September 27, 2017 / 2:12 PM / in a year

DERIVATIVES-Inflation swaps begin electronic shift

LONDON, Sept 27 (IFR) - Inflation swaps have made their first foray towards electronic execution with the first contracts traded over Tradeweb’s European request-for-quote platform for interest rate swaps.

The inaugural trade, from Legal & General Investment Management, marks the start of an anticipated shift from voice trading to electronic platforms, which enable traders to request prices from multiple dealers simultaneously, while also reaping the benefits of straight-through processing and direct access to post-trade services such as clearing and compression.

According to Philip Hunter, head of rate trading at LGIM, the transaction marks a significant milestone for the inflation swap market, which has already migrated to central clearing without the aid of a regulatory mandate.

“The STP benefits of electronic execution coupled with the improved price discovery achieved via the RFQ model satisfy the industry’s increasing need to streamline trading desk procedures, while simultaneously enabling buyside firms to demonstrate best execution,” Hunter said.

New requirements under MiFID II, which takes effect across Europe on January 3 2018, stop short of forcing inflation swaps to be traded over regulated platforms - at least in the first wave. But all products will be subject to more stringent reporting rules and best execution requirements as part of the sweeping overhaul.

“More people will use regulated venues for mandated derivatives and we anticipate that they will immediately feel the need to have a uniform workflow for mandated and non-mandated swaps,” Tradeweb’s Europe and Asia business head, Enrico Bruni, told IFR.

“We know from the SEF experience that when clients migrate to the electronic environment for a certain portion of the business, there are benefits to migrating other products and we want to provide avenues for those clients that want to take advantage of that.”

In the first instance, the platform offers zero-coupon sterling inflation swaps out to 50 years and eurozone and French inflation swaps out to 30 years. US contracts are expected to be added in due course while other products that fall outside the scope for the trading mandate are also being considered.

One week after launching, regular trading has been seen in UK and eurozone inflation swap contracts on Tradeweb’s platform. Eight dealers signed up as liquidity providers at launch, with a further three lining up to join and new buyside clients being added on a daily basis.

“It was very exciting to see the response of the buyside customers and in particular the sellside, which showed up to the party despite the resource crunch of MiFID,” said Bruni.

While MiFID II is expected to drive the migration, greater adoption of central clearing ultimately paved the way for inflation swaps to make the shift to regulated venues.

“Clearing makes it easier to make a product electronic as it addresses some of the pricing and onboarding challenges by reducing the credit element and XVA charge issues,” said Bruni.

Although inflation swaps are not subject to the clearing mandate, new margin requirements for uncleared derivatives have driven a migration to central clearing. Typically long-dated, the instruments attract hefty capital charges if left uncleared.

LCH’s SwapClear has cleared more than US$2trn notional of the instruments since launching the service in 2015 and more than 120 buyside clients are now clearing the instruments in the clearinghouse.

Tradeweb is part-owned by Thomson Reuters, IFR’s parent company. (Reporting by Helen Bartholomew)

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