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Regulation to Push Swap Spreads Wider, Greenwich Associates Says

Most companies that use interest-rate derivatives expect tougher capital rules to push spreads on the contracts wider, increasing their costs to hedge, according to a study by Greenwich Associates.

Basel Committee on Banking Supervision rules known as Basel 2.5 and Basel III have led to higher credit charges on swaps for bank customers, increasing trading costs, the Stamford, Connecticut-based consulting firm said today. “The impact will be felt even more widely when the new Basel capital requirements are implemented by all derivatives dealers, which is expected to happen before 2019,” the firm said in the report.

While most derivatives users say they’re willing to absorb the impact of wider spreads without reducing trading, a “large share” of those surveyed said that having to post collateral “would cause them to reduce hedging activity and/or cut back their activity in interest-rate derivatives,” Greenwich consultant Andrew Awad said in the report.

About $1.3 trillion in interest-rate derivatives were traded last year, little changed from 2010, according to the report. Markets are “poised for a pickup” this year after “modest growth in new fixed-income issues overall” in 2011, Greenwich Associates consultant Woody Canaday said in the note. That would mean more derivatives activity, “albeit with some possible dampening as a result of new derivatives regulations,” he said.

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