Converting Swaps into Futures
“Regulators win as ICE converts swaps to futures” –
read the Thompson Reuters
headline on Aug 6. The Intercontinental Exchange (ICE) had announcedthat all its over-the-counter (OTC) cleared energy swaps would be converted tofutures contracts from January 2013.
A “cleared swap” is a term introduced in 2009 as
part of an effort to standardise theOTC derivatives in order to bring them on to exchanges, and be subjected to mark-to-market and margining rules. Cleared swaps are swaps that are traded and settledwith the exchanges. Hence, when a party enters a cleared swap, the other side of the trade is the Exchange.Once a standardised swap trades on the exchange, they quite resemble futures. Inthis article, I show how a swap can be converted into futures. The trade is chosenfrom one of the trades published by the CFTC (the U.S. Commodity Futures TradingCommission) in the U.S. Federal Register in Nov 2010.
We have a fixed for floating WTI (West Texas Intermediate) Crude Oil swap withfeatures shown in
. This swap will have cash flows as shown in
, withParty A paying a fixed rate of $80 per barrel for 100,000 barrels every month andreceiving the floating rate for 100,000 barrels each month. The floating rate is thesettlement rate of the one-month futures expiring on the 22
of the precedingmonth.
Notional Quantity 100,000 barrels a monthFixed Price $80 per barrelFloating PriceDaily official next to expire price for the NYMEX WTILight Sweet Crude Oil FuturesCalculation period One month (i.e. floating rate is re-set once a month)Settlement type CashSwap term Six months (Jan 1 to 31 June)
Chart 1 : Fixed Floating WTI Crude Oil Swap