Swap futures are being prepared for launch in South Africa after the Johannesburg Stock Exchange and Eris Exchange struck a licensing agreement for cash-settled hybrid contracts. The products, which combine the economics of over-the-counter derivatives with the capital efficiency of listed futures, are expected to begin trading before the end of the year.
The agreement is the latest in a string of partnerships made by the US futures exchange as it aims to expand its swap futures methodology beyond the current offering for US dollar interest rate products.
New launches slated for this year include euro and sterling-denominated interest rate swap futures to be listed on the InterContinental Exchange during the first half, while credit default swap futures will begin trading on ICE later this month. Canada’s Montreal Exchange is also readying interest rate contracts using the Eris methodology for early 2016.
As part of its multi-year agreement, JSE will first launch swap futures on the Johannesburg Interbank Agreed Rate denominated in South African rand. The list of products is expected to grow with the exchange seeing potential for futures on cross-currency swaps and contracts on CDS single names and baskets.
“Providing these swap futures products via the JSE will offer our clients the regulatory certainty of futures and allow market participants to operate within the familiar eco-system of futures while broadening their international exposure,” said Warren Geers, head of interest rates and currencies at the JSE.
Much of the demand is expected to come from domestic clients looking for a listed hedging alternative that can be traded without the need for ISDA documentations. While some international business is anticipated, a large portion is likely to remain in cleared OTC swaps, which currently have gross notional outstanding of R11.8trn (US$970bn) at LCH.Clearnet’s SwapClear, out of US$300trn total cleared volume across all currencies.
Regulatory shift
Swap futures have gained prominence in response to sweeping regulatory reforms intended to push much of the US$691trn over-the-counter derivatives market onto regulated exchanges.
New rules impopsing five-day VaR margin requirements on OTC swaps compared to just two-day VaR for listed futures was expected to drive a migration to exchange-traded alternatives.
A widespread shift has not yet materialised, but Eris notes that volumes are rapidly increasing. Demand is coming not only from a migration of dealer hedging as banks come under leverage ratio pressures to slash their OTC derivatives gross notionals, but also from new users such as CTAs that are largely shut out of the OTC markets and are now active traders of swap futures products.
“We expect to see a significant percentage of OTC volume make the shift to listed alternatives, but we’re also bringing a host of new users into the swap market that were previously shut out. We’re gaining share and we are also adding new demand,” said Neal Brady, CEO of Eris Exchange.
“We’ve seen record activity in the products recently. March was our biggest month by average daily volume and we continue to hit new highs in open interest.”
Open interest in the US dollar-denominated contracts listed on the Eris Exchange currently stands at around 171,000 contracts. While just under half of that reflects Flexes contracts that are subject to swap-based margin of five-day VaR, open interest figures are skewed by the buy-and-hold nature of those products and around 90% of the trading activity is now seen in the standard contracts that attract futures margin.
By comparison, deliverable swap futures listed at the CME, which also clears the Eris cash-settled contract, have open interest of just under 90,000 contracts.
“We see significant jumps in new clients and customer usage every time another OTC product gets mandated for clearing and SEF trading and each time a bank or region comes under the Basel III regime, which can cause the cost of traditional OTC trading to jump,” said Brady. “People are looking for alternatives and we’re seeing growth every time we experience less liquidity in swap markets and clients seek out alternate pools of liquidity.”