- The Swaps Marketplace: Post Dodd Frank Act
Trade Execution
In the post Dodd Frank swap marketplace, central clearing allows for anonymous, more liquid and cheaper execution. Customers are now able to trade either on anonymous central limit order books (CLOBs) or anonymous request for quote (RFQ) trade systems. Low cost CLOB trading will accommodate a wide range of standardized, highly liquid structures. RFQ will still be used to allow bespoke transactions and block size transactions that don’t lend themselves to CLOB execution.
Counterparty Risk
Counterparty risk will now be mutualized as a result of clearing each transaction through a clearinghouse. The clearinghouse will be the buyer to every seller and the seller to every buyer, mitigating counterparty, settlement, and overall systemic risk. Guarantee funds and margin accounts ensure stability. No ISDA agreements are needed and simple clearing agreement with your FCM is all that is required. With such an agreement, customers will be permitted to trade with multiple counterparties.
Result
In the post Dodd Frank swaps marketplace customers enjoy two key components: lessened counterparty risk through central clearing and cheaper, more liquid execution. Because more dealers and market makers enter the market, there is greater competition for customers and thus execution costs drop and liquidity increases. Customers no longer must forgo trade anonymity and thus information leakage is minimized. Customers importantly now have equal knowledge and access to best pricing as it enters the market. Clearing houses mitigate counterparty risk. Systemic risk is lessened in the marketplace because participants enjoy more liquid execution and mitigated counterparty risk.