The FINANCIAL -- Seeing that
a pending regulatory overhaul of the $708 trillion private derivatives
market will bring down the curtain on the lucrative business of dealing
in swaps, UBS is looking for a new way to stay in the
game.
According to London Stock Exchange, in a wholesale shift in how credit derivatives have been traded, the Swiss banking giant has launched an electronic market for credit-default swaps, allowing customers to buy or sell the insurance-like instruments directly with other customers on-screen or trade with the bank's own traders.
The product, called the Price Improvement Network, originally went live in mid-December with a few customers. About $1.3 billion of CDS trades have been executed so far. CDS account for about $32 trillion of the market for private derivatives.
Since credit-default swaps were created two decades ago, dealer banks have controlled trading by taking one side of every trade. Such dealer involvement wasn't legally required, but customers were reluctant to face one another on trades for fear the other party would be unable to honor its obligations. Dealers dominated the market because they were seen as the most creditworthy trading partners.
But under regulatory changes designed to reduce risk in the financial system--led by the U.S. Dodd-Frank financial overhaul law of 2010, and including similar changes in Europe--a substantial portion of the swaps market will shift to open "platforms" resembling futures exchanges and be processed by clearinghouses.
Since clearinghouses will guarantee swap trades, it will become less important to trade with the most creditworthy counterparties, obviating the need for dealers to be on every trade and threatening their hold on a market that has for years been a cash cow for investment banks.
"Dealers are not sure which parts of the business will make the most money postreform--whether execution, clearing or financing--so they're bundling them all together to see what sticks," said Kevin McPartland, principal at independent research firm TABB Group.
UBS is the first major dealer to bring this type of electronic swaps execution-platform to the CDS market. About 50 clients--including asset managers, hedge funds and endowments--are trading on the platform so far, said UBS in an interview Friday, without disclosing names.
Customers are mostly trading default protection on individual borrowers, called "single-name" CDS, so far rather than index CDS, although a market for index trades is available.
The platform also offers live prices in single-name CDS, something that is rare, in addition to live index prices. That means a customer can execute immediately and not have to wait for their trading partner to post a firm price. Lives prices are available on 60% to 70% of the names quoted.
In a survey last year by the TABB Group, all 14 top-tier swaps dealers said they were working on, or contemplating, similar "liquidity aggregation platforms" for clients, McPartland said.
The list is believed to include Credit Suisse; Deutsche Bank and Goldman Sachs Group.Representatives for these firms didn't immediately respond to enquiries or declined to comment.
The UBS platform is designed to allow customers to trade directly with the bank or other customers, aggregating or pooling those resources with the goal of offering a one-stop shop for CDS trading at low prices.
UBS eventually could act as clearing agent on all CDS trades executed on the new platform, even when its execution desk has lost a trade to another firm. That would let it retain customers--and the associated fees--in other areas of business beyond the trading desk.
For now, however, before the swaps regulatory overhaul is implemented, UBS will make money from the bid/offer spreads on trades its own desk wins and a commission on trades customers do with other customers.
On the web-based portal, bids and offers will be open for all to see on-screen, but be anonymous.
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