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Implementing Dodd-Frank : Examining the Effects of Regulation on Trading, Valuation, & Hedging

Implementing Dodd-Frank : Examining the Effects of Regulation on Trading, Valuation, & Hedging. Mary Ann Thomas Fixed Income Specialist mthomas172@bloomberg.net ph : 212-617-2517. AGENDA:. Hedging with interest rate products: pros & cons

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Implementing Dodd-Frank : Examining the Effects of Regulation on Trading, Valuation, & Hedging

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  1. Implementing Dodd-Frank: Examining the Effects of Regulation on Trading, Valuation, & Hedging Mary Ann Thomas Fixed Income Specialist mthomas172@bloomberg.net ph: 212-617-2517

  2. AGENDA: • Hedging with interest rate products: pros & cons • The mechanics of transacting in the new regulatory environment • New standards for discounting cashflows

  3. Swaps SWAP DESK INVESTOR 5% 5% 3M LIBOR IBM swap: an exchange of streams of payments over time according to specified terms

  4. Yield Curves SWAP SPREAD = DIFFERENCE BETWEEN SWAP RATE (AA) AND GOV RATE (AAA)** SWAP YIELD GOV YIELD SWAP SPREAD YIELD Maturity  **As of 4/27 US GOV is still rated AAA

  5. Gov’t Yield + Swap Spread = Swap Rate How the swap rate is derived…

  6. LOIS Spreads LOIS <GO>

  7. Hedging interest rate exposure • Pre-issuance hedging • Treasury Locks • Rate Locks • Post-issuance hedging • Swaps • Caps, Floors, & Collars

  8. PRE-TRADE Hedging: FWCM <go> • HEDGING AGAINST RISE IN FUTURE BORROWING COST • “LOCK IN” RATE TODAY FOR FUTURE BORROWING

  9. Treasury lock FPA <go>

  10. TREASURY LOCK PROS CONS CAN’T MATCH CASHFLOWS DOESN’T HEDGE CREDIT/SPREAD RISK Less transparency for when issued treasury • INEXPENSIVE • HEDGES INTEREST RATE RISK • EASY TO UNDERSTAND • VERY LIQUID

  11. Forward starting swap SWPM <go>

  12. FORWARD STARTING SWAP PROS CONS LESS TRANSPARENCY MORE EXPENSIVE Increased regulatory scrutiny • HEDGE INTEREST RATE RISK • HEDGES SPREAD/CREDIT RISK • CAN MATCH CASHFLOWS PRECISELY

  13. DDIS <go> POST-TRADE HEDGING:CHOOSING FIXED OR FLOATING INTEREST RATE EXPOSURE?

  14. SWAP FIX-> FLOAT SWPM <go>

  15. Interest rate SWAP • HEDGE INTEREST RATE Exposure • Synthetically convert debt to fix or float • X-currency swap can convert cashflows back to native currency

  16. Interest rate cap • Synthetically convert debt to float • Cap maximum floating interest rate payment • Provides protection against higher rates • Adding floor cheapens total cost

  17. Interest rate cap PROS CONS LESS TRANSPARENCY MOst EXPENSIVE Most complex • HEDGE INTEREST RATE RISK & volatility risk • HEDGES SPREAD/CREDIT RISK • CAN MATCH CASHFLOWS PRECISELY

  18. Regulatory Effects on the OTC Markets BGOV <GO>

  19. Executive summary • Background • Financial services industry groups are affected by Dodd-Frank provisions in different ways: • Reporting, registration, and examinations by new or current regulators • Direct fees/costs, enhanced regulations such as capital requirements, indirect compliance costs • There are two main areas of focus for regulators: • Monitoring companies and markets during normal times • Assistance during crisis times • Dodd-Frank was signed into law on July 21, 2010 • About 45% of the law has been implemented • It will be several more years before all the rules are written and in place • Impact

  20. Systemically important Financial Institutions Are you a SIFI? Do you transact with a SIFI? • 38 bank holding companies have assets of $50 billion or more, including: • Megas: Wells Fargo, Citibank, Goldman Sachs and Bank of America • Regionals: Zions Bancorp., Keycorp and Fifth Third • About 90 other foreign banks doing business in the U.S. will be considered SIFIs for many Dodd-Frank requirements, including: • BNP Paribas, Credit Suisse, and HSBC • Fewer than 25 nonbank financial firms could be designated as systemically important by the Financial Stability Oversight Council. • Prudential Financial, AIG and others currently being considered • First designations expected by the end of the year and reviewed annually • 27 Global SIFIs designated by the Financial Stability Board and Basel Committee • 8 are U.S. companies • List is being updated soon

  21. key terms: • Clearinghouses • Category I, II, III users • End user exemption

  22. Using a swap execution facility (sef)

  23. Bloomberg as a sef

  24. OIS Discounting for Cashflows SWPM <GO>

  25. WHAT’S GOING ON? • SWAP DEALS ARE INCREASINGLY BEING SENT TO CLEARING HOUSES (LCH, ICE,CME) • DODD-FRANK WILL REQUIRE THIS • INSULATED FROM COUNTERPARTY RISK • SUBJECT TO COLLATERAL REQUIREMENTS CLEARING HOUSE

  26. WHAT’S GOING ON? • COLLATERAL EARNS OIS, NOT LIBOR • CHANGING THE WAY WE DISCOUNT CASHFLOWS OF A SWAP AND OTHER DERIVATIVES • LIBOR-> OIS DIFFERENCE BETWEEN LIBOR AND OIS

  27. WHO IS AFFECTED? • EVERYBODY THAT HAS INTEREST RATE SWAPS • SWAP VALUES WILL CHANGE! • GREATEST EFFECT AND DEALS WITH LARGE MK-TO-MKT VALUES AND LONG DATED SWAPS

  28. Contact Information: Mary Ann Thomas Fixed Income Specialist mthomas172@bloomberg.net ph: 212-617-2517

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