound monthly growth rate of 2%. Buy-side
4
100 access to clearing via ICE has been available since Dec 15,
2 2009, but open interest is negligible. They will not utilize CDS
50 clearing until they are required to or it becomes economically
- - suitable for their investors. TABB Group expects little growth
in CDS clearing until final clearing mandates are put in place
both in the US and EU, forcing additional volume into CCPs
from both the sell-side and buy-side.
Open Interest Trade Volume
ICE Trust US
US– Index CDS
ICE Clear Europe Average trade size hovers around $80 million for index CDS
140 Index CDS 123 10 as this is a purely dealer-to-dealer (D2D) market. This
compares to the average trade size of $26 million for the CDS
ands
120
8
ons
80 46
4.6 6 accountst for
f < 2% off the
th total
t t l CDS outstanding
t t di notional.
ti l
60 4 ICE Clear Europe – Index CDS
40
20
2 ICE Clear Europe has seen a slow but steady increase in
Index CDS open interest through 2010. Transaction volumes
- 0
are on par with ICE Trust US
US, despite open interest half the
size of its US counterpart. Average transaction size for index
products is lower than its US counterpart at $52 million
Source: ICE, TABB Group
Open Interest Transactions (assuming a EUR/USD rate of 1.3).
TABB Group The Global Risk Transfer Market | October 2010 33
OTC energy transactions have been cleared by CME’s ClearPort since 2002;
Nearly 125 million OTC contracts cleared in 2009
500 459
Thousa
10 $2.33 $2.0
▲ TABB Group estimates last 12
5 $1.0 months (LTM) OTC clearing
revenues of $272 million; 2009
- $0.0 OTC clearing revenue of $260
million or $2.09
$2 09 per contract.
contract
OTC Clearing Only - Bclear (Commodities) they will adopt more of its unbundled cost
$1.470 they will adopt more of its unbundled cost
structure, including the adoption of clearing and
$1.00 structure,, including g the adoption
p of clearing g and
Log S
$0.783 execution
ti venue ffees. For F comparative ti
ETD Clearing and Exchange - CME execution venue fees. For comparative
purposes, inter-dealer broker (IDB) fees can
purposes, inter-dealer broker (IDB) fees can
$0.390 ETD Clearing and Exchange - Eurex serve as a proxy for execution venue fees.
serve as a proxy for execution venue fees.
$0.278 ETD Exchange Only - CBOE ▲ Although these examples are not necessarily
▲ Although these examples are not necessarily
apples to apples comparisons – since OTCD fees
ETD Clearing Only - OCC apples to apples
are clearing only comparisons
clearing-only – since OTCD
and the ETD examples fees
include
$0.10 are clearing-only
both clearing and and the ETD
exchange feesexamples
– they do include
both clearing and exchange fees – they
illustrate the nominal divergence between OTCD do
* NOTE: SwapClear clearing fee illustrate
and ETD.the nominal
Adding divergence
“exchange” fees between
to the OTCDOTCDs
estimates are derived from fixed and ETDs. Adding “exchange” fees to the OTCD
trades would only exacerbate this divergence.
membership fees, and therefore, trades would only exacerbate this divergence.
$0 016
$0.016 represent average levels
levels. ICE clearing fee ▲ Per trade estimates for SwapClear and ICE are
estimates are derived from proportional Per-trade
▲based estimates
primarily for SwapClear
on reported transactionand levels,
ICE are
$0.01
revenue disclosures. based primarily
proportional on reported
revenues, and/ortransaction
membership levels,
fees.
2009
proportional revenues, and/or membership fees.
Source: CME, CBOE, Eurex, NYSE Liffe, ICE, SwapClear, OCC, TABB Group
TABB Group The Global Risk Transfer Market | Nov 2010 35
When normalized on a cost-per-million basis a pricing structure governing both
OTCD and ETD exchange fees emerges with wholesale, “retail” and bespoke
segments; typical wholesale exchange fees come in at $2-$10 per million
Exchange Fees Normalized Exchange Fee Comparison
Cost Per Million (CPM) ▲
▲ When isolating exchange fees by various
product types, a clear pricing structure emerges
$100 Bespoke Pricing
that transcends and highlights g g the
interdependencies of OTCD and ETD domains.
▲ * Note that IDB broker fee estimates are
▲ IDB broker fee estimates are used as a
$80 used as a proxy for exchange fees in order
proxy
to createfor an
exchange fees in order
apples-to-apples to create
comparison
66 anOTCD
of apples-to-apples
and ETD markets. comparison of OTCD
and ETD markets.
markets
“Retail” Pricing ▲ Normalizing exchange fees on a Cost per Million
$60 53 ▲($CpM) basis, the delineation
When normalizing exchange fees between
on a the
cost-per-
market segments becomes clear:
million basis, the delineation between the marketthe wholesale
market
segments – for large participants
becomes clear: the –wholesale
incorporates bulk
market
pricing; theparticipants
– for large “retail” market , which is a bulk
– incorporates slight
$40 i
misnomer i“retail”
it iismarket,
till primarily
i which
il is
d istill primarily
b
Wholesale Pricing pricing; thesince still driven by
institutional trading, has higher pricing.
driven by institutional trading, has higher pricing The
bespoke
for selectmarket,
products. whichThecaters
bespoketo larger
market, players,
whichis
where the highest pricing occurs.
caters to larger participants with precision needs,
$20
10 ▲ As adoption
is where the of ETD execution
highest and clearing
pricing occurs.
75
7.5 75
7.5 models increase in the traditional OTCD domain domain,
2.6 As adoption
▲these of ETD
differences willexecution and clearing
solidify further.
$0 models increases in the
▲ TABB Group believes that as the OTCD domain,
OTCD these
Exotic Avg Equity Vanilla US Interest S&P Index differences will matures,
transformation solidify further.
the concepts of ETD and
Structure Option Structure Treasury Rate Swap Future OTCD with dissolve; instead becoming known as
▲ TABB Group believes that as the OTCD
(OTCD) (ETD) (OTCD) Future (OTCD) (ETD) “Large
Large Block”
Block , “Small
Small Block”
Block , and custom market
transformation matures, the perceptions of ETDs
(ETD) segments.
Low Mid High and OTCDs with dissolve; instead becoming
known as Large Block, Small Block, and Custom
Source: CME, CBOE, Eurex, NYSE Liffe,TABB Group market segments.
TABB Group The Global Risk Transfer Market | Nov 2010 36
All-in transaction costs, measured in bps, solidify the demarcation lines and
the possibilities in the GRTM; Standard, high-volume OTCD products often
match the transaction costs of the average ETD futures products at ~.05 bps
Comparison of Transaction Costs for Average Contracts
Clearing and Execution Venue Costs
sis Points
30y IR Swap Future
og Scale
3,125
OTC CDS Single (HY)
1,600 OTC 10y IR
OTC CDS Single (IG)
Swap
Lo
Bas
$1 000
$1,000 5y IR Swap Future
600
OTC CDS Index (HY)
469
og Scale
100 OTCD – Rates Cost differential is 96%, then the weighted average
CDS Reduction limits of sunk cost savings from the migration
of OTCDs to an ETD-like operational
paradigm
di iis 89%.
89%
▲ Note that some of the most vanilla IR swaps
10 are already approaching the costs and
Cash - Rates
OTCD - FX transparency of highly liquid ETD rates
FX - Spot products. In a report published on Nov. 9,
2010 by
b ISDA,
ISDA it was concluded,
l d d in
i part,
t that:
th t
2007 Avera
It is unclear if confirmation-matching
g utilities could
Cleared contracts must be traded register as an SEF.
on a registered venue (Board of
Execution Trade (BOT) or “SEF” in the US). If no SEF or BOT offers trading in the product,
even if it is centrally cleared, the trading
requirement does not apply.
Dealers and “major swap Key definitions, such as dealer and corporate end
participants” must register with
participants user,, are onlyy looselyy defined to date.
Registration regulators; capital and collateral How firms are required to register will have a
requirements will be more tightly dramatic impact on their capital and collateral
regulated. needs.
Source: TABB Group
Focus Overview
Reporting All OTC Derivatives transactions must be reported
Highlights
In the US and EU, “swaps entered into on or after such date of enactment shall be reported to a registered swap data
repository…”
In the EU a “threshold” will exist under which corporate end users will not have to report certain trades.
A swap repositoryy is “anyy person that collects and maintains information or records with respect to transactions or
positions in, or the terms and conditions of, swaps entered into by third-parties for the purpose of providing a centralized
recordkeeping facility for swaps.” This would include the DTCC Trade Information Warehouse (TIW) or ICAP/TriOptima’s
interest rate derivatives repository, for example.
Focus Overview
Dealers and “major swap participants” must register with regulators;
Registration capital and collateral requirements will be more tightly regulated
Highlights
Key goal of passed and proposed legislation, globally ,is registration of systemically-important entities.
In the US, dealers and major swap participants must register with a “prudent regulator”. It is unclear how the EU will
segment participants, other than expected exemptions for corporate end users.
US regulators will likely cast a wide net when determining who qualifies as a swap dealer and major swap participant
participant. It is
expected that nearly 200 firms will qualify as swap dealers and the list of major swap participants will be longer still, likely
including non-financial companies with large trading entities, since they are systemically important.
ecution
Reporting
e-Trade
Cllearing
Data End User
/ Data
Trade
Post-
Participants Repository 4%
Trade Group 7%
P
Exe
Pre
T
7%
Top Tier Dealers
Dealer
29%
“Emerging” Dealers Solution
Provider
P id
Traditional Buy-Side 7%
Hedge Funds
IDB
14%
End Users Exchange /
CCP
Exchanges / Clearinghouses SEF 18%
14%
Interdealer Brokers / OTC Execution
Venues
Data Providers / Aggregators
Top dealers and execution venues will look to provide not only execution access, but also liquidity aggregation and pre-trade
analytic tools to clients.
Bothtop-tier and emerging dealers will offer post-trade services beyond simple clearing access, creating a model that builds
upon existing prime services businesses.
on liquidity?
usage/focus
Firm’s view on e-
by/of yyour firm?
requirrements?
View on Trade
missions?
ositories?
pact on
Top-tier and emerging
Participants dealers believe the OTCD and
Impact o
comm
% OTCD
Imp
Impact o
OTCD u
Repo
ETD markets will continue
their growth following reform,
as it will improve broader
market sentiment.
Top-Tier Dealers Nearlyy all market players
y
believe that bid-ask spreads
“Emerging” Dealers will tighten and per-trade
commissions will shrink
following OTCD reform. Views
Traditional Buy-Side on whether this is good or bad
f liquidity
for li idit diff
differ.
Hedge Funds OTCD “buyers”, asset
managers, hedge funds and
end users, are unhappy with
Corporate End Users new margin requirements
b
brought
ht on b
by clearing
l i
Exchanges / Clearinghouses mandates. It is expected to
add a considerable new cost
Inter-dealer Brokers / OTC to many parts of the business.
Execution Venues Trade repositories are
viewed
i d iin a positive
i i lilight
h bby
Data Providers / Aggregators most stakeholders, due to
transparency. Main concern is
Increase
Source: TABB Group Decrease Same Positive Negative Indifferent how data will be used.
TABB Group The Global Risk Transfer Market | Nov 2010 53
Top-tier dealers will see their preeminent market position challenged;
Emerging dealers have a tough battle ahead, but will establish themselves in
the new OTC derivatives market
Participants Sentiment Growth Curve
Top Tier Dealers The major dealers look to continue dominating the OTCD market
despite an acceptance that flow products, initially vanilla IR swaps
Success
and CDS, will move toward a higher volume and lower margin model.
Time
The new business model entails a combination of multi-asset prime
services offerings and a close linkage with the futures business, which High upfront costs for
will take on the task of OTCD central clearing. technology and business
model changes will create
Trading and clearing businesses within the bank must be kept a challenging environment
separate under Dodd-Frank, however exactly how separate is still up in the short term.
to regulators. Despite the separation, it should be expected that The capital base and one-
value-added services (both pre- and post-trade) and reduced stop shopping approach
execution and/or clearing costs will be offered to those who both mean top dealers will
execute and clear with the same firm. remain a big part of this
market.
k t
“Emerging” Dealers Second-tier swaps dealers and the largest FCMs see OTCD reforms
as their golden opportunity to break into this lucrative market.
Success
Regulators have made it clear they want execution venues to be open
and clearing access to be available to all who meet the requirements. Time
This will allow these “new” dealers to compete where they were
Growth will be slow to
previously boxed out.
start as new rules are
The big FCMs will look to offer execution and clearing services that implemented but, over
complement the futures products traded by existing clients. This will time, the new market
allow current clients to trade swaps with their FCM, where in the past g y
structure will be hugely
th were forced
they f d to
t go to
t a top-tier
t ti dealer.
d l beneficial.
New dealers will also look to leverage electronic execution platforms
more than the big dealers, as they have little or no existing voice
business to protect.
TABB Group The Global Risk Transfer Market | Nov 2010 54
The buy-side will see better market access and price discovery after adapting
to the new structure; Most corporate end users will see little impact
Participants Sentiment Growth Curve
Traditional Buy- They have demanded access to clearing since the beginning of
Side the OTCD reform debate. The discussion has evolved over
Success
time however, from buy-side firms wanting to be clearing
members to wanting cheap
cheap, easy access to clearing via their Time
existing brokers. Allbut the biggest will be exempt from
They are generally satisfied with how they execute OTCD clearing so will see little short term impact.
today. They find ample price discovery via RFQ platforms and Reform will ultimately create a more
via phone. Had they wanted electronic executions, they would transparency market for buy-side traders
have pushed the dealers there years ago
ago. with lower fees and easier access to data.
data
Hedge Funds A move towards electronic trading for vanilla swap products
Success
creates a host of new potential strategies for hedge funds.
The largest hedge funds in the swap space will likely be labeled Time
as Dealers, formalizing their importance to the market. New strategies will emerge following
Dealer status will also require additional reporting and reform.
disclosure that most hedge funds would rather avoid to protect Post-reform business will simply adapt
their strategies. and move on.
End Users End users in the US and Europe will be for the most part
exemptt from
f trading
t di requirements
i t as they
th are nott viewed
i d as
Success
s
systemically important the costs of clearing are seen as too
great. Time
However, some of the largest corporation will fall under the Due to exemptions, end users will see little
same category as financial firms based on their activity and short term change.
open positions in the swaps market
market. Businesses
B i will
ill continue
ti tto use OTC
These firms will likely need to transform non-cash collateral into derivatives to hedge risks with greater
cash collateral that can be posted at a clearinghouse. transparency into the market.
Success
Clearinghouses new CCP is exchange owned, exchanges are experts in execution
(CCPs) and they already own and distribute related data to the market.
Time
Futures exchanges are in good position as US regulations look to
Execution,
E ti clearing
l i and dddata
t allll
shape the cleared OTCD market similarly to the US futures market. present huge opportunities for
It is critical that exchanges do not assume OTCD will fit into exchanges.
traditional execution and clearing models. Exchange listing will be Competition will come from new
replaced with platforms that facilitate price discovery and execution angles creating a hyper competitive
of constantly evolving OTCD contracts. landscape
landscape.
Interdealer Brokers IDBs already control the majority of OTCD executions as dealer-to-
Success
(IDBs) / OTC dealer trading dominates the market.
Execution Venues Client -focused platforms, some independent and some dealer
(SEFs) owned, already have models in place to trade OTCD electronically Time
Execution mandates will send more
that make their transition to SEFs straight forward. flow to the platforms.
In both cases, a mandate to trade certain OTCD via a regulated
Competition will be intense with
platform will only drive more trading towards IDBs and independent only a handful surviving
platforms.
Data Providers / Registered execution facilities
facilities, clearinghouses and reporting
Success
Aggregators requirements will create data for OTCD markets that never existed
before.
Time
Traditional market data providers and existing OTCD focused data
The market will be saturated as
firms see the reform as a huge opportunity to expand into new dealers, exchanges and IDBs all
products.
p compete
compete.
The “new” market data available
will create lasting business lines
and new products.
TABB Group The Global Risk Transfer Market | Nov 2010 56
With OTC derivatives rules to be set in motion in 2011, new players will enter
the market as the playing field is leveled while incumbents look to secure their
place in the new paradigm
New Players in the OTC Derivatives Markets: Dealer 2.0?
Major dealers completely dominate the market today, but competition is coming
Dealers are the only ones allowed to trade via IDBs, even though IDBs might welcome new business from buy-side
Dealers can refuse to trade directly with smaller players/competitors (and they do)
New dealers competing with the big boys
Regulations will create a much more level playing field
They are generally smaller and more nimble
Technology savvy from the start
Buy-side
Buy side crossing the line
Anonymous trading and clearing will let “near-dealers” into the market directly
Smaller buy-side firms setting up sell-side style OTC desks
Conclusions – What OTC Derivatives Reform Means and What’s Next?
The OTC derivative market will, broadly speaking, remain somewhat in a state of stagnation until new rules are finalized.
E
European regulators
l t will
ill lik
likely
l ttake
k a similar
i il approachh tto US regulators
l t tto lilimitit opportunity
t it ffor regulatory
l t arbitrage.
bit
US regulations are set to be enacted by fall of 2011; however, market participants must expect 6-12 months of implementation
time to allow for compliance.
Exchanges have opportunity in nearly every aspect of the OTC derivative market, however, they must not assume that these
products will fit nicely into their existing models and instead create new paradigms suited to OTC derivative trading.
Dealers and buy-side firms, both new and old, are looking ahead of new legislation to re-craft business models for the new world.
Opportunity exists at nearly every stage of the OTC derivative trade lifecycle. While major dealers will look to compete in nearly
every facet, many firms will focus on a single element. Trade facilitation, proprietary electronic trading, client clearing, OTC
derivative prime brokerage, and reporting and analysis are a few of these areas.
The early focus of the market is in interest rate and credit default swaps
swaps. The former is the biggest market and presents the
largest opportunity while the latter remains in the spotlight from an early push by regulators to reduce systemic risk in the market.
After all is said and done, the Global Risk Transfer Market will not be risk-free, but it will be a market with more opportunities for
more participants than ever before.
TABB Group The Global Risk Transfer Market | October 2010 57
Appendices
market segments,
g representing
p g 87% and
7.3 6.9 73% of notional values of each,
300 respectively, as of 2009 – and making
4.7 hedging and investing in interest rate
200 risks the leading factor in the world.
600 188
▲ The APAC region – which represents
500
537 32% of total global GDP as of 2009 –
400
300 accounts for only 5% of ETD Rates
200 derivatives volume.
100 75% 75% 76% 74% 73% 69% 72% 75% 74% ▲ Three exchanges – CME, Eurex, and
-
NYSE Liffe – represent over 90% of
2002 2003 2004 2005 2006 2007 2008 2009 2010e
volume as of August 2010, with
Total Rates(OTCD + ETD) Total Non-Rates (OTCD + ETD) Eurodollar futures and options accounting
Source: BIS, WFE, FIA,TABB Group for nearly 25% of the total.
TABB Group The Global Risk Transfer Market | Nov 2010 60
Within Rates derivatives, a majority of activity is skewed to short term (<1 y)
exposures; Vastly dominates ETD, biased OTCD; New trade repository offers
new insight: 3.8 million trades averaging $126 million each in Oct ‘10
ETD Rates 73 71 Short Term Skews
Notional Open Interest 7% 5%
45 3% 6% ▲ ETD rates exposures are almost
4%
6% entirely short term, with maturities
5%
93% 95% < 1 yyear. These figures
g are
96% 97% 94% partially skewed by standard
95% 94%
product durations of 3-, 6-, 9- and
12-months which are often “rolled”
2004 2005 2006 2007 2008 2009 2010e from the expiring front month to a
STIR (< 1y) LTIR (> 1y) $ trillion subsequent month.
OTCD Rates ▲ OTCD rates are much more
Notional Values Outstanding 480
393 balanced across tenors - on a
30% notional outstanding basis – with
30%
33% 34%
only moderate bias to maturities of
191 26% 30% 30%
191 33% 1 year or less.
26% 26% 34%
38% ▲ The new OTC interest rate trade
41% 41% 40% 40%
36% 32% 33% repository provides asset class
33% 33%
detail with bi-monthly update
2004 2005 2006 2007 2008 2009 2010e frequency and limited lag time.
STIR (< 1y) MTIR (1 - 5y) LTIR (> 5y) $ trillion
29%
Because of this information
26% 26% Exposures
p by
y Maturity
y warehouse, observers can
OTC Interest Rates Trade Repository – October 1, 2010 calculate metrics and conduct
comparative analysis that could
8%
never be done before with much
6% 4% accuracy. As of October 1, 2010,
2% average trade size was $126
52% 20% 17% 4% 2% 4% 1%
million, representing 3.8 million
0 - 2y 2 - 5y 5 - 10y 10 - 15y 15 - 20y 20 - 30y 30y + trades. The largest trades being
Notional Oustanding Trades (italics) OIS (<2 years), averaging $735
Source: BIS, WFE, ICAP/TriOptima, TABB Group million.
TABB Group The Global Risk Transfer Market | Nov 2010 61
Extremely high concentration in short term Rates and high turnover (estimated
to be 25x for 2010) go hand in hand; The TOF in ETD Rates explains 40% of
activity in the GRTM; Eurodollar futures and options alone represent 10%
High concentrations, few products ETD
▲ ETD Rates and combined (OTCD and ETD) Rates represent 47% and 66%, respectively, of 1,981
estimated total 2010 notional turnover of $3.7 quadrillion.
▲3 eexchange
c a ge g groups
oups – CCME,, Eurex,
u e , and
a d NYSES Liffee – represent
ep ese a at least
eas 80% oof the
e ETD Rates
a es
notional turnover figures, or $1.35 quadrillion in 2009. Estimates of notional turnover by these 1,764
same groups in 2010 is $1.7 quadrillion. Within these 3 exchange groups, the top 10 Rates
products – led by Eurodollar futures – represent over 80% of notional turnover.
▲ In OTCD, 85% of exposures are in vanilla swaps, forward rate agreements (FRAs) and OISs.
CCPs handle the largest trades, which are less than 2y maturities, averaging $839 million per
trade; non-G14 dealers handle the smallest trades (10-15y maturities averaging $61m per trade).
▲ NOTE: G14 dealers include Barclays Capital, BNP Paribas, Bank of America-Merrill Lynch, Citi,
Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, J.P. Morgan, Morgan Stanley, Royal 36
Bank of Scotland, Société Générale, UBS, and Wells Fargo
OTCD 28
Notional Outstanding / Open Interest 25
Notional Turnover / Volume
Turnover Frequency 676
US$ Trillions
23
22
22
2.2 490
1.4
1.3
1.8
1.4
71
1998 2000 2002 2004 2006 2008 2010e 1998 2000 2002 2004 2006 2008 2010e
Source: BIS, WFE, TABB Group Dashed points are interpolated estimates
TABB Group The Global Risk Transfer Market | Nov 2010 62
Within Rates, the asset class is dominated by 79% single currency swaps on
the OTCD side and 69% options on the ETD side; Trade repository expands
the view of OTCD Rates from 3 basic to 12 detailed product categories
500 480
OTCD Rates 2% Product Breakdowns
9% 3%
Notional Outstanding 12% 4% ▲ There
are no surprises on the
400
By Product Type ETD side other than the growth
6% OTCD Rates Detail
US$ Trillions
300 N ti
Notional l Outstanding
O t t di in proportion of options relative
10% By Product Type to futures. Outside of equities,
options on futures (OOF) are not
200 79% known for wide adoption, which
is an indication of forthe
thefurther
further
14% 12%
100 growth of options
g p relative to
9%
78% futures.
- X-Currency Exotic Swap ▲ The main takeaways from the
2002 2004 2006 2008 2010e ▲ The mainoftakeaways
analysis product types fromcomes
the
Exotic Option analysis
(All) Swaps Forwards (FRAs) (All) Options from the of product
OTCD side:types comes
It can now
Debt Option from the OTCD side, with
be seen that the historical catch- the
80 Inflation Swap
historical
all category catch-all
catch all category
for swaps used for
by
71 swaps used by BIS, actually an
70
ETD Rates BIS is actually an amalgamation
Exotic Swap amalgamation of at least 7 sub-
Notional Open Interest of at least 7 sub-categories.
60 By Product Type X-Currency Swap categories. The same
Same with options, nowisknown
true for
62% options, now known to consist of
US$ Trilliions
EMEA, 32%
EMEA, 65%
20 Eurex lists futures on the iTraxx index, but as of
September 2010 there was zero open interest.
As centrally cleared CDS begin to grow, it is more
likely the market will see a move to cleared swaps
10 54%
traded on SEFs rather than moves to CDS futures
futures.
Market Participants
- Financial firms still account for the majority of CDS
holdings, with “reporting dealers” accounting for
54% of the outstanding notional in 2010.
Reporting dealers (net) Usage by non-financial firms has grown to 5% from
Other financial institutions below 1% in 2004 driven largely by efforts to
Non-financial institutions standardize CDS contracts and the trading
Source: BIS, DTCC, TABB Group lifecycle.
TABB Group The Global Risk Transfer Market | Nov 2010 67
The credit crisis deflated a bubble in CDS holdings by special purpose
vehicles that peaked in 2007
8,000
6,000
4,000
4y CAGR 5%
2,000
Thousands
Single-Name CDSs
175 Euro Index
20 13%
150
ons
15 US Single
34%
100 22%
75 10
50 US Index
5 31%
25 Total: $928 billion
- - (August 2010)
ands
300
Single-Name
Single Name CDSs complex pricing models.
models Since single-name
single means
Low liquidity name CDSs trade
daily pricing
Thousa
250 20 infrequently, marginmust
needed for margin mustbe bedone
calculated via marking-to-model,
via mark-to-model process.
US$ Billions
with assumptions
Models must then on default
predict howlikelihood incorporated.
likely a credit event is.Despite
Despite
200 15 continuous modeling of default scenarios, it is unclear how
scenarios of reference entities
and clearing
if existingmembers,
single CDS it isclearing
unclearmodels
how and mutualize risk
if existing as
single
150 effectivelyy asg assumed.
CDS clearing models mutualize risk as effectivelyy as believed.
10
100 Single-Name Central Clearing
5
50 Open interest for single CDSs has grown more quickly in the
US than Europe as new legislation
regulationsinare
theforthcoming.
US is set and
- - regulationsan
Assuming are
FXforthcoming.
rate of 1.3, average
Assuming trade
an FX
sizerate
in the
of 1.3,
US and
averageare
Europe trade
similar
size at
in nearly
the US$8
$and
- 9Europe
million are
per similar
trade. atThenearly
$8
growth
– 9 million
in single-name
/ trade. The
CDSgrowth
clearing
in single
is a result
CDSofclearing
their falls
Open Interest Transactions in
increasing
line with popularity
their increasing
over index
popularity
CDS.over index CDSs as
Source: ICE, TABB Group discussed earlier.
TABB Group The Global Risk Transfer Market | October 2010 70
CDS contracts that reference corporate debt account for the majority of
outstanding notional with over 80% held in Europe and the Americas
Top 1000 Reference Entities - Net Notional Top 1000 Reference Entities - Net Notional
by Type by Country
LCDS Japan Asia Ex-
1% RMBS 3% Japan
1% 3% Australia
Other State Body
Sovereign 1% NZ
8% Other 2%
17% 10%
Americas
41% Europe
41%
Corporate
72%
%
62 187,000.in The
change notional
net change
outstanding
in notional
during
25 56
42 outstanding
the same period,
duringhowever,
the same wasperiod
a
- howeverofwas
decline $3.4down
trillion.
$3.4 trillion.
(3) (29)
(25) (63)
Trade
Trade compression
compression efforts,
efforts, netting
netting
via clearinghouses,
clearinghouses and the entrance
and the
(50) via clearinghouses, entrance
of
Sum of changes = 186.900 contracts of more
more short
short term
term traders
traders are
are driving
driving
(75) volumes up while keeping notional
volumes up while notional levels
levels in decline.
continue to decline.
Average trade size has remained
Average
steadyg attrade
roughlysize$24
hasmillion
remained
per
1 000
1,000 steadyhowever
at roughly $24 Group
million sees
per a
Change - Total Notional Outstanding trade, TABB
trade. TABB Group sees a
shift towards smaller trade sizes asshift
500 814 towards
the movesmaller
towards trade sizes as the
an electronically
684
Billions
activity moves
traded, toward an world
centrally-cleared
- electronically-traded
begins. and centrally-
(140) cleared
l d environment.
i t
US$ B
$ Millions
average trade size throughout the period.
100 40
80 Credit events and macroeconomic data
30
(such as the European debt crisis in the
Tho
60
US$
20 spring of 2010) have had measurable
40 impacts on the CDS market.
20 10
Recently, average trade size is trending
- -
slightly below the 2009-2010 average of
$26 million
illi per contract,
t t but
b t average
trade size has remained remarkably
consistent over the past 18-22 months.
Source: DTCC
New Trade Avg Trade Size Linear (Avg Trade Size)
Driversof
Drivers ofTurnover
TurnoverFrequency
Frequencyin in
Equity Markets
Equity Markets ETD - Equity
277
▲ A substantial portion of the equity OTCD market is similar in structure to the ETD
market. As a result, the skew caused by short-term expirations is not as prevalent here
as in other OTCD asset classes, p particularly
y interest rate derivatives.
▲ Contracts-for-Differences and Total Return Swaps have higher turnover levels since
they are used as a substitute for cash instruments. These products are designed to be
liquid and cost-effective for investors.
OTCD - Equity
Notional
N ti lOOutstanding
t t di / Open
O Interest
I t t 30
Notional Turnover / Volume 109
Turnover Frequency 24
85
21
US$ Trillions
66
10 10 9
14
8 7 5
2004 2005 2006 2007 2008 2009 2010e 2004 2005 2006 2007 2008 2009 2010e
1 000
1,000 23% assets.
657
800 The prices of many US dollar-
600 23% 57% denominated assets are correlated
58%
400 to the value of the US dollar. FX
54% forwards pprovide an effective way
y to
200
20% 20% hedge this exposure.
22%
-
Although more than three-quarters
2004 2005 2006 2007 2008 2009 2010e
of OTCDs in FX occur outside the
Dashed points are interpolated estimates US, 42% of OTCD turnover is in US
dollar-related instruments.
ETD FX – Notional Turnover 4% Outside the US, FX spot market
40 transactions are popular with the
22% retail sector, who hedge their own
US$ Trilllions
OTC FX Swaps
Turnover Maturity Breakdown
2010
11.2 10.4 74%
11.5
25%
2004 200
2005 2006 200
2007 2008 2009 2010
2010e
Notional Outstanding / Open Interest 1%
Notional Turnover / Volume
Turnover Frequency < 7 days 7 days - 1 yr > 1 year
Source: BIS, WFE, TABB Group
TABB Group The Global Risk Transfer Market | Nov 2010 78
Similar to Rates, comparing the TOF of OTCDs and ETDs for commodities
yields questions about structural versus strategic motivations; Currently,
detailed information about OTC commodity derivatives is elusive
OTCD - Commodity Few near-term changes
45 42
▲ The low utilization of OTC
40
US$ Trillions