In this video blog Udi Sela, Vice President of the Numerix Client Solutions Group and Numerix CMO Jim Jockle discuss the results of a new Greenwich Associates research report by Kevin McPartland titled, “Corporate End Users Unfazed by Derivatives Reform.” Surprisingly, (or perhaps not so surprisingly) the report concluded that regulations are having little to no impact on corporate use of, and dealer selection for trading interest-rate derivatives.
As regulators have focused on managing risk concentration amongst the large market makers, Udi discusses the impact on banks and the corporate end user. Where it's become more expensive to engage in bilateral trading from a regulatory cost of capital perspective, banks are streamlining operations, measuring the profitability of business lines and shifting towards SEFs and central clearing. Regardless of being “unfazed” by derivatives reform policies Udi explores the potential impact of these changes on corporates, especially as the debate continues around FX Swap exemptions.
Jim Jockle (Host): Hi welcome to Numerix Video Blog. I’m your host Jim Jockle. I’m here with Vice President of the Client Solutions Group, Udi Sela. Udi how are you?
Udi Sela (Guest): I’m good thank you Jim.
Jockle: Well thank you for joining. I want to talk about a report that came out this week from Kevin McPartland of Greenwich Associates at one of the analyst firms, and the report was titled Corporate End Users Unfazed by Derivative Reforms. This was based on a survey of just about 400 corporate treasurers who utilize interest rate derivatives. So the question I will ask you Udi, is this surprising?
Sela: I guess not so much. You can slice this in various ways. I think it has to do first of all with relationships. I think the focus of the article was on interest rate swaps, where normally the market is very liquid. So one could expect a pretty tight bid-ask spreads. So if I already have my relationship with the bank and I get my research and everything (deals) is processed, and the bank already has its software on my desktop. So what would be my motivation to change and shop around? Basically in this article Kevin is making the assumption that increasing regulation would mean the cost of the increasing regulation would be transferred to clients. And I would suspect that the banks would have similar costs so I don’t know how much difference would that make to the corporate, if you’re already being serviced and you already have the relationship and so forth.
Jockle: So one of the questions though is as Dodd Frank was rolling out, there was a large debate about corporate end user exemption from a lot of these rules. However, the banks themselves are not exempt. So, one would assume regardless of this “being unfazed” we’ll still start seeing more movement to central clearing because of the regulatory capital charges imposed by the banks with the corporate end user who is exempt but the banks themselves are going to have more regulatory capital held against them for those trades. So one, do you agree with that assumption in terms of a general movement towards central clearing as well as SEFs. And two, what potential impact would that have for the corporate user with less optionality to engage in bilateral trades.
Sela: Well I think that regulators really were targeting the banks rather than the corporates. Hence also the exemption of corporates, in this way at least - because the main fear with the risk concentration right? So yes I think that we will see dramatic changes mostly in the interdealer market. So we will see more and more deals going into SEFs and then being cleared centrally. We’ll see more of deal compression but again deal compression is performed mostly between the market makers rather than the corporates. And eventually another thing that I think we’ll see, and we’re starting to see, is the futurization of swaps.
So basically corporations or corporate treasurers can go directly and trade future contracts on interest rate swaps. And thus mitigate the exposures. You’ll still see usage of swaps. For instance, if you have corporates that finance their commercial operations taking a foreign currency loan. So take a case like Hungary where the interest rate is much higher than the Euros. And what corporates tend to do there is take loans in Swiss Francs and then swap them into Hungarian Forints. So this is probably something we’ll continue seeing. Because this is a real commercial flow if you like.
Jockle: So clearly we all like to think we have a crystal ball. Corporates will be affected by this trend. But to Kevin’s assertion it’s not happening. But what kind of timeframe can we expect. Do you think we’re one year away, two years away, for this transformation to begin?
Sela: I actually think that we’ll start seeing more traction next year, in 2015. So take for instance the EMIR regulation in Europe. I think it’ll push corporates and asset managers more towards organized trading if you like and organized clearing. If I had to bet, when we’ll have this conversation next year hopefully at the same time, you will see that more flows of buy side will be actually going towards more organized trading and clearing.
Jockle: Well thank you Udi. And so why don’t we take out our Outlook calendars and put something on the calendar for this time next year exactly and see where we are today. Again the report is Corporate End Users Unfazed by Derivatives Reform by Kevin McPartland at Greenwich Associates. The summary came out on Monday, June 16th. So it’s an interesting read and something that Udi and I continue to talk about, and we’ll continue to talk about again. Thank you so much for your time today Udi.
Sela: Thank you very much Jim. It was a pleasure.
Jockle: And of course we want to talk about the things that you’d like to talk about. Follow us along @nxanalytics on twitter as well as our LinkedIn group for Numerix as well as our users for information on Numerix to stay on top of all the information that we bring to the market place. And again we want to hear from you and would like to talk about the things that you’d like to talk about. We’ll talk to you next time. Thank you.
Sela: Thank you. Bye.