Structure of Global Swap Market

    The episodic liquidity in many of the swaps markets that they have generally evolved over the past several decades into two-tiered marketplaces for institutional market participants, that is, “dealer-to-customer” (D2C) marketplaces and “dealer-to-dealer” (D2D) marketplaces.

    Dealer-to-Customer (D2C)

    In D2C marketplaces, corporate end-users of swaps and other buy-side traders recognize the risk that, at any given time, a particular swaps market will not have sufficient liquidity to satisfy their need to acquire or dispose of swaps positions.

    As a result, this liquidity “taking” counterparties turn to sell-side dealers and other market makers (i.e., liquidity makers) with large balance sheets that are willing to take on the liquidity risk for a fee.

    These buy-side-to-sell-side transactions are known in the swaps industry as dealer-to-customer or D2C transactions.

    From a market structure standpoint, liquidity takers benefit from D2C liquidity makers acting in a competitive environment.

    The liquidity makers compete with each other, often deriving small profits per trade from a large volume of transactions.

    By relying on their ability to deploy capital to make markets and using their distribution and professional knowledge to offer competitive prices to their customer base, sell-side dealers and other market makers provide essential liquidity to these customers for hedging and other risk-management strategies.

    Dealer-to-Dealer (D2D)

    In D2D marketplaces, sell-side dealers have access to marketplaces operated by wholesale and interdealer brokers for the secondary trading of their swaps exposure.

    These wholesale marketplaces allow dealers to almost instantly hedge the market risk of their large swaps inventory by trading with other primary dealers and sophisticated market-making participants.

    In this way, these wholesale markets are similar to upstairs block markets in stocks or off-exchange block trading in futures for large, sized trades.

    These transactions are known in the swaps industry as dealer-to-dealer or D2D transactions.

    Dealers price their customer trades based on the cost of hedging those trades in the D2D market.

    Without access to D2D markets, the risk inherent in holding swaps inventory arguably would require dealers to charge their buy-side customers much higher prices for taking on their liquidity risk, assuming they remained willing to do so.

    Similarly, swap markets support third-party vendors that provide compression, risk reduction, risk recycling, dynamic hedging, and other services that seek to reduce counterparties’ outstanding trade count, outstanding notional value, or risk exposures.

    These services provide innovative solutions for participants to help them achieve operational efficiencies in managing their swaps portfolios and reduce systemic risk.

    These services exist in the swaps market given the non-standardized terms and conditions of swaps products, such as unique termination dates, coupon rates, and notional amounts that make it operationally challenging to offset risk.

    This situation exists to a far lesser extent in the futures market, given futures products’ standardized terms and conditions.

    Disclaimer: While we make every effort to update the information, products, and services on our website and related platforms/websites, inadvertent inaccuracies, typographical errors, or delays in updating the information may occur. The material provided on this site and associated web pages is for reference and general information purposes only. In case of any inconsistencies between the information provided on this site and the respective product/service document, the details mentioned in the product/service document shall prevail. Subscribers and users are advised to seek professional advice before acting on the information contained herein. It is recommended that users make an informed decision regarding any product or service after reviewing the relevant product/service document and applicable terms and conditions. If any inconsistencies are observed, please reach out to us.

    Latest Articles

    Related Stories

    Leave A Reply

    Please enter your comment!
    Please enter your name here

    Join our newsletter and stay updated!