Battle for EUR discounting compensation enters critical phase



Critical phase for swaption compensation

The multi-million euro question over will-they or won’t-they pay is reaching its head as Total Derivatives understands the first requests for EUR swaption compensation have been sent and the first responses, whereby a dealer gives its legal viewpoint on the issue, have been returned.


“There has been a lot of reaching out and a lot of people asking for money,” said one source, “I have not seen anyone offer to pay compensation,” they added.


Some traders argue the next few days will be crucial as banks reveal their position and a body of opinion starts to form, giving the market a better idea whether a large enough consensus exists to move forward with a compensation scheme. Should a few banks turn around and not offer compensation, most traders agree it will make it more difficult to proceed.


Market talk over the past few days has included reports that:


  • Some clients have already been asked by their counterparties to pay compensation, a move that rival dealers describe as very surprising, adding that “obviously there must be a decent amount of money involved” for a dealer to pursue a client for cash. An example could be a real money client holding a deeply in-the-money receiver swaption.


  • One bank has been approaching other banks and trying to get them to sign up to a letter.


  • Some institutions are considering stating publicly where they stand on the issue.


  • Several dealers are wary about having conversations with clients in case they disclose information that breaches competition and anti-trust laws. In other words, either by revealing the firm’s general position on the issue of compensation, or by speaking to a client about specific trades held by that client, it could disclose information about what a firm plans to do with another client’s trades.


  • Dealers in favour of compensation have paired up with service provider Capitalab and are conducting test runs in a move they hope will show regulators that value transfers can be exchanged efficiently.


  • There is talk of certain banks getting together and forming a new Working Group to discuss the outcome of the ECB-convened Working Group on Euro Risk Free Rates.


  • Banks in favour of compensation continue to lobby the US regulator CFTC and the European regulator ESMA, pressing them to issue a clearer directive and coerce banks into compensation. Given the banks lobbying for compensation are said to be predominately European, some argue this makes the US CFTC less likely to intervene on the issue (the US faces its own CCP discounting switchover in October this year).


Ahead, time is of the essence given the discounting switch is scheduled for July 27 meaning the first option expiries to be hit by the changeover are less than four weeks away. “The reality is that the next week or so will be really critical as the window for trying to make compensation happen is going to shut pretty quickly,” said one dealer.


Still, some fear it will not be the end of the matter with disputes continuing after July’s big bang and dragging out for the rest of the year. “My concern is that as some banks continue to pursue the issue you end up with market fragmentation whereby banks from one country want to do one thing and banks from another country want to do another thing.”


Amid the ongoing uncertainty, EUR option dealers continue to be exposed to the market risk from the 8.5bps difference between the new discount rate €STR and former discount rate EONIA. “There are significant delta differences based on which discounting methodology you use, and markets do move,” noted one trader.


Whatever the outcome, there are clearly going to be some big winners and losers given the sums of money thought to be involved, “Whether or not they are large enough to be career-ending sort of numbers is not certain,” felt one source.   


For more background, please see Conflict persists amid voluntary swaption compensation recommendationFierce debate greets EUR swaption compensation proposals€STR discounting battle tests dealers' relationship with clients and Banks battle it out for €STR compensation