Clearing up Deutsche’s swaps ‘shift’

Reported move of euro business is not as straightforward – or as dramatic – as it seemed

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In the battle for euro swaps clearing, Frankfurt scored some points this week, as Deutsche Bank moved half of its business to Eurex.

The news was broken by the Financial Times, and seized on by dozens of other outlets – plus UK celebrity businessman, Alan Sugar – as a sign Brexit is starting to have an impact on London’s strength as a financial centre.

The problem is that cleared swaps don’t move – they have to be offset, compressed to zero, and then executed anew at a different venue. And Deutsche Bank says that’s not what happened. There’s also been no physical transfer of people or operations as some reports suggested.

So, what did happen?

The official line is that “a large part” of new cleared swaps business will be cleared in Frankfurt, according to a spokesperson at the bank. But, to a large extent, this isn’t Deutsche Bank’s choice. The clearing venue for an interest rate swap is determined by the client, not the dealer, and it would be no surprise if the customers of the German bank’s clearing franchise were choosing a German clearing house.

There may still be a Brexit angle here, however. If more of Deutsche’s clearing clients are starting to send their trades to Eurex, then it may be a reflection of their desire to avoid a disorderly Brexit. And as more of the client business travels to Frankfurt, Deutsche Bank is able to send a larger portion of its house business – interdealer trades that hedge client activities – in the same direction.

According to a source familiar with the situation, Deutsche Bank is currently sending as much as 40–45% of new euro swaps business to Frankfurt.

The bank presents its motives in all of this as straightforwardly commercial, stemming from a profit-sharing agreement introduced by Eurex in late 2017 – the German venue’s attempt to prise business from LCH on a voluntary basis.

Of the 30 scheme members – soon to be 35 as the first hedge funds seek membership – the top 10 firms (ranked by volume with additional credits awarded for other metrics such as pricing quality and introducing new clients) enjoy a share of the profits. The bigger their share of activity, the bigger the spoils.

Deutsche Bank is already topping that table, closely followed by JP Morgan and BNP Paribas.

A big caveat applies here as well. The bulk of trades currently being directed to Frankfurt are short dated and low risk. Of the €8 trillion ($9.3 trillion) notional in cleared euro swaps sitting with Eurex, €5.7 trillion are forward rate agreements (FRAs) – interdealer products where the clearing venue is not dictated by client needs. That represents around 12% of total cleared euro FRA notional but Eurex reckons its share of new trades has been almost half the market’s volume in some months.

Boiling it all down, there are some signs that Brexit tailwinds are benefitting the German exchange – but this is a story that has some way to run. Based on this week’s coverage, you might assume it was already over.