In September 2009 the leaders of the G-20 met in Pittsburgh to hammer out a coordinated approach to regulatory reform. Chief among their concerns in the wake of the financial crisis was a lack of adequate capital backstopping the system. Now, several years later, Basel III and other capital rules are coming into into force, making efficient use of capital a global priority.

As Eris Exchange’s swap futures contracts continue to set new volume and open interest records, Eris CEO Neal Brady sat down with John Lothian News editor-at-large Doug Ashburn to discuss the emergence of swap futures as an important tool in the new financial order. In addition, ICE Futures Europe announced it will list Eris’ standard interest rate futures contracts denominated in euro and British pound sterling, starting on June 29.

“Capital efficiency has always been important in OTC and futures trading, but what is hitting the market these days are the leverage ratios, which come out of the Basel III framework,” says Brady.

The complicated formulas banks must use to determine leverage ratios boil down to one fact: gross notional exposure is treated unfavorably by the standards and will require banks to hold a lot more capital on their balance sheets. Brady says such requirements will affect not only banks but bank clients as well, as charges are passed on.

The user base for swap futures, however, is not limited to bank customers.

“We see about 50/50 between traditional users of swaps and new users who had previously been shut out of the swap market,” says Brady. Traditional users include customers who, due to the coming capital crunch, have seen prime brokerage costs rise dramatically. “In some cases they have been fired by their clearing firm and told they don’t do enough business to justify a clearing relationship.”

New users, according to Brady, are typically traders who have done high volume spreading in treasury futures and options products as well as cash treasuries.These users now have access to a swap order book and can enter trading and spreading algorithms that include swap futures contracts.

In 2015, the exchange looks to licensing agreements, such as new European interest rate and credit derivatives with the IntercontinentalExchange (ICE), to fuel the next phase of growth. Brady also sees growth coming from standardized swaptions contracts.

“Options are particularly hard hit in the new capital regime. These are currently traded OTC with lots of different flavors and customization, and lots of gross notional outstanding,” he says, making swaptions a perfect candidate for standardization.

That sounds like a swap in which all sides win.

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