SwapClear may assist OIS development

SwapClear, the interest rate swap clearing service run by London-based LCH.Clearnet, wants to extend the use of overnight indexed swap (OIS) discounting to its entire swaps portfolio – and, as part of that, might help develop OIS markets in countries that don’t currently have them.

SwapClear began discounting dollar, euro and sterling interest rate swaps using OIS in June 2010, and said last month it would do the same for yen-denominated trades from October, which will bring a further ¥1,417 trillion ($18.5 trillion) notional into the new discounting regime.

A parallel move is under way in the over-the-counter markets, where dealers are working to develop a standard credit support annex (CSA) that will mirror the approach taken by SwapClear for the major currencies.Under this framework, derivatives trades will be allocated to one of five silos – dollar, euro, sterling, Swiss franc and yen – with the relevant OIS rate used to discount the trade. So, a dollar swap would be allocated to the dollar silo, requiring counterparties to post dollar cash collateral, with the trades that reside in that bucket discounted using the federal funds rate.

Minor currencies – such as the Norwegian krone – lack liquid OIS markets, and SwapClear uses a Libor-style curve in these cases. Its preference would be to use a local OIS curve, and the company thinks it might be able to help these markets develop – playing a similar role to that of an exchange that obtains pledges of support from market-makers before launching new listed products.

“If we all agree the non-arbitrageable, pure, economically correct model is to discount using OIS, maybe we should try to encourage people to make these markets. We already clear Norwegian krone out to 10 years using Libor for discounting, but maybe we could say ‘we’ll clear Norwegian krone OIS out to 10 years using OIS, but you have to give us two-way prices and we need x amount of participants to make it a valid product’, therefore assisting in developing a liquid OIS market that is referenced for discounting,” said Daniel Maguire, executive director at SwapClear in New York.

In the OTC market, dealers have said they are likely to allocate all minor currency trades to the dollar silo under the standard CSA in the absence of a liquid OIS curve. But some suggest they might ultimately look to copy SwapClear’s approach.

“We will see how they do it at LCH.Clearnet and might try to replicate it in the end. The key will be to have a common approach on both sides,” said one London-based interest rates head.