* Dodd-Frank Act seen opening up $640 trillion swaps market
* Swaps account for about a third of top brokers' revenues
* Exchanges targeting a big chunk of that business
By Luke Jeffs
LONDON, Jan 3 The world's top brokers face a
fight to hold onto hundreds of millions of dollars of revenue
this year when U.S. legislation throws open the vast swaps
trading market to stock exchanges.
Brokers like ICAP and BGC Partners make
around a third of their revenue from the $640 trillion industry
for trading swaps - financial instruments used by companies to
cover their exposure to changes in interest rates, foreign
exchange rates and credit ratings.
Exchanges like CME Group, NYSE Euronext and
the IntercontinentalExchange, meanwhile, dominate the
much smaller market for futures, which give similar protection,
but are more standardised and so tend not to offer exact cover.
However, new U.S. swap rules enshrined in the Dodd-Frank
Act, due to be finalised in the coming weeks and take effect in
the middle of this year, could drive business to the exchanges
and away from the brokers, and reshape the industry globally due
to the size of U.S. markets and the power of their regulators.
"It is going to be tough for the brokers. The exchanges are
huge with deep pockets and they are not the types of companies
you'd want invading your space," said Simmy Grewal, a senior
analyst at research house Aite Group.
Swaps trading involves brokers matching buyers and sellers
in murky over-the-counter (OTC) markets. It has historically
been less tightly regulated than futures trading on exchanges.
U.S. regulators want to drive swaps trading onto electronic
platforms, like those run by exchanges, to make it more
transparent and easier to regulate, and to protect the global
financial system from problems that arose after the collapse of
U.S. bank Lehman Brothers, one of the largest swaps traders.
These changes will effectively see brokers and exchanges
starting to compete directly for swaps business later in 2013,
with exchanges eager to grab a chunk of a huge market.
According to the Bank for International Settlements, the
swaps industry was worth $639 trillion at the end of June 2012,
compared with $25 trillion for futures trading.
The world's top five brokers - GFI, Tradition
and Tullett Prebon as well as ICAP and BGC -
made a combined $2.7 billion, or 35 percent, of their revenues
in their last full financial years from interest rate swaps, the
most common type.
The exchanges have hinted half the swaps market could be up
for grabs under Dodd-Frank, which, if true, could see hundreds
of millions of dollars in revenues moving to them from brokers.
The U.S. Commodity Futures Trading Commission (CFTC) wants
two new categories of regulated markets called Swap Execution
Facilities (SEFs) and Designated Contract Markets (DCMs).
Brokers are likely to trade swaps through SEFs, while the
exchanges are set to offer swap-like futures as DCMs.
Analysts are reluctant to estimate the extent of likely
broker losses at this stage but early research suggests the
reforms will have a significant impact.
Three-quarters of respondents to a Berenberg Bank survey in
July predicted the reforms would cut OTC trading levels by up to
30 percent while one in eight saw regulation reducing swaps
trading by between 31 percent and 50 percent.
In a note published in November, Morgan Stanley analysts
flagged potential risks to the world's largest swap broker,
ICAP, which in its last financial year made 681 million pounds
($1.1 billion), or about two fifths of its revenue, from
interest rate swaps.
"The greater certainty in the futures model ... will favour
futures over swaps, leading to cannibalisation of the swaps
market," they predicted.
$8 BILLION QUESTION
The exchanges received a boost in October when the CFTC said
any company trading more than $8 billion of swaps in a year must
register with it as a "swap dealer", a designation which
increases capital and collateral requirements.
That could encourage some swaps traders to switch to futures
to avoid the hassle of registering with the CFTC.
Top banks, which trade billions of dollars of swaps each
day, will smash the $8 billion limit and some 65 of the top
swaps traders, like Goldman Sachs, Morgan Stanley
and JP Morgan Chase registered as dealers on Wednesday.
However the CME, the world's largest futures exchange, said
it saw a definite shift to futures contracts over swaps in the
weeks following the CFTC announcement.
Exchanges are also doing everything they can to encourage
the shift. ICE, the leading energy futures market, in October
transformed its energy swaps to futures, allowing clients to
continue hedging their energy exposure without adding to their
Since the CFTC's October announcement, shares in ICAP have
fallen 7.5 percent, while Tullett's have shed 13 percent.
But the brokers are fighting back. ICAP, Tradition and
Tullett have all launched swap broking platforms in a bid to
ICAP's i-Swap and Tradition's Trad-X reported strong demand
late last year as clients switched to the new regulated swap
systems. Analysts say these efforts should help to stem the flow
of business to exchanges, though brokers concede they face a
"In terms of regulation, some parts are better crafted than
others, but we are where we are and we have to make sure ICAP is
well positioned," ICAP boss Michael Spencer said in November.