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APG explores swap futures to cut cost of central clearing

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NETHERLANDS – APG is studying the possibility of using swap futures – a derivative instrument under development in the US – as a means of cutting the cost of initial margins in central clearing.

Speaking with IPE, Thijs Aaten, managing director of treasury and trading, said the central-clearing requirements set under EMIR, the new EU regulation for over-the-counter (OTC) derivatives, could lead to much higher initial-margin costs for end-user clients such as APG.

Aaten added that, even though it is still "cheaper" to continue trading OTC derivatives bilaterally due to the European Commission's temporary exemption for pension funds, APG sees potential benefits in swap futures.

"At the moment," he said, "swap futures are not an attractive alternative because of the exemption from clearing requirements, which means no initial margin requirements currently apply to bilateral OTC derivatives.

"However, looking forward, if pension funds no longer benefit from the clearing exemption, then it will all go down to an economic choice where you have an exposure you want to hedge, and you have to look at the different alternatives available in the market."

Aaten said he was closely following product offerings at ERIS Exchange, a US derivatives start-up specialising in swap futures, as well as at other institutions such as CME and Eurex, to assess what alternative products were being offered to the investment community.

"ERIS does not currently offer a European rate-based swap future and only offer US dollar interest rates at the moment," he said. "APG welcomes the opportunity to help define the specifics of these new instruments."

Both ERIS and CME Group in the US are offering swap futures, arguing that using such derivatives instruments, as opposed to traditional interest rate swaps, would help market players cut initial-margin costs set under the central clearing system.

After CME unveiled its new offering in September last year, Sean Tully, managing director of interest rate products, said: "Our customers will now have a complementary, standardised product that provides the advantages offered by futures contracts, including pricing transparency, the automatic netting of positions and margin savings."

Banks and end-user clients such as pension funds and asset managers have complained about the "unfavourable" initial-margin requirements set for swaps compared with futures under regulations in the US and Europe.

Under Dodd Frank in the US and EMIR in Europe, initial margin calculations are likely to be five to 10-day VaR to a high confidence level of 99.5/99.7 for swaps, whereas the valuation of margins could go down to one-day VaR for futures.

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