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The Interest Rate Swaps Market: An Old Product Has New Issues

The Interest Rate Swaps Market: An Old Product Has New Issues

Interest rate swaps have served as important risk management and financial engineering tools for many years. New regulations will be far-reaching, but their full impact remains up in the air.

Boston, October 12, 2010 – A new report from Aite Group examines interest rate swaps (IRSs), the changes expected from regulatory reform in this space, and regulators’ determination on requirements for swap execution facilities (SEFs). Based on a number of Aite Group interviews with IRS market players, the report cites the applications this mature product confers upon banks’ risk management strategies and issuer needs.

Though similar to the credit default swap, IRSs’ oft-mentioned OTC derivative counterpart, interest rate swaps are much more frequently used, and serve as part of banks’ interest rate risk management and debt issuances. The IRS market will change under legislation outlined in the Dodd-Frank Wall Street Reform and Consumer Protection Act (aka FinReg) and new rules implemented by the CFTC/SEC. This change, however, will fall well short of legislators’ hopes.

A major issue at play is how the regulators will determine the ownership structure of a swap execution facility and what related reporting requirements will be implemented. A new, proprietary-shop-backed entrant, Eris Exchange, may challenge the traditional liquidity providers. Outside of this threat, interest rate swaps trading is expected to change modestly given that the nature of this mature product will ultimately determine its market structure.

“The interest rate swaps market is unlikely to experience large-scale changes in the near to medium term,” says John Jay, senior analyst with Aite Group and co-author of this report. “Within the context of regulatory reform, the structure of IRSs and their usage will determine how the IRS market will evolve.”

This 18-page Impact Report contains six figures. Clients of Aite Group's Institutional Securities & Investments service can download the report.