REFILE-CDS moves towards swap execution facilities
By Mike Kentz
NEW YORK, Feb 27 (IFR) - The over-the-counter credit default swap market took its first steps onto exchanges this week as current CDS contracts referencing investment-grade and high-yield corporates were mandated to trade on swap execution facilities.
The first wave of affected contracts - CDX IG, CDX HY, iTraxx Main and iTraxx Crossover - represent around 10% of the total US$24trn gross notional outstanding in CDS across the two relevant series, according to DTCC data.
Clients will still be able to contact dealers for quotes on specific five-year contracts, but firms will have to reach out to at least two sellside entities and the prices will have to be entered into the electronic SEF platform prior to execution.
Despite concerns about readiness, the market is prepared for the shift, which comes a week after interest rate swap benchmark contracts came under SEF jurisdiction.
"Volumes came off a bit but overall liquidity was preserved and there was minimal disruption," said Laurent Samama, head of US credit trading at BNP Paribas.
"This was the best outcome possible. It's almost business as usual, but with slightly lower volumes."
One asset management executive said a technical glitch on one platform required clients to refresh bids at regular intervals to ensure pre-trade credit checks functioned smoothly.
But otherwise there were few issues, the executive said.
As the market gets comfortable with the new structure, trading relationships will change - and platforms will jockey for revenues.
Electronic execution opens the door to a broker-style model in which banks connect to platforms and execute for clients on an agency basis, allowing the client to step back from the reporting requirements associated with SEF connection.
Three days into the mandate, UBS executed the first CDS under the introducing broker model, executing a trade for a client that later was connected through the ICE Swap Trade SEF.
Some believe the IB-style model is the future of swaps trading, as it eases burdens for clients associated with direct SEF connection.
To work efficiently, introducing brokers would need to access a range of registered platforms. But some SEFs appear to be pushing back against the move to protect the status quo.
Meanwhile many banks are skeptical, because a dramatic shift away from the traditional principal-based execution model for swaps trading will hurt the revenues of major dealers.
Investors are watching to see if planned listings of CDS futures will provide a better way to hedge credit exposures.
ICE launched the most recent iteration of a credit future last year, but it has failed to generate interest, with no trades registered since August 1.
It is planning a second try with a new structure that will address criticism of its "when-issued" format that leaves buyers uncertain of the constituents at the point of purchase.
Others are also looking to capitalize. Start-up SEF trueEX hopes to launch a credit future in the second quarter, while GFI is in discussions on a possible hybrid product.
Some predicted swap futures volumes could spike on the back of the commencement of mandatory swap trading on SEFs. However, if the experience of the rates market's shift into the electronic world a week previously is any indicator, operational SEF issues may not be the fire-starter once imagined.
CME Group's deliverable swap future traded an average of 1,579 contracts per day the first week of mandatory IRS trading, compared to 1,789 contracts per day the week prior - partly due to a one-day public holiday across the US.
Eris Exchange reported a more significant decline over that period as 1,500 contracts traded in the post-mandate week, compared to 2,501 contracts the previous week. That being said, open interest across all hybrid contracts at the exchange has been steadily gaining over the past several months, and in fact broke 100,000 contracts on Friday, February 21.
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