TABB Says 90% of Top-Tier Swap Dealers See Their Profits Down or Flat after Dodd-Frank Implementation

By | October 19, 2011

PR on my recent study:

New Annual Fixed Income Industry Benchmark Study Shows 60% of Current Dealers Expect Increased Barriers-to-Entry; Basel III to have Greater Business Impact than Dodd-Frank

NEW YORK & LONDON, Oct 19, 2011 (BUSINESS WIRE) — Despite the risks to liquidity posed by CFTC-proposed regulation, over the long term nearly 75% of existing swap dealers tell TABB Group they believe liquidity will ultimately improve in the post-Dodd-Frank Act era due to increased market participation, further product standardization and electronic trading access.

However, based on new fixed income industry benchmark research published today by TABB, in the first year after Dodd-Frank implementation, nearly 9 out of 10 top-tier dealers and two thirds of mid-tier dealers say they expect profits to remain flat or decline, says Kevin McPartland, a TABB principal, director of fixed income research and author of the new study, “Credit and Rates Swaps Dealers 2011: Redefined and Reborn.”

Regardless of the unknowns, complexities and costs, the dealer community as a whole feels it’s ready for change. “Although lobbying will continue and politics persist,” McPartland says, “dealers see the advantages of a mostly cleared swaps market.” Taking advantage of new opportunities won’t be easy though, as nearly 60% of current dealers believe barriers-to-entry will grow and most expressed doubt as to why non-dealers would want to get into a business where profit margins are decreasing and regulatory oversight is increasing.

The 42-page study with 38 detailed exhibits is based on in-depth interviews with 23 swaps dealers, including everyone on the Office of the Comptroller of the Currency’s top 10 derivatives holdings list; 13 of the 14 G14 firms; 16 of 20 Federal Reserve primary dealers; and the top 11 futures commission merchants (FCMs).

Four key subjects were covered:

— Strategic approaches of both top-tier swaps dealers and new competition

— Future of liquidity in the swaps market and the impact that proposed regulations can have on trading, profit selection and dealer business models

— Swap execution facility (SEF) selection process and how dealers will continue to service clients in an electronic world

— Importance of clearing membership for swaps dealers and their views on clearing access

According to McPartland, his interviews with these dealers, execution platforms and interdealer brokers confirmed that dealer-to-dealer (D2D) electronic trading of on-the-run, investment grade credit default swaps (CDS) index products in the US now accounts for over 80% of total transaction volume of those products, proof that swaps trading is moving to the screen ahead of regulatory mandates. “Even in the dealer-to-client (D2C) market, trading in the CDX.IG is roughly 25% of the total contract volume.”

Dodd-Frank is not the only change weighing on markets. Nearly 60% of the swap dealers interviewed claim Basel III will have a bigger impact on their business than Dodd-Frank. While Basel III doesn’t dictate how a swap must be executed, it does impact each bank’s capacity to fund their swaps trading desk by defining the maximum leverage allowed. Questioning these dealers further, McPartland learned that traders felt Dodd-Frank would have the biggest impact on their day-to-day business and P&L. “But at the bank level, Basel III’s impact would be far greater, that if billions in assets were suddenly untouchable, their business make-up and bottom-line profitability will be affected.”

The study also confirms that over 90% of existing dealers see clearing certainty as a major issue; 95% plan to offer some form of margin financing to clients; and technology was only second to relationships as a strategic advantage after Dodd Frank implementation.

The study is available for download by TABB Group Research Alliance Derivatives clients and all pre-qualified media at https://www.tabbgroup.com/Login.aspx .

For an executive summary or to purchase the report, visit http://www.tabbgroup.com or write to info@tabbgroup.com.

Other recent related TABB research includes: Initial Margin for OTC Derivatives: The Burden of Opportunity Costs; Higher Frequency Swaps Trading: Market Making and Arbitrage; The Changing Environment for Managing Interest Rate Exposure; Interest Rate Derivatives 2011: Collateral Damage in the Duration Market; The Changing Environment for Managing Interest Rate Exposure; and Swap Execution Facilities: An Industry Barometer.

About TABB Group

TABB Group is the financial industry’s strategic advisory and research firm focused solely on capital markets. Founded in 2003 and based on the proven interview-based research methodology of “first-person knowledge” developed by founder Larry Tabb, TABB analyzes and quantifies the investing value chain from the fiduciary, investment manager and broker, to the exchange and custodian to help senior business leaders gain a truer understanding of financial markets issues. For more information, visit www.tabbgroup.com . In January 2010, TABB Group launched TabbFORUM, the online community currently with more than 8,500 capital markets members, drawn from buy-side and sell-side firms, exchanges, regulatory agencies, academia, consultants, vendors and media, focusing on issues covering current industry-wide topics.

SOURCE: TABB Group

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        Martin Rabkin, 914-420-5739
        mrabkin@martinrabkinink.com

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