It has been a long time coming, but the influence of regulation on derivatives pricing still seems to be taking buy-siders by surprise.
"Before the crisis, everyone had basically the same swap model. It was Libor-based. Even if you can't trust Libor today, you could agree what it was," one buy-side trader tells Risk.net. Such a world blinked out of sight at the start of this year.
Since then, understanding the pricing of non-cleared derivatives trades has become universally more complex, firms say. Dealers talk of a tipping point where pricing the cost of capital into trades has become the norm across the industry.
Yet, as rules such as the leverage ratio begin to shape pricing, it is clear their effect varies widely from bank to bank. In some cases, their effect varies widely even from trade to trade.
The bank-to-bank asymmetry arises because of how the leverage ratio works – creating a fixed limit on leverage, but one that some banks are closer to reaching than others. Thus for some the leverage ratio is a binding constraint, for others it is not.
Features of the leverage ratio explain some of the trade-to-trade anomalies, too. Receiving non-cash collateral is costly under the rule, so the way a trade changes a bank's collateral position at the portfolio level with a client can affect its pricing.
In some instances, the effects are counterintuitive. Certain banks are charging to unwind trades if doing so reverses the collateral position of a client – even for long-dated trades that allow non-cash collateral, which buy-siders thought banks would be keen to get out of.
These effects mean understanding pricing is getting harder for buy-siders and dealers alike. Calculating the capital implications at portfolio level of individual trades is computationally intense for banks. Buy-side firms talk of needing to create and maintain "dashboards" of how different dealers price non-cleared swaps.
Buy-siders worry that if they don't understand pricing, they will miss out on the benefit when the capital impact of a trade is in their favour. Collateral considerations will skew pricing, says one trader, "and it is unlikely to skew in the client's favour".
Some are uneasy about whether banks looking to wind down activity in given areas of the market might be more aggressive in charging to unwind or restrike legacy trades.
Meanwhile, derivatives pricing is also getting more complex in other ways, owing to the effect of negative interest rate floors, for example. And in some instances, firms talk of difficulties novating trades to banks where collateral terms between dealers are also a factor.
Banks say the changes are beyond their control. "One actor is incentivised to do one thing, while the other is dictated to by the regulation to act in the opposite way," says a banker. And, broadly, the buy side seems sympathetic to the pressures dealers face.
Yet the practical implications of regulatory change for legacy portfolios are only beginning to become clear. Resolving the tensions that are emerging will be tough.