A New Way to Hedge Interest Rates


With the Dodd-Frank clearing mandate approaching, market participants are looking for more capital efficient alternatives for their OTC activity.

Deliverable Swap Futures (DSF) may provide a solution for those looking to obtain interest rate swap exposure, but who want the efficiencies and margin savings of standardized Futures contracts.  DSFs can be executed across multiple venues like electronically via CME Globex, via block trades, or open outcry in the trading pits, and at expiration of the future, all open positions deliver into CME Cleared Interest Rate Swaps.  DSFs were created based on client demand from both buy and sell side firms, and we have a strong amount of support from market participants heading into the launch.

CFO magazine summed this up when writing about DSFs in November:

“Centrally cleared swaps and now futures products will provide nonfinancial companies more options for hedging interest-rate risk. And that’s a good thing, because, although bilateral OTC interest-rate swaps aren’t going away, they could get more expensive.”

We are at a new time in the market with a changing regulatory environment. These are often the times that provide the most opportunity for innovation to meet new demand.  Tom Lee, senior portfolio manager and principal of The Clifton Group is one such market participant who sees value in the new product. We decided to ask him a few questions about how he sees DSFs working in the new environment.

Does the current regulatory environment make deliverable swap futures more attractive than some of the OTC alternatives?

In the centralized clearing world we are moving towards, there is a material margin requirement associated with OTC interest rate swaps.  Deliverable swap futures have significantly lower margin requirements than OTC interest rate swaps when they are centrally cleared.  The reduction in required margin gives deliverable swap futures an enormous advantage over centrally cleared OTC interest rate swaps.

 Can you describe a client or situation that would benefit from using DSFs as opposed to other futures or swaps products?

We have clients that are margin constrained.  For example, pension clients often need duration to hedge their estimated liabilities but lack large pools of qualified collateral.   With centralized clearing, they will be challenged to hold interest rate swaps due to the associated collateral requirements.  Treasury futures offer one solution but, depending on spreads, they may not always offer the best solution.  Deliverable swap futures provide a viable alternative for gaining swap exposure in a capital efficient manner.

 How are you talking to your clients about the product?

We most definitely are speaking with clients about using deliverable swap futures.  As more clients come to understand the capital requirements associated with centrally cleared swaps, their interest in deliverable swap futures will grow.

 What else do you want to share about the new contract?

I think swap futures have the potential to be very successful.  Previous attempts to develop a liquid swap futures market achieved modest levels of success.  Liquidity never reached escape velocity.  This contract is different.  As noted, it currently provides a significant capital advantage over centrally cleared swaps.  Additionally, the ability to take delivery should increase the efficiency of the calendar rolls, a problem  with previous swap contracts.

Watch Sean Tully, CME Group managing director of interest rate products, and Pete Barker, executive director of interest rate products, discuss what the launch of Deliverable Interest Rate Swap Futures means for customers.



Jack Callahan is Executive Director of OTC products and services at CME Group.

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