By Mary Childs and Matthew Leising
Credit-default swaps traders are executing more of the derivatives on an electronic UBS AG (UBSN) system than at any time since it was started six months ago, according to the bank.
Monthly volumes of index trading on the firm’s Price Improvement Network rose to an average $11 billion in July and August, compared with an average $7.5 billion in the four months ended June, according to the Zurich-based lender. More than $50 billion of the swaps, tied to credit benchmarks including the Markit CDX North America Investment Grade Index and the Markit iTraxx Europe Index, traded through the end of August, UBS said.
Switzerland’s biggest bank is pushing a greater share of transactions onto the automated platform even as the industry’s two-biggest lobbying groups resist regulators seeking to mandate exchange-like systems. UBS’s platform lets customers directly post prices with a so-called order-book model where bids and offers are shown before the trade.
“What UBS did is nothing short of revolutionary,” said Sunil Hirani, who co-founded Creditex Inc., a credit-swaps brokerage he sold to Intercontinental Exchange Inc. in 2008 for $513 million. “The buy side, they’ve got a taste of it now, and you can’t go backwards.”
The Dodd-Frank Act that became law in 2010 requires most swaps to be processed by clearinghouses and traded on exchanges or similar electronic systems after the contracts complicated efforts to resolve the financial crisis four years ago. As regulators continue to write the details of the rules in Dodd- Frank, platforms are springing up to serve the evolving market.
“We’ve taken a view of what regulation’s likely to lead to,” Paul Hamill, a managing director in global credit trading for UBS in New York, said in an interview at the bank. PIN is a “platform that’s a safe sandbox for ourselves and our clients for how the market might look and feel,” he said.
The automated trading is a shift in a market where transactions historically have been negotiated over the phone after dealers, acting as a go-between for clients, send out indicative prices by e-mail. The dealers offer to buy a swap from a client at one price and sell the same contract to another for a higher amount, profiting from the gap known as the bid- offer spread.
In another process that banks and industry groups have more readily embraced, dealers can show negotiable prices on a request-for-quote, or RFQ, system.
Javelin Capital Markets LLC has both a central-limit order book and RFQ platform swaps on indexes and individual companies, according to its website.
Tradeweb Markets LLC, part-owned by broker-dealers, supports RFQ and “click-to-trade” methods for swaps indexes on its institutional platform, and MarketAxess Holdings Inc., the owner of an all-electronic bond and derivatives trading system, offers RFQ for index and single-name contracts and “executable dealer markets” for indexes. Bloomberg LP’s FIT platform use the RFQ model. Bloomberg LP is the parent of Bloomberg News.
TrueEX, co-founded by Hirani, applied this year to be a designated contract market, an exchange overseen by the Commodity Futures Trading Commission.
The International Swaps and Derivatives Association, the industry group that sets standards in the swaps market, and Securities Industry and Financial Markets Association urged regulators last year not to mandate order books.
Swaps market incumbents opposed changes that would crimp profit margins made by keeping prices private, according to Will Rhode, director of fixed-income in New York at Tabb Group, a financial-markets research and advisory firm.
“The whole RFQ debate was originally used as an excuse to argue for why nothing should change,” he said in a telephone interview. “But prolonged regulatory uncertainty has been unexpectedly expensive. These days there is the sense that incumbents would rather just have the rules out so they can adapt their business models rather than keep fighting an indefensible corner.”
Trading on UBS’s PIN system compares with an average $64.2 billion that was traded daily on the four most-active credit swaps indexes in the three months ended June 19, according to the Depository Trust & Clearing Corp., which runs a central registry for $25 trillion in outstanding contracts.
The bank seeks to maintain a rate of at least 85 percent of credit-swap bids and offers that clients can execute on PIN without further negotiation, Hamill said. It’s often closer to 100 percent live, he said.
UBS clients offered contracts tied to about $100 billion of index and $40 billion of single-name contracts through the end of June, all immediately executable, according to the bank.
In August, typically a slow month in the U.S. and Europe because of vacations, 55 percent of trades for single-name credit swap contracts were done between customers, up from 20 percent in June, UBS data show.
“August most closely replicated an environment where dealers are pulling back in liquidity” and clients are “looking for any avenue they can,” Hamill said. “When liquidity was harder to find, clients will work a little harder to find it, and we are a venue where they can.”
UBS doesn’t have immediate plans to register PIN as a so- called swap execution facility, or SEF, under Dodd-Frank, and plans to collect customer orders to send to a regulated SEF also offering live prices, Hamill said. PIN’s future may be an “integrated partnership” with a SEF or designated contract market, he said.
“Some of these other business have been reluctant to cannibalize their business, so they’re waiting till it’s more to the time when SEFs are launching,” Peter Tchir, founder of New York-based macro strategy firm TF Market Advisors, said in a telephone interview. Because it isn’t already a major player in swaps and doesn’t have as much market share, “UBS has had less to cannibalize,” he said.
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