The International Swaps and Derivatives Association (ISDA) just announced the publication of a standardized form for over-the-counter (OTC) interest rate swaps called the Market Agreed Coupon (MAC) contract. The contract attempts to standardize the offering of interest rate swaps in the OTC market by specifying available tenors (1, 2, 3, 5, 7, 10, 15, 20 and 30 years), coupon increments (25 basis points), effective dates (IMM dates) and currencies (USD, EUR, GBP, JPY, CAD and AUD).
The MAC contract was developed in concert with the asset management group of the Securities Industry and Financial Markets Association (SIFMA). The MAC contract is meant to"present another alternative to the choice between bespoke interest rate swapsand deliverable interest rate futures" as well as "reduce or eliminate time-consuming unwind processes and market inefficiencies and improve transparency associated with bid/ask spread risk" according to the SIFMA rationale .
The idea behind these new standardized contracts is that when more participants use a smaller set of terms for their swap agreements, those positions can be more easily compared to one another in a process called 'compression'. Compression in this context refers to the practice of netting off-setting interest rate swaps, which can reduce counterparty exposure and expenses. In February 2012, the ISDA estimated that compression reduced the size of the interest rate swap market by approximately 30%. Also, with a smaller set of possible contract parameters, it may be easier to aggregate market prices for interest rate swaps, significantly improving the transparency of this very large and very important derivatives market.
The MAC contract essentially offers a solution in between the conventional, highly-customizable, OTC interest rate swap and the relatively new, highly-specific, exchange-traded interest rate swap futures. It will be very interesting to see which of these solutions is more widely adopted.
Interest rate swaps have been a frequent topic of discussion here on the blog and we're excited to witness the evolution toward increased transparency and liquidity in one of the largest over-the-counter derivative markets in existence today.
