Principal Trading Groups to Make Markets for Interest Rate, Credit Default Swaps

Principal trading groups, firms that flourish in highly liquid and electronic markets, will become the new market makers for interest rate and credit default swaps once the new regulatory landscape is in place, a Tabb Group report contends.

PTGs will benefit from the Dodd-Frank mandate requiring swaps trades to go through central clearing since it'll be easier to trade in and out of positions quickly, Tabb Group analyst Kevin McPartland wrote in a report entitled "Higher Frequency Swaps Trading: Market Making and Arbitrage."

He added that statistical arbitrage will exist in the new marketplace, but it'll be slower to develop and will only be in favor when automated market making meets an already liquid market that's backed by real money trades. He also sees those companies boosting the amount of liquidity in the marketplace.

"Trading, clearing and reporting mandates need to be in place so that market and trade data can be generated sufficiently and available publicly to make stat arb trading accessible to most PTGs," McPartland wrote.

But despite the near certainty that even the most vanilla products will have to be traded on swap execution facilities and go through central clearing, most firms are still unprepared for the new regulatory requirements, he notes. Further compounding matters is the lack of clarity throughout the industry on how the new rules will function, the report adds.

The "unresolved and nuanced details of (the) proposed rules could still leave barriers to entry excessively high," McPartland wrote.

Meanwhile McPartland predicts PTGs will drive nearly a third of all the trading volume in the over-the-counter energy swaps markets. But with the U.S. political system facing gridlock over the near-term, McPartland adds that he doesn't expect full implementation of the new OTC derivatives rules until at least 2013.

"The groundwork, however, is set and there's no turning back," he wrote. "The pre-SEF era is upon us and electronic swaps trading will see slow growth over the coming months."

As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced Trading in 2010, Grant's news analysis has touched on everything from the latest ... View Full Bio