ISDA analysis on COSTS vs benefit of Mandatory Electronic Execution for OTC Derivs


ISDA has released an excellent in-depth discussion and analysis of the impact of electronic execution requirements on over-the-counter (OTC) derivatives markets that were mandated by the Dodd-Frank Act (DFA).

Effect on Bid-Ask Spreads: ISDA surveyed large number of buyside firms, and here is summary of expected changes to bid-ask spread, no surprises that they all widen (page 23).

Dealer Costs for Swaps: In terms of costs, ISDA estimates the top 16 dealers will invest approx $750mln to get ready, and an additional $150mln in annual operating costs, although these costs will also cover new infrastructure to support other OTC products (page 27).

Costs of Setting up and running a SEF: ISDA estimate the cost of establishing a SEF for IRS to be in the region of $7.3mln, with operating costs of around $11.9mln, see below (page 32)

The paper finds that:

  • OTC derivatives pricing is extremely competitive, compares favorably to similar futures products and, unlike futures execution, is available in large transactions.
  • The electronic execution mandate and the proposed new regulatory framework will limit choice for end-users and ultimately increase transaction costs.
  • The possible benefits for small end-users will be no more than $1,000 for a $10 million interest rate swap before fees for execution and clearing.  Any net benefit for small end-users will be dramatically outweighed by costs to the market as a whole.
  • Estimated initial set-up costs to market participants from the new rules are more than $750 million while ongoing costs are more than $250 million per annum.
  • The initial and ongoing costs identified in the paper amount to approximately $1,300 per transaction.  These costs, of course, do not currently exist in the marketplace.
  • Derivatives users believe restrictive provisions in the proposed rules such as the 15 second rule, the requirement for at least five participants to quote through a request for quote (“RFQ”) platform, very high block trade thresholds and very short block trade reporting delays will negatively impact liquidity and push transaction costs up further.

Hard to see who actually benefits, other than SEFs!

Worth reading here:

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