By Simon Miller

Basel 2.5 and III derivative regulations could result in wider spreads in the market and ultimately increase their cost of capital according to research from Greenwich Associates.

Corporate interest rate derviative users that particiapted in Greenwich's Global Interest Rate Derivatives Study said the regulations had led to higher credit charges on swaps for bank customers, increasing trading costs.

The report added: “The impact will be felt even more widely when the new Basel capital requirements are implemented by all derivatives dealers, which is expected to happen before 2019.”

However, there was less consensus over whether these new margin requirements and revised capital reserve requirements on banks will affect trading practices or hedging strategies.

Overall, a plurality of interest rate derivatives users said the new capital requirements regarding derivatives trading would have little to no impact on current practices, or did not feel they have enough information about the regulations to make a meaningful assessment.

Of those that are concerned about direct and indirect consequences of the regulations, most derivatives users seem willing to absorb the impact of wider spreads without reducing their level of trading activity.

"It's a much different story when it comes to margin requirements," says Greenwich Associates consultant Andrew Awad. "A large share of study participants predict that the need to post collateral would cause them to reduce hedging activity and/or cut back their activity in interest rate derivatives."

Notional trading volume in interest rate derivatives totaled approximately $1.3trn in 2011 and followed a significant decline of nearly 20% the prior year.

Derivatives trading volume from 2010 to 2011 was relatively stable in Europe, decreased in the Americas, and increased in Asia Pacific, with companies in each region respectively accounting for 61%, 23%, and 16% of the global total.

Within Europe trading volume actually declined by approximately 30% in the United Kingdom while increasing modestly on the Continent. The U.K. decline comes in the wake of a 45% drop in trading volumes in 2010. Those global volume totals were rooted in a year of flat global corporate bond issuance and only modest growth in new fixed-income issues overall.

"World bond markets are poised for a pickup in 2012," says Greenwich Associates consultant Woody Canaday. "Corporate bond issuance in Q1 2012 is surging, and a sustained year-long rally would lead to increased derivatives activity among corporate end-users, albeit with some possible dampening as a result of new derivatives regulations."

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