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Derivatives regulation generates boom for some

Global lenders’ need to cut the mounting cost of running their swaps portfolios has turned what was once a cottage industry into a cornerstone of the global derivatives industry.

BGC Partners, the US interdealer broker, became the latest to underline this trend after revealing the value of interest rate swaptions it had torn up for banks this year more than trebled to $3.5tn. A swaption gives a trader the right, but not the obligation, to open an interest rate swap, which are used by companies to hedge against changes in borrowing costs and currencies.

Reform of the derivatives industry, which regulators blamed for amplifying the financial crisis of 2008-2009, is forcing banks to examine every aspect of their trading operations to squeeze out further costs. Basel regulations target the gross value of derivative portfolios of which swaptions are a part.

The likes of BGC’s Capitalab business are now benefiting as banks are happier handing over sensitive trading data to third parties rather than competitors. One service in high demand is so-called compression, an accounting technique designed to lower the gross value of derivatives positions by cancelling offsetting trades.

‘’It reduces the stock of unnecessary instruments. It’s not just a matter of good housekeeping but also gives confidence around resolvability issues,” said Charles Bristow, co-head of rates trading at JPMorgan. “If you have a strong ability to compress derivatives, you can have all the customisation of OTC but with many of the benefits of listed markets.”

The disclosure on Tuesday by BGC comes after ICAP, run by Michael Spencer, last week reported a 20 per cent jump in first-half revenues to £42m for its TriOptima business that offers similar services. In October, it expanded its offering to other big institutional investors who use derivatives, such as hedge funds and asset managers.

In the fiscal first half, TriOptima eliminated $94tn of gross notional outstanding in swaps, taking the total to $862tn since the business was launched more than a decade ago. In a sign of rising demand, Capitalab began 2016 having eliminated a notional €800bn in euro-denominated swaptions. Now, including US dollar deals, that total has jumped to $3.5tn.

In the last six months, Capitalab has begun compressing options on Libor and Euribor forward rates, as well as dollar-yen and euro-dollar currency options. “It’s about 10 times more expensive to keep on the books [than swaptions],” said David Bachelier, Capitalab co-founder and a former interest rate options trader at HSBC and BNP Paribas.

So far Capitalab has compressed about $20bn. Mr Bachelier said he expected growth next year to come from the foreign-exchange industry as customers embrace compression techniques.

“We are very pleased with the enthusiasm in this new FX option space,” said Mr Bachelier. “As dealers become more familiar with the process in 2017, we expect it to continue to grow.”

Mr Bachelier also expects a larger part of the market to move as European rules on off-exchange derivatives come into effect. “A large part of this market is European banks facing other European banks,” he said.

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