Energy swaps migrating to futures as Dodd-Frank rules take hold

Volumes soar in exchange-traded energy futures

Credit Swaps

The company said last year it plans to offer futures in the first quarter based on credit-swap indexes belonging to Markit Group Ltd., the largest creator of the derivative instruments in the $23 trillion market. The gauges will reference London-based Markit’s North American and European corporate credit swap measures.

The market for swaps, in which investors trade payments for as long as 30 years, is measured by notional value to calculate money flows and doesn’t represent cash that has changed hands.

The notional value of interest-rate swaps totaled $379 trillion as of last June, according to the Bank for International Settlements in Basel, Switzerland. The credit swap market stood at $23.5 trillion, according to the Depository Trust & Clearing Corp.

Pirrong said more swaps won’t be turned into futures in the rates and credit swap markets because of the CFTC threshold. Instead, investors are more likely to use futures contracts such as Eurodollars, which track interest-rate movements over three months and settle to the London interbank offered rate, he said.


CME Group began offering interest-rate swap futures in December as another option for derivatives users to trade futures instead of swaps. They’re bought and sold as futures and convert into a cleared rate swap if the contract is delivered.

Congress passed Dodd-Frank in July 2010 to oversee the unregulated over-the-counter derivatives market following the financial crisis and the collapse of Lehman, one of the largest swaps dealers. The millions of swap trades between banks made it difficult for government officials to determine how interconnected the firms had become.

The legislation also addressed several changes in the regulated futures market that the CFTC has overseen since 1974.

Under Dodd-Frank, all swap prices and trades will be required to be reported to data repositories so that regulators can view the market. Most swaps will now be backed by clearinghouses that collect margin and cancel any trade in which investors can’t cover their losses so that risk doesn’t build in the financial system. All trades that are cleared must be executed on exchanges or similar electronic systems.

Dealer Registration

JPMorgan Chase & Co., Goldman Sachs Group Inc. and Barclays Plc were among the first banks to register swap-dealer divisions under Dodd-Frank this month. In all, 65 trading units signed on, including the biggest banks in the U.S., U.K., France, Germany, Switzerland and Japan, according to the CFTC.

Intercontinental’s energy swaps market totaled $9.3 trillion in notional value in 2011, according to its annual report. CME Group has a similar share of the business, according to a person with knowledge of the matter who asked not to be identified because the information isn’t public.

About 97 percent of the former energy swaps at Intercontinental are now traded as futures, while at CME Group they’ve transitioned 88 percent, according to the companies.

The change to futures from swaps resulted in an additional 1.36 million daily energy trades on average at Intercontinental from Jan. 2-15, according to data from the company’s website. That amounted to 52 percent of the average 2.6 million trades across all its energy products over the same period.

Protection Concerns

Bloomberg LP, the parent of Bloomberg News, is part of a coalition called Companies Supporting Competitive Derivatives Markets, consisting of companies with swap-trading systems that raised concerns futurization will result in fewer protections for customers and less stringent margin rules. Other members include GFI Group Inc., Thomson Reuters Corp., ICAP Plc and Tradeweb Markets LLC.

Dodd-Frank encouraged competition in the swaps market by allowing contracts to be executed and cleared at different companies. For example, a swap bought on Tradeweb could be cleared at LCH.Clearnet Group Ltd., CME Group or Intercontinental.

In contrast, futures trading and clearing can only be done at the same company, allowing Intercontinental and CME Group to wall off their energy clearing from rivals.

Pushing swaps trading onto futures exchanges hands too much control to Intercontinental and CME, Christopher Giancarlo, executive vice president of GFI Group, told Bloomberg Businessweek. Interdealer brokers such as GFI have lost business from futurization.

‘Natural Progression’

The CFTC granted CME Group an extension to Dec. 31 for the $8 billion level for swaps dealer to begin because the company wasn’t ready for the change as of October.

CME Group and Intercontinental said they expect revenues from clearing the block futures trades to remain the same as when they were swaps as the fees are largely the same.

Given the level of complexity of the new rules, including the $8 billion threshold, the migration to the futures market reflects a “natural progression,” CFTC Commissioner Scott O’Malia said in a telephone interview.

“They were leaving behind a regulatory nightmare that is the swap dealer definition,” said O’Malia, who said he doesn’t oppose the trend. “How you compute up to the $8 billion de minimis swap dealer level is anyone’s guess.”

Bloomberg News

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