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News: Did Swaps Businesses Dig Their Own Graves? | Reaction to FOW Article

18 July 2013 | Ben Larah  

For those of you who missed Philip McBride Johnson's wonderfully spluttering article in Futures and Options World, published recently, it's certainly worth a read. McBride Johnson states his case; that the unequal initial margin (IM) treatment for swaps and swap-futures is entirely the fault of the very swap participants complaining in the first place. They apparently rushed to the regulators in the early days of Dodd-Frank to ensure that swaps were treated differently than futures (presumably to escape too much regulatory oversight), and now they're complaining that the very regulations that were enacted to enforce this difference are hurting the swaps market. McBride Johnson says that he's well aware that swaps and swap-futures are "eerily similar", but swap market participants should be more "careful what you wish for". It's an interesting argument, but I'm not convinced by McBride Johnson's central premise that swaps businesses dug themselves into this hole. His article only briefly discusses the central focus of all the contention:  the difference in the time-horizon for IM between swaps and futures. But this difference isn't necessarily the result of the early Dodd Frank lobbying that McBride Johnson describes in the article. To recap, the IM for swaps is calculated using a 5 or 7 day time horizon, and the IM for swap-futures is calculated using a 1 or 2 day time horizon. The difference in IM methodology was established long before the financial crisis of 2007/8, and the role that the CFTC played in the issue post Dodd-Frank is being overstated. Shortly after LCH.Clearnet started clearing IR swaps in 1999, an H-VaR methodology was implemented to calculate IM using a 5-day time horizon. So nothing really changed as a result of the early Dodd-Frank lobbying. The CFTC rule 39.13(g)(2)(ii), "setting forth ... a five-day minimum liquidation time for ... [interest rate] swaps", simply enshrined the existing IM calculation methodology into law. Furthermore, the decision to use different  time horizons for IM is not based on one contract being called a "swap" and the other a "future" per se, it has to do with the flexibility of the contracts, and swaps just so happen to be more flexible than futures. As a case in point, Eris Flex swap-futures (which are bespoke) are given a 5-day time horizon for the calculation of HVaR. Why? Because they're flexible. But they are still futures! I do agree with many of McBride Johnson's points, especially his assertion that swaps and futures really aren't that different. But I don't subscribe to the belief that the CFTC drove the separation between IM methodologies due to early lobbying. Ben L.


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