If Congress really had its way (well, the Democrats anyway) than all swaps would have been forced to look and trade like futures. If you’re reading this blog than you know that would be a classic square peg, round hole. Case in point: Eurex launched iTraxx futures some years back and no liquidity every developed. But times have changed, and although I’m not completely convinced the world needs credit-default swap (CDS) futures, the upside if the contracts are successful is big enough that it is nearly inevitable that they will come to market ahead of CDS trading and clearing mandates later in 2012. Why?
Firstly clearinghouse margin requirements for CDS are seen by many as unnecessarily high. Complications related to clearing sovereign and bank CDS, two of the most highly used CDS segments, will leave margin requirements for those products even higher than for index CDS. These high margin requirements alone could open the door for CDS futures as the margin requirements for futures are tracking much lower than for comparable swaps.
Hence my comments to Dow Jones. CDS futures won’t take off just because the market wants to take directional bets on credit, they’ll take off because they provide an economic incentive to those wanting to take direction bets on credit:
Kevin McPartland, principal at the independent research firm TABB Group, said these so-called “liquidity” issues would drive more trading in CDS and “that would only translate to demand for CDS futures” so long as they offered some economic benefits over the existing swap contract.
A dealer working on the CDX futures project said it could be a solution that would drive volumes because the contracts could be traded in smaller sizes than CDS, and this could appeal to investors not currently trading in swaps. “It’s something that makes sense,” he said.
Over the last few weeks the topic of CDS futures has come up a bit in my conversations with industry participants. In fact we discussed this back stage at our recent Fixed Income Trading 2012 event in New York on January 24th. Everyone seems convinced that several firms are “working on the problem”. However, a TABB Group estimated 80% of CDX.IG trading in the interdealer market happening electronically based on a highly standard contract (remember the Big Bang in 2009?) begs the question, with such a standard, relatively liquid market already in place why do we even need a future? Its nothing more than a different regulatory rubber stamp calling the product one thing over another.
It can even be argued that margin rates for cleared CDS and the comparable cleared CDS future should be the same. If they’re economically equivalent than why wouldn’t margin requirements be equivalent? That point leads to another discussion that I’ll come back to in the coming months.
The bottom line – someone will bring CDX.IG futures to market, but betting on their success is purely a game of chance. Only time will tell.