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Paul Rowady

TABB Group

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Paul Rowady

13 October 2011

An Agency Brokerage Model for Swaps: Navigation for New Liquidity Access

Executive Summary
The writing is the wall:  Clearing, margin and execution mandates represent the combined forces that will drive the OTC derivative product spectrum further from the exotic to the vanilla.  The impact of these shifts will further decrease the profitability of vanilla transactions while simultaneously increasing the opportunity cost of warehousing risks in the principal model.


An agency brokerage model for swaps is emerging as a potential antidote for these impacts; a means by which dealers-turned-brokers will seek compensation from execution and related services as the primary payment mechanism.  However, since there has never been a need – much less, a desire – to contemplate an agency model for swaps, the journey towards developing one will be riddled with challenges.  Though regulatory uncertainty has given way to rays of clarity, operational uncertainty will now gladly fill the void.


At the top of the challenge list is liquidity aggregation.  No one yet knows to what extent, for which products and under which trading models swap execution facilities (SEFs) and related execution venues will manifest themselves in the new OTC derivative landscape.  And since execution services are central to the success of the agency model, the form of such an operation remains in question too.  That said, some level of fragmentation is expected, and therefore, liquidity aggregation is certain to be a priority and the technology to manage fragmented liquidity will become a core competitive advantage.


TABB Group believes that the technology spend necessary to navigate the new liquidity landscape for internal dealer flow purposes can be repackaged and redeployed as an external client-facing trading platform with minimal additional costs.  Despite this potential advantage and the first-mover novelty of an agency swaps desk, significant challenges remain.  Since there is a level of inevitability to the launch of agency desks for OTC derivatives, the competition to attract business, while maintaining a suitable balance between an agency desk and the traditional OTC flow operations, will be won incrementally.  Services such clearing, cross-asset trading overlays, and portfolio finance, are examples of add-ons that make the agency desk more compelling, particularly for what many hope will be an insurgence of new participants to these markets.


At minimum, if the agency model can be deployed for OTCDs in such a way as to assure break-even (or at least, minimal loss) performance in the near term, then it will serve as a strong business hedge against the possible scenarios that could play out as the regulatory dust settles.


TABB Group Vision Note
An Agency Brokerage Model for Swaps: Navigation for New Liquidity Access
This 22-page, 18-exhibit vision note details how the move towards more vanilla product structures could make an agency brokerage model for swaps successful, and at minimum, how the development of an agency desk for swaps is an effective business hedge for dealers against remaining unknowns.  Furthermore, this report estimates how much of an increase in volumes would be needed to compensate dealers for recent levels of profitability in the bilateral era.

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