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Swaps Market Takes Another Hit: New Rule Mandates Collateral to Back-Up Treasuries
By Nik Venema | November 18, 2013

Last week marked more bad news for the swaps market. The CFTC announced— to much objection from brokers, traders and clearing-houses alike—that Treasuries will no longer be considered feasible collateral for potential defaults, and instead they will need to be supported with additional credit lines. Swaps have already taken a beating against futures contracts which in definition appear nearly identical to swaps, but are favored for their shorter clearing times (five days less than swaps) and lower margins. In a crisis like that of 2008, regulators fear the time needed to liquidize Treasuries, which is 24 hours, would be too long a window to wait.

The lopsided market continues to face increased volatility, as many traders utilize futures for their hedges in place of swaps, which incur greater risk. Companies like CME Group have developed their own solution, known as a tool called a swap-future. Demand for this hybrid product is impressive, with the number of contracts growing from 10,000 in January to 95,000 this September, and average daily volumes spiking at that time to 10,000 contracts. Despite their appeal, the market for swap-futures severely lacks liquidity, and many are skeptical as to how this market would sustain the types of volumes that exist with standard OTC swaps.

While some hope remained that the commission would ease back on its swap rules, the CFTC seems to be moving towards further restrictions. Liquidity fees for the added collateral required by clearing houses are expected to double, transferring $800 billion to $4.6 trillion in costs to swap users (Treasury Borrowing Advisory Committee).