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Fitch: U.S. Swaps to Futures Migration to Reduce Hedging Costs
June 20, 2013 / 1:53 PM / 4 years ago

Fitch: U.S. Swaps to Futures Migration to Reduce Hedging Costs

(The following statement was released by the rating agency) CHICAGO, June 20 (Fitch) U.S. regulatory changes favoring the use of futures contracts by institutions seeking alternatives to over-the-counter (OTC) swap transactions will ultimately drive trading and hedging costs lower while increasing portfolio returns, says Fitch Ratings. Futures based on OTC derivatives provide a lower-cost risk management tool as a result of lower initial margin (IM) requirements, reduced execution costs and advantageous capital treatment. The use of futures also allows for increased netting and margin offsets with other listed products. In essence, an arbitrage situation has developed that will benefit exchanges, as cleared swaps must be traded on a swap execution facility (SEF) and centrally cleared while futures have and will continue to be traded and cleared on an exchange. In the long run, Fitch believes that IM for both products will be more closely aligned as the market perception of risk associated with the futures products evolves. The Dodd-Frank Act mandated that certain OTC swaps migrate to central clearing counterparty (CCP) platforms. As a result of the new regulatory requirements, standardized futures contracts referencing cleared OTC derivatives were launched in fourth-quarter 2012. The ICE and CME exchanges converted energy swaps and interest rate swaps (IRS), respectively, to economically equivalent futures. On June 17, ICE began offering credit futures as an alternative to credit default swaps (CDS). In addition, Eris Exchange has been offering IRS swap futures since 2010. Under Dodd-Frank, cleared swaps are subject to more regulatory requirements than futures, which are exempt from the act. Market participants that trade cleared swaps must register and report trades to a swap data repository (SDR). Futures markets lack of transparency is circumventing the tenor of the act. In the long-term, it could perpetuate the same risks that Dodd-Frank is addressing. The lower initial margin requirements for futures compared with OTC cleared swaps are based on different time frame assumptions for the calculation. For futures, IM is based on a one- to two-day horizon for liquidation, whereas for OTC cleared swaps, it is based on a five-day horizon. There are still only a limited number of futures products offered by the exchanges that are economically equivalent to OTC swaps. We believe exchanges will need to develop additional swap-based products in order to remain competitive. Contact: Tara Kriss Senior Director Financial Institutions +1-212-908-0369 Bill Warlick Senior Director Fitch Wire +1-312-368-3141 Fitch, Inc. 70 W. Madison Chicago, IL 60602 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at All opinions expressed are those of Fitch Ratings. ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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