- 1. Eurex Group July 2013 Institutional Insights What is inside
(tap to get there) Editorial 1 Thought leadership 3 Riding the next
wave of futurization Trading insight 8 Clearing insight 9 In
conversation 10 With Olivier Zeyssolff about risk management Market
insight 16 Conversations... I was told that writing the opening for
a new publication would be a therapeutic and inspiring exercise.
With Imagine Dragons Night Vision blaring in the background, the
task started. Where to begin? What to say? Whats important? How
long? What tone? Sedate? Humorous? Contempla- tive? Provocative?
Irreverent? Whats the story? Three weeks ago it was my privilege to
spend a considerable amount of time with Richard Hytner, Deputy
Chairman of Saatchi & Saatchi. And one of his phrases
fortuitously echoed in my mind as I wrote this Always be genuine.
Institutional Insights was conceived following an accidental game
of join the dots. At Eurex Group we have a simple yet incredibly
genuine dream (yes you read correctly I just said dream).
Passionately shaping the derivatives industry. We organize markets
globally. This was dot number one this is what we do and the spirit
in which we do it. Dot number two was the recognition that shaping
an industry means shaping ideas. Ideas are only shaped if youre
having EditorialDeepesh Shah Olivier Zeyssolff Chief Credit
Officer, Tudor Group Clive Tillbrook Global Managing Editor, MNI
Renaud Huck Head of UK Buy Side Relations, Eurex Group Kathryn M.
Kaminski, PhD KTH, MIT Deepesh Shah Vice President, Business
Development London, Eurex Group
2. Institutional Insights July 2013 www.eurexgroup.com 2
conversations with all your partners and from all parts of your
industry. The third and final dot was an awareness that our role as
an exchange is to bring people and markets together so why not
ideas? As an organizer of markets, who better to bring together the
various constituents with the goal of sharing ideas by having
conversations? Next came the question of how? To be authentic,
stifling ideas through censorship is clearly out of the question.
Not only is this against the principles of stimulating writing, its
also against the principles of having a conversation. Weve
therefore assembled a host of spirited permanent writers who all
share at least one common trait they are all passionate about their
work and their respective fields. And they want to talk about it
from their unique perspectives. Over the next months, well also be
welcoming guest contributors with only one mandate be interesting,
be open, and be genuine. The goal here is not to lecture but to
catalyse debate. And finally the question what? We begin this first
edition with the increasingly hot topic of futurization. Some say
futurization is the natural evolution for over-the-counter deriv-
atives. Others believe it is impractical due to inflexible
constructs and liquidity risks. Futurization is not a new topic,
but it is an underexplored topic and therefore worthy of
discussion. Were very pleased that our lead writer Kathryn (Katy)
Kaminski of KTH Royal Institute of Technology, MIT Sloan and the
Stockholm School of Economics has been able to shed light on this
subject in her own unique and balanced style. Katy will be tackling
a number of challenging and thought-provoking topics in the months
ahead for Institutional Insights. Im also delighted to welcome
Olivier Zeyssolff, Global Head of Credit Risk with Tudor Capital
Management as our guest interviewee for this first edition. I have
no doubt that youll find Oliviers views on the challenges faced by
buy side firms, his concerns about systemic risk and thoughts about
how the future could evolve, both engaging and insight- ful. The
title of this publication is, after all, Institutional Insights. As
Head of Buy Side Relations in London at Eurex Group, Renaud Huck is
keen to share his thoughts about the state of the industry, current
trends, concerns and reasons for optimism. And as youll see later,
he has an encyclopaedic knowl- edge of the markets and strong views
on a range of topics. In this edition, Renaud comments on asset
protection as well as sharing an update on the success of French
government bond futures. Lastly, Clive Tillbrook, Global Managing
Editor at MNI, will leverage his network of bureaus around the
world to bring you the latest news, analysis and intelli- gence. In
this edition, we cover the June 2013 Global Economic Prospects
report issued by the World Bank. Deepesh Shah Vice President,
Business Development London, Eurex Group 3. Institutional Insights
July 2013 www.eurexgroup.com 3 And now I turn the focus to you.
Conversations, by their nature, require two or more participants.
Therefore Im doing something Ive been urged not to do Im opening up
my inbox: [email protected] Please use it. Do you have an
opinion on something youve read? Do you agree or disagree and why?
Do you have a hot topic that youd like to see us cover? What do you
really care about? Do you want to write something yourself? Or do
you simply want to say hello and introduce yourself? Whatever your
reason for writing to me, please do write. Like all creative
processes, this publication will evolve together with you. I hope
you enjoy reading this be it at your computers, on the Tube (or
sub- way) on your iPads or in your bathtubs. Let the dots be
joined! Deepesh, on behalf of the team Thought leadership Kathryn
M. Kaminski Riding the next wave of futurization The world of
derivatives as we know it is ripe with change. Prior to the credit
crisis, derivatives trading was taking place on two very different
fields: over-the- counter (OTC) via dealer networks and
exchange-traded derivatives (ETD) via centralized clearing houses.
Although in theory the nature of derivatives contracts should be
roughly the same, in application the rules, as well as the
structural way these contracts change hands, varied substantially.
The mess that unfolded in 2008 led to a sharp review of the way
derivatives contracts are cleared, collater- alized and change
hands. In an attempt to level the playing field on both sides and
create a more cohesive and less dis- jointed approach to
derivatives markets, legislation such as the Dodd-Frank Act in the
U.S. and EMIR in Europe spearhead the restructuring and
reorganization of how derivatives trading will be conducted.1
Setting the stage for futurization The derivatives industry is a
700 trillion dollar business. Historically, exchange- traded
derivatives have taken up a smaller piece of the pie maintaining a
small frac- tion of the total notional value (roughly 10 percent).
Most OTC derivatives con- tracts are held by a few of the largest 1
John E. Parsons from MIT discussed this analogy and futurization in
his blog: Betting the business, financial risk management for
non-financial firms. See bettingthebusiness.com Kathryn M.
Kaminski, PhD CAIA, KTH Royal Institute of Technology, MIT Sloan
and the Stockholm School of Economics 4. clearing of most
derivatives contracts will be done through central counterparties
(CCPs) allowing for aggregation of information for reporting,
multilateral position netting, and cross validation. The share of
derivatives that are not centrally cleared will become low4 and
regulatory costs in the form of increased reporting, operating, and
collateral are set to impact all users of OTC derivatives products.
New players are also entering the swaps markets by registering as
swap execution facilities (SEFs)5 , creating competition for swap
dealers. Transaction costs, oper- ational efficiency and collateral
manage- ment should bring down differences between OTC and
exchange-traded products. Despite this move, there are still plenty
of adjustments to be made and room for growth.6 For example in
2012, 60 percent of all derivatives in the U.S. were swaps. There
is a migration towards exchange-traded products but it is happening
gradually. For example, today, futures/forward contracts which are
mostly exchange-traded have climbed to 19 percent of total notional
value in derivatives from 11 percent in 2006. www.eurexgroup.com 4
Institutional Insights July 2013 2 OCC Q4 Report 2012 3 Title VII
of the Dodd-Frank Act focuses specifically on swaps and in the U.S.
there is a legal distinction between swaps and futures. In the EU,
EMIR attempts to deal with counterparty risks and transparency in a
more pluralistic manner by creating a list of all derivatives that
must be centrally cleared as well as which derivatives should have
mandatory trading. The list includes the standard options, swaps,
futures, cash settled commodity derivatives and other exotics.
Implementation in the EU will be phased in over the next few years.
4 Those which are not cleared will be possible via exception or
with collateral constraints above the five-day margin requirement
for vanilla OTC swaps. Implementation in Europe is still in process
and discussion. 5 In the EU, these include multilateral trading
facilities (MTFs) and organized trading facility (OTFs). 6 This is
especially true in Europe where implementation is delayed until
2014 or later. The path leading to futurization banks. A closer
look at these banks, or at least the top tier banks by size, shows
that only a very small percentage (around 4 percent) is held in
exchange- traded derivatives. Reasons for this distribution have
been attributed to the previously lower costs in trading off-
exchange and potential difficulties in dealing with block trades on
exchanges. The core of the action, in both total notional value and
in banking trading revenues (17 trillion in 2012 to be exact)2 , is
in OTC interest rate swaps. New regulation aims to tighten control
regarding reporting, registration, and mandatory central clearing
of many, especially vanilla OTC contracts.3 Central Most
derivatives are OTC Systemic risks Concerns over collaterization,
transparency Regulation Mandate central clearing of all vanilla OTC
Increase reporting, registration, and collateral costs Increased
competition in the clearing/execution space Enhanced role of CCPs
and exchanges New players entering registering as SEFs Migration
towards ETD Futurization of OTC products 5. moving a step closer to
futures contracts. As regulatory demands begin to stretch the
limits of OTC contracts, this is creating further incentives for
futurization which may allow users to circumvent some of these
issues. The new wave of futurization: swap futures Swap futures (or
futurized swaps) are new, exchange-traded variants of swap
contracts which are meant to mimic swaps. To use an analogy,
futures are to forwards as swap futures are to swaps. To appease
users of swaps, these new futures contracts are an attempt to keep
some of the customizable features of swaps while maintaining some
of the advantages of a centralized exchange. Exchanges will allow
for more flexibility on delivery options.7 Exchanges will also
allow for more flexibility on block trades (something that was
debated at the recent CFTC discussion panel in February 2013).
Exceptions and modifi- cations will make swap futures fit some-
where in the gray zone between tradi- tional swaps and traditional
futures contracts. The key advantages of swap futures include
transparency, lower collateral requirements, possibly reduced
registration requirements, and ease of trade when highly liquid.
The key disadvantages may include lack of cus- tomization, delivery
limitations, concerns for block trades, and the potential for
liquidity issues. A simplified comparison of contracts is presented
in the following table. www.eurexgroup.com 5 Institutional Insights
July 2013 7 For example in the U.S., deliverable swap futures were
recently launched. These are futures contracts which provide
delivery of an OTC swap at maturity. The advantages of these
contracts are that during the life of the future, the contract, as
a futures contract, is eligible for much less stringent collateral
and margin requirements than the delivered OTC swap contract.
Forwards/futures Swaps Notional value Q4/2006 I I Options Credit
derivatives I I Notional value Q4/2012 Forwards and futures take a
bigger piece of the pie development of the derivatives market in
the United States What is futurization? Futurization is the
migration of traditional dealer based bi-lateral contracts into
similar standardized futures-style contracts which are centrally
cleared and exchange-traded. This idea is by no means novel. In
fact, this is exactly why futures contracts came about; to mimic
bilateral OTC forward contracts. The futures market structure is
meant to address counterparty risks, lack of transparency, and lack
of transferability (non-fungible structure) of bi-lateral OTC
contracts. An aggregated exchange- traded structure allows for
collateral reductions, multilateral position netting, and risk
mitigation across pools of counterparties. The new wave of futuri-
zation of swaps and other OTC deriv- atives is occurring to adhere
to some of the same issues. By mandating centralized clearing, OTC
derivatives are already 6. www.eurexgroup.com 6 Institutional
Insights July 2013 8 This is even more evident in the U.S. where
collateral and margin requirements for swaps are treated
differently than futures. In the EU, these distinctions are less
clear as EMIR focuses on a contract by contract basis. The jury is
still out in the EU how this will play out. Futures are to forwards
as swap futures are to swaps Exchange-traded Cleared Rare, ~2%
Standardized Daily margin required for collateral Low Futures OTC**
(U.S.: exceptions, EU: exception for physical delivery) Depends
Mainly delivery Customized Depends Moderate (varied) Forwards
exchange-traded with exceptions Centrally cleared with exceptions
May depend, contract dependent Standardized with some flexibility
12 days margin required for collateral Low Swap futures OTC* (U.S.:
SEFs, EU: MTFs and OTFs) Most cleared** with exceptions Mainly
delivery Customized, more standardized* 5 days required for
collateral (may vary as well) Low*, moderate (for bi-lateral,
uncleared contracts) Swaps Trading Clearing Delivery Transparency
Collateralization Counterparty risks *This characteristic will be
in effect post regulation implementation of Title VII of the
Dodd-Frank Act and EMIR. **There are some exceptions for forward
rate agreements and FX. Physical delivery and some customized swaps
may also be exempted. parties are designated as systemically
important entities or entities that are too big to fail. Critics of
this structure are weary of vertically integrated clearing and
execution. In addition, new users of futures also have concerns
about potential basis risk and liquidity issues with new products
that may not be adequately customizable. Issues related to block
trading, flexibility, and increased delivery options are of high
priority. Proponents of futurization cite the long and successful
history of futures markets, the benefits of more migration to
futures, and the potential for cost reduction and flexibility in
new futures products. Core issues of contention: the pros and the
cons There are some concerns about the appli- cability of
futurization in a market that is focused on customization. General
con- cerns are related to regulatory arbitrage, systemic risk, and
potential issues with lack of customization and usability.
Opponents screaming regulatory arbitrage cite concerns related to
the asymmetries in fees and collateral across similar con- tracts.8
Their concerns are that markets driven by regulatory arbitrage may
have unclear consequences. Cross border issues and differences in
regulation across the globe may complicate things even further.
Systemic risk is another key issue. In a post Dodd-Frank and EMIR
world, with man- datory clearing and contract migration onto
exchanges, large central counter- 7. www.eurexgroup.com 7
Institutional Insights July 2013 wave of futurization. The push
towards transparency and transferability has already begun.
Yesterdays challenges may be addressed, but the perils and
challenges that lie ahead in derivatives markets remain unclear.
Despite many opposing views, it does remain evident that the future
of derivatives markets is futurization. References Rodriguez
Valladares, Mayra, Futures and Futurization: Full Steam Ahead on
Dodd-Frank, MRV Associates, 19 November 2012. Kurbanov, Rashad,
Swap Futurization The emergence of a new business model or avoiding
regulation and retaining the status quo?, DerivSource, 13 February
2013. Acworth, Will, Futurization: Market Participants Clash,
Futures Industry, 10 March 2013. Litan, Robert, Futurization of
Swaps: A Clever Innovation raises novel policy issues for
regulators, Bloomberg Government, BGOV Analysis, 14 January 2013.
Parsons, John E., 3 points on the futurization of swaps, Betting
the Business Blog, 31 January 2013. Futures markets have a
long-standing relationship with regulation. They were designed with
a keen focus on transpar- ency, transferability, reduction of
counter- party risk, optimized collateral costs, and risk
mitigation. Yet, it is important to emphasize that futures gain
much of their success in numbers. Illiquid futures contracts are
not as popular and have added liquidity risks especially with con-
tracts that are marked to market so frequently. Proponents of
futurization suggest that increased volumes in futures markets may
help diversify product offerings. For example, one positive sign
has been the relatively eventless 18 trillion dollar migration from
energy swaps into futures in the fall of 2012. Increased volumes
may help make room for new contracts which can better mimic longer
dated swap contracts. Consistent with anecdotal comments from
energy traders who switched to futures, cost reduction, lower
collateral requirements, efficiency and flexibility are the
commonly cited advantages for using futures. Lastly, similar to how
futurization of forwards created futures, proponents of
futurization can argue that the current wave of futurization in OTC
derivatives is simply a natural development of modern financial
markets. Consistent with futurization of the past, this wave will
help level the playing field and increase flexibility. Concluding
remarks The derivatives industry is a 700 trillion dollar business.
Regulatory forces and demographics in this industry are migrating
contracts from dealer net- works onto exchanges spawning a new 8.
Following the 2008 financial crisis and the resulting market
volatility, the situation led to a dramatic widening of yield
spreads. Eurex Exchange responded with the introduction of the
Italian govern- ment bond (Buoni del Tesoro Poliennali BTP) segment
in 2009 which has become extremely successful with over 15 million
contracts traded since launch. Then, in 2011, due to the continuing
European sovereign debt crisis, even the spreads of core European
countries over Germany widened. Spreads remain wide and volatile in
this segment. In order to react to the new market conditions and
the increasing market demand for a dedicated French hedging
instrument, the 10-Year Euro-OAT Futures (with a delivery window of
8.510.5 years) were born at Eurex Exchange in April 2012. On a more
anecdotal note, it is the revival of an old glory, the Notionnel
futures of the Matif, and it takes me down memory lane to the good
old days during my time as a floor trader on the Matif floor for JP
Morgan trading French futures contracts. The French government bond
futures offer market participants a listed futures product which in
terms of credit risk lies between Germany and Italy. Customers at
Eurex Exchange can now replicate and hedge most of the existing
long end interest rate/credit risks in Europe using our Bund, OAT
and BTP Futures. The Euro-OAT Futures launch was the most
successful fixed income futures launch in recent history across all
ex- changes globally. In May 2013, one year after inception, the
total cumulative volume stands at approximately 9 million
contracts. In May 2013 alone over 1 million contracts were traded.
The next logical step was to expand this successful segment the
majority of market participants suggested Mid- Term Euro-OAT
Futures (with a delivery window of 4.5 5.5 years) in order to
facilitate hedging and basis trading on www.eurexgroup.com 8
Trading insightRenaud Huck Institutional Insights July 2013 1,100
1,000 900 800 700 600 500 400 300 200 100 275 250 225 200 175 150
125 100 75 50 25 Order book volume Open interest OTC volume Jun
2012 Sep 2012 Dec 2012 Mar 2013 Euro-OAT Futures: traded contracts
& open interest (in thousands) Renaud Huck Head of Buy Side
Relations, Eurex Group 9. Clearing insightRenaud Huck the mid-term
segment of the French yield curve. Launched in March this year,
weve experienced steady growth as the Eurozone begins to stabilize.
To support all of these innovations, and to offer our clients the
full spectrum of trading opportunities in the fixed income yield
curve, Eurex Exchange also supports the short-term interest rate
segment with a new initiative of its three month EURIBOR Futures.
So far, the market signals have been very positive but ill update
you on this topic, as well as our other plans in the next edition
of Institutional Insights. www.eurexgroup.com 9 An entirely new
regulatory program was initiated by the G20 in 2008 featuring the
shift from bilateral OTC trading to OTC clearing. The details are
still being finalized but were not very far from having a complete
script. One feature of this new era is that of segregation models.
This is quite an all- encompassing term so what exactly are we
talking about here? We should be more specific and define properly
what the models of segregation are, what the purpose is and what
will be its role in this new world of OTC clearing. There are
several definitions of segre- gation floating around so Id like to
provide you with ours. At Eurex Clearing, when we say segre- gation
we define it as a full segregation model. A model where collaterals
are physically protected and which, in the event of a Clearing
Member default, allows the positions and collaterals of the end
client to be ported. This is what we have structured and what we
offer to our clients. And I mean ported, not liquidated. There is a
big difference here. While some models theoretically claim to be
fully segregated, in practice both positions and collaterals in
these models are liquidated (value seg model) and a cash equivalent
is returned to the client. Which is fine for some clients but not
all. I dont see where the value proposition and interest of such a
limited model lies. Its a rather heavy handed approach which is
even more disruptive during very distressed market conditions. The
default of a Clearing Member results not only in disruption to said
Clearing Member but also to their customers and to market
infrastructures as a whole thereby rendering it extremely difficult
to liquidate assets effectively. Institutional Insights July 2013
Renaud Huck Head of Buy Side Relations, Eurex Group 10. In
conversationDeepesh Shah and Olivier Zeyssolff At Eurex Clearing,
we thought long and hard about this and recognized that under these
potentially difficult market conditions, we needed to adopt a very
different approach and help our buy side clients as much as
possible in making the transition from one Clearing Member to
another. A more collaborative process was going to be needed hence
in our default man- agement process, we considered that a 5-day
interim period where the end clients can transition their clearing
activity was necessary be this via porting or liquidating. The
choice is theirs. But above all, the protection of collaterals
(away from the clearer and the clearing house) placed in a CSD or
ICSD (required by regulators) such as Clearstream, was a must-have
in order to offer a practical solution to the trading community in
this new world of OTC clearing. The new world is a giant,
unchartered territory with new frontiers for Eurex Clearing, and
together with you, were devising new and innovative solutions.
bientt! www.eurexgroup.com 10 Deepesh Shah, Eurex Group, spoke to
Olivier Zeyssolff, Chief Credit Officer at Tudor Group, about the
opportunities and challenges in risk management. Eurex: Could you
tell us a bit about yourself? Zeyssolff: I am the Chief Credit
Officer for the Tudor Group, a multi-strategy investment management
company with assets under managements of approxi- mately USD 13
billion. I oversee global counterparty risk and any non-trading
risk we take when we engage in trading activities across all
products. We have relationships with FCMs, OTC counter- parties,
prime brokers, CCPs and cus- todians. I look at a broad range of
both credit and operational risks. Eurex: One of the topics that
keeps us busy is regulation, the two of the most important being
EMIR and the Dodd- Frank Act. What are the effects of these
regulations on your business? Zeyssolff: As you know, back in 2009
the G20 committed to implementing new regulation that would reduce
systemic risk and make financial markets more transparent. As an
active market participant, we are supportive of these goals. These
regulations will have a long- Institutional Insights July 2013
Olivier Zeyssolff Chief Credit Officer at Tudor Group 11. term
impact on all market participants and in particular on how the buy
side operates and transacts on a day to day basis. We have a fairly
long experience both in clearing and in posting margin and
collateral across all facets of our business. So its not really new
for us. However, it is a different way of doing business especially
in the OTC swap space. The new legislation has had a fairly
significant impact in terms of regulatory requirements. It is
important that we understand what rules apply to us and that we
comply. However, the timing of the implementation of the rules
varies significantly between Europe and the U.S. and can be
confusing and problematic for market participants. Additionally, a
number of rules have yet to be finalized. Eurex: How did you tackle
that challenge? Zeyssolff: Tudor has been trading futures actively
for a few decades and we have used swap intermediation with our
prime brokers for a long time. We have an infra- structure in place
to manage these changes. We already have the systems and processes
to support clearing. OTC Clearing has become an extension of those
established protocols. We are using our main FCM relationships for
clearing OTC swaps. We looked at the trading documentation we
needed to have in place. These negotiations were new for everyone
for us and for the clearing members so there was a period of
adaptation. There are also a number of operational challenges that
need to be addressed, including estab- lishing and testing
connectivity with CCPs, setting up legal entity identifiers and
upgrading trade management and portfolio reconciliation systems in
time for the deadline. We started clearing OTC swaps on 11 April
this year. Eurex: How was the experience? Zeyssolff: The experience
has been rela- tively flawless so far. We are currently only
clearing eligible swaps that fall under the mandatory clearing
obligation under the DFA. At the end of the day, this represents
only a modest portion of Tudors portfolio. It will increase as more
products become eligible for clearing. For the current universe, we
did not have any major issues with the CCPs or clearing members. I
think from an infra- structure perspective we were well- prepared
to accommodate this change and therefore it has been a fairly
smooth transition. Eurex: What opportunities are you seeing from
the transition and what are some of the challenges? Zeyssolff: We
now have a new type of product on the marketplace. We trade cash
products, OTC derivatives, futures and now OTC cleared swaps. So it
is an additional product class which has its own specs and
requirements whether it is margin, margin efficiency, collateral,
execution or reporting. We are still in the early days, so if the
system expands and works well then I think everyone will benefit
from, for example, margin efficiencies. www.eurexgroup.com 11
Institutional Insights July 2013 We are still in the early days, so
if the system expands and works well then I think everyone will
benefit from, for example, margin efficiencies. 12. But you could
also ask I used to trade OTC derivatives with a very small number
of counterparties and then I had very strong margin efficiencies
across products. Now I have to trade different types of futures and
swaps across differ- ent CCPs which may not have adequate portfolio
margining across and between them, so are you really in a better
position? One could argue that youre not. So its not all strictly
positive but I would say the OTC clearing market has high potential
for operational and capital efficiencies. Eurex: What are your
clients telling you? Zeyssolff: One of the concerns of our
investors is how their assets are pro- tected, but they know that
this is high on the priority list for us. On the OTC derivatives
side, we have always made sure that we post initial margin, not to
the bilateral counterparty but to an independent third-party
custodian. Obviously when we moved to the cleared side whether in
futures or OTC cleared, there is some degree of comin- gling with
other customers. One could argue that we are losing some of our
asset protection in moving to OTC clearing. Thats certainly a
drawback, even though the LSOC model is going in the right
direction. It is an improvement over the futures model, but it is
not as strong as the pro- tection our collateral assets benefit
from on the OTC bilateral side. We are talking to market
participants and ex- ploring any solution that would get us to or
close to full individual account segregation on a fund-by-fund
basis. Eurex: You mentioned that you are losing some efficiencies
in cross margining, having to spread yourself out between different
clearing houses. But what is your view on the too big to fail
aspect? Zeyssolff: This really throws a spark into the coals with
the potential for an unintended outcome. One of the main issues
that must be addressed is inter- connectedness. Clearing does not
elimi- nate interconnectedness but creates new connections to CCPs.
While these new connections do contribute to operating and capital
efficiencies to some extent, concentrating risk at CCPs also
creates new nodes of risk across the financial system. My view is
that counterparty risk is transformed and reallocated to CCPs but
counterparty risk does not disappear from the system. These highly
concentrated nodes of risk at CCPs mean that CCPs are in turn
potentially becoming too big to fail. Eurex: So where do you strike
the balance between those two issues too big to fail vs. capital
efficiencies? Zeyssolff: Well, I am a risk person so my perspective
may differ from others. We are speaking mainly about tail risk
here. While there will be significant improvements in capital and
operational efficiencies, if there is an issue that does flare up,
it could be catastrophic. www.eurexgroup.com 12 Institutional
Insights July 2013 One of the concerns of our investors is how
their assets are protected, but they know that this is high on the
priority list for us. 13. And my role and what I believe the market
should be looking at and thinking about is how can we make sure
that this tail risk is understood and then to some extent provided
for. You cannot be complacent about the risk inherent in trading
cleared products, and the risks do not disappear when trading on
CCPs. So, how do you manage that? We are incentivized by regulators
to trade standardized products and move our swaps onto exchanges
and CCPs. You try to increase efficiencies by con- centrating them
rather than spreading your risk across CCPs. If something happens
there, you certainly cant talk about risk diversification. Is the
financial system better off as a result? I still struggle to find
an answer to that. There are remaining issues around insolvency
laws, cross-border inconsistencies, and its unclear whether the
institutions would benefit from government systemic support. We
should not be complacent about systematically important financial
institutions (SIFIs), nor should we be about CCPs. Eurex: Moving
onto the future of OTC, with all the restrictions in place for
firms such as Tudor, what do you see in terms of the size of the
OTC space going forward? Zeyssolff: Well, again, in a world where
OTC clearing is working well with a proven track record of
operational and capital benefits, then I think participants will
make a decision to direct as much business toward cleared products
as possible. If you can replicate OTC swaps in a more standardized
format, with less punitive requirements for capital, then thats
what will happen. The jury is still out: some say the end of the
OTC swap market is nigh and I do not share that view; some say both
exchange trades and OTC derivatives markets will reduce in size as
a result of additional regulation. There are two types of buy side
market participants: the risk takers (the traders who want to take
a speculative position), and the hedgers. These latter participants
make up a large part of the market so they should not be forgotten.
And these professionals may not have the same flexibility to move
from a tailor-made OTC bilateral contract to a standardized futures
contract, which may be totally inadequate to hedge their specific
cash flows. I think there is a chance of creating a two-tiered
market. One of the drawbacks of the bilateral market is the lack of
transparency where it is difficult to see who does what. But based
on academic research and the information out there, we see a huge
amount of OTC derivatives that are originated by end users and
asset man- agers, who are using these contracts more for hedging
and risk protection purposes. The amount traded by risk takers and
banks (for their own account) is probably less than half of the
total OTC volume. We should keep in mind when implementing
regulation with punitive aspects that there are likely to be
unintended consequences on the real economy. www.eurexgroup.com 13
Institutional Insights July 2013 About the interviewee Olivier
Zeyssolff oversees global counterparty risk as Chief Credit Officer
at Tudor Group, a multi- strategy investment management company
with assets under managements of approximately USD 13 billion. 14.
If you had to abide by certain of these rules, you would have to
change your business model, mobilize liquidity that would otherwise
be used elsewhere, and therefore think about the effects of this on
the bread and butter of your investment. Ultimately, investors and
shareholders pay the price for it. Eurex: Could you conceive that
some of these firms would see it as unviable and exit the market?
Zeyssolff: One of the key proposals that is not yet finalized is
the margining regime for uncleared swaps proposed by BCBS-IOSCO. If
it remains as it is, then I probably would say yes. But its not too
late to amend it. Eurex: One of the major topics of this issue is
the futurization. Have you given any thought to this topic?
Zeyssolff: Were entering an era where you have regulators who are
incentivizing users to trade instruments which are standardized and
can be cleared, as opposed to bilateral transactions. You now have
a range of products which have their own margin regime. When you
are a company operating in a multi- asset class environment,
managing a business can get really complex as a result of the
diverging regimes. I wonder if at some point we will see some
convergence between these regimes and move, for instance, from a
less punitive to a more favorable regime for swap futures and for
futures. Eurex: Why hasnt it happened before? Zeyssolff: You really
have to look at who the participants in the OTC market are. I think
many of these participants just need tailor-made products and have
some specific requirements. I think futurized swaps is not anything
new. It has been experimented with for 5 to 10 years, but has never
really taken off. So why now? Especially with the different types
of margin regimes, if you have some con- vergence and maybe cross
margining across the CCPs that is transparent and accepted by the
market, then, yes there is potential. Another important aspect we
have not touched on and which is key from a trading standpoint is
liquidity. The depth of the market is generally better on the OTC
side for a large number of contracts. Some futures contracts may
exist but they do not have much liquidity, which is what matters
for market parti- cipants. They need to have good depth in the
market, good price discovery and good liquidity and this wont
happen overnight. Futurization may happen as a result of the
regulatory push toward standardized products, but would it happen
naturally? I think we have now gone far enough and the entire
market has been mobi- lized around OTC clearing for three or four
years. Once the three categories of eligible participants in the
U.S. are trading at full speed and they are joined by European
markets in late 2014 to 2015, www.eurexgroup.com 14 Institutional
Insights July 2013 One of the key proposals that is not yet
finalized is the margining regime for uncleared swaps proposed by
BCBS-IOSCO. If it remains as it is, then I probably would say yes.
But its not too late to amend it. 15. we will then have a much
better idea of what to expect as far as depth and liquidity of this
market are concerned. Eurex: What new innovations are exciting you
at the moment? Zeyssolff: As a credit risk manager, the safety of
our assets remains my main concern. As I said, we take great pride
in protecting our investors assets such that we have negotiated and
implemented a robust solution on the OTC side. We are constantly
talking to our counterparties, our prime brokers and our brokers to
enhance the standards for asset protec- tion. So we support
anything that moves toward stronger protections. Asset pro- tection
is closely linked to insolvency laws, and the extent to which these
laws permit such protection. EMIR, in partic- ular, has clear rules
about individual client segregation that should be offered by CCPs
and clearing members at a reasonable price. Of course not every-
one will want to take that route, cost is an issue, but the option
should definitely be offered. However, these types of rules are
beneficial to market participants if they add more certainty. These
are complex issues that will keep us busy for a long time. Eurex:
What keeps you up at night? Zeyssolff: Complacency and tail risks
of any kind. As we all know there will always be another crisis,
the question is where and when? Complacency about too big to fail,
about large levels of risk concentrated in ever larger institu-
tions, banks and CCPs. No participants, whether large or small, can
afford to become complacent or less risk disci- plined. This goes
back to the tail risk we discussed earlier. Eurex: Are credit risk
managers the new rock stars of the hedge fund world? Zeyssolff: If
only. Risk management is an integral part of what we do at Tudor
across departments as an investment management firm and a market
partici- pant. Obviously managing market risk is our primary focus,
but credit and counterparty risks have always been high on the
radar. We have dedicated significant resources to analyzing and
trying to find ways to limit our counter- party exposure, while at
the same time maintaining access to markets. I do not see this
focus on counterparty risk dimin- ishing at all as a consequence of
the new regulation for OTC clearing; the new regulation is only
shifting the emphasis somewhat. So we will continue to be focused
on that as we always have been. To answer your question, I dont
think we are rock stars, but counterparty risk is a very important
piece of the jigsaw and it can be easily overlooked... particularly
in good times. www.eurexgroup.com 15 Institutional Insights July
2013 The opinions in this interview are those of Olivier Zeyssolff
and do not necessarily reflect the opinion of Tudor Group. I dont
think we are rock stars, but counterparty risk is a very important
piece of the jigsaw and it can be easily overlooked... particularly
in good times. 16. World Bank more upbeat on global economic
prospects as risks wane Washington The World Bank offered a
refreshing view on the global economy in June saying risks have
diminished even if growth forecasts are short of impressive, and
market volatility reflects uncertainty over the potential end to
quantitative easing and should be short-lived. In the semi-annual
Global Economic Prospects reports, Kaushik Basu, World Bank Chief
Economist and Senior Vice President, stated the outlook is little
changed from January, and in a turbulent global economy that is
good news. Roughly our view is that the risk sce- nario is
better,he said since the huge downside risks that were a concern we
dont think that is there.He described the outlook as an inverted
plateau saying Were now at bottom with slow pickup taking place.
From next year well see some improvement. The report trims the
world growth forecast two-tenths to 2.2% from the January forecast,
with the biggest downward revisions coming in the euro area and
China, as well as other large emerging market economies, while the
U.S. was essentially unchanged. World growth is expected to
accelerate next year to 3.0% and 3.3% in 2015. The euro area
forecast was cut a half point to -0.6% from January, while China's
was slashed to 7.7% from 8.4% previously. The report projects euro
area growth of 0.9% in 2014 and 1.5% in 2015, while China is
expected to see expansion of 8.0% and 7.9%, respectively, the
report said. Lead author Andrew Burns said the down- grades are by
and large reflection of whats already happened rather than what
will happen, including a very weak fourth quarter, particularly in
Europe. For China, Burns said, it is "not the slowing that worries
us, since we see that as necessary. China has very high investment
rate, that is not sustainable, and if maintained would sow the
seeds of future difficulties." The World Bank predicts U.S. GDP of
3.0% this year, 2.8% in 2014 and 3.0% in 2015, barely changed from
the pre- vious. But it cut the estimate for Brazil to 2.9% from
3.4% for 2013, while 2014 is expected to improve to 4.0% and 3.8%
the following year. India's expansion was cut to 5.7% from the 6.1%
forecast in the January report, while 2014 and 2015 suffered
smaller downward revisions to 6.5% and 6.7%, respectively.
www.eurexgroup.com 16 Market insightMNI Institutional Insights July
2013 17. www.eurexgroup.com 17 Institutional Insights July 2013
Uncertainty, market volatility due to U.S./Japan QE questions There
remains anxiety over the trajectory of stimulus in the United
States and Japan when and how the Federal Reserve will begin to
remove quantitative easing, and whether and how much Japan will
increase theirs although it is not a major concern and expected to
be short-lived. Burns said there is a state of unconditional
anxiety, where they and the markets are worried about everything.
Were worried about quantitative easing rising in Japan and we're
worried about quantitative easing falling in the U.S. and it almost
doesnt matter what happens because what we're worried about is
change, Burns said. Markets are worried about uncertainty of change
and were worried about the markets reaction to uncertainty of
change. He said commu- nications by central banks will be key to
signalling to markets so that there arent surprises, because it is
those sharp changes in expectations that create volatility. The Fed
is still new to the process but they understand they need to
provide guidance to markets since sharp changes in expectations
create volatility, Burns said. The Fed is learning how markets are
reacting, so they will be fine tuning going forward. However, Basu
said the volatility including deep depreciation in emerging markets
is likely to be a short-term issue. Despite the sometimes
breathless anxiety portrayed by some in the media, he said he is
not concerned. I think on balance the Fed doing well, he continued.
The point is no matter what the form of communication, when a
change is anticipated market players try to beat others to it, and
take up posi- tions in advance of other players, and so there is
always a period of turmoil be- cause there is no way of
neutralizing that. Actually, Im not very concerned about this
trauma because I dont think it will last for too long. My
expectation is its an adjustment trauma in anticipation of what is
to come, and as soon as the policy changes ... I do expect this
trauma to go away." In response to a query, Basu confirmed he was
referring to trauma not drama in the markets, and in three to six
months "we will be in a less volatile situation" though he
cautioned that there may be other kinds of trauma that could impact
markets. Meanwhile, Bank of Japan QE and Abenomics is providing a
contrary impact on markets, but Basu said it was exactly what Japan
needed to do. Although the report acknowledges the policies have
led to yen depreciation, he added that was a correction from the
over-appreciation of the prior six to eight years and this
correction was needed. It has given lift to the economy as a whole,
and while there are undeniably spillovers, other countries also
will benefit as Japan recovers so some of the consequences we will
live with. Burns stressed that Japan eventually will have to
tighten fiscal policy to address the debt levels but it doesnt have
to happen this year or next year. 18. Contact information We are
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Insights July 2013 Euro area turnaround hampered by weak confidence
Burns said weak confidence in Europe following the long series of
setbacks is impairing growth since companies and individuals are
reluctant to invest. A key question is when the turning point will
come. How strong that recovery is likely to be is going to depend
very strongly on confidence, he said. People have been disappointed
in the expectations of a recovery in the past and so theyre being
very cautious. And the fact that theyre being cautious helps to
under- stand why growth is so slow to come. But there also is an
upside risk to the World Bank forecast because as soon as that
confidence starts to return, as soon as people start to recognize
the economy is recovering, that were past the worst of the recovery
and thats our very strong view then you will see them returning to
the market. Larger middle income countries adjusting to new normal
of slower growth Large developing economies like Brazil, Russia,
India and South Africa are finding it hard to return to high,
pre-crisis growth levels, Burns said. Although they have recovered,
those countries now find it hard to have strong growth without
creating inflation. They are in the pro- cess of adjusting
expectations to new normal, slower growth. Another group of
countries face a risk of overheating and are showing signs of
strain in terms of the supply side keeping up with demand side, he
said. These include the Philippines, Thailand, Vietnam, Colombia
and Ecuador among others. For more articles from MNI, please visit
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