Clarity on Clearing

Terry Flanagan

Futures exchanges have been building out their capacity for clearing OTC swaps, and have also rolled out futures products that seek to replicate the economics of swaps as part of the ongoing ‘futurization’ of the swaps market.

“You have a market that been fairly opaque and non-transparent converging with a market that’s been publicly traded and transparent,” said Mark Cox, executive director of clearing solutions at CME Group. “As those two converge, that creates opportunities for innovation.”

Mark Cox, executive director, CME Clearing

Mark Cox, executive director, CME Clearing

CME Clearing has been clearing credit default swaps since 2009, and interest rate swaps since 2012, well in advance of the mandatory clearing deadlines.

In the United States, swap dealers, major swap participants and private funds active in the swaps market have all been required, from March 11, to begin clearing certain index credit default swaps and interest rate swaps.

All other financial entities will be required to clear swaps beginning on June 10, 2013, for swaps entered into on or after that date. Buy-side market participants transacting swaps must determine whether they are subject to the mandatory clearing requirement.

“The clearing mandate for Category I dealers did not create any surprises for us,” Cox said. “We have introduced unique capabilities in our OTC clearing model, such as anonymous clearing, real-time clearing, and immediate certainty of cleared status, which are extensions of the OTC cleared model we’ve had in pace for commodities for ten years now.”

CME has “had an increasing utilization of its clearing service by buy-side clients,” Cox said.

In May 2012, CME Group launched portfolio margining of its Eurodollar and Treasury futures and Cleared OTC IRS products for house accounts, and in November extended this capability to customers.

“We received regulatory approval to allow our FCMs to provide their customers the ability cross margin interest rate futures with interest rate swaps,” said Cox. “This was in direct repose to clients’ needs to offset the cost of clearing, and realize capital efficiencies by offsetting the risks between futures and saps. That’s a CME-centric service that we can offer because we are a mulitasset exchange.”

The futurization of the swaps market has engendered considerable controversy, with some market participants claiming that it gives futures exchanges and unfair advantage over swap execution facilities.

Bloomberg this week filed a lawsuit to prevent the U.S. Commodity Futures Trading Commission (CFTC) from implementing what it termed “flawed regulation” relating to the clearing of swaps.

The regulation requires five times the margin requirements to trade a cleared financial swap than an identical cleared financial swap future. This will push investors of all types toward swap futures which have less regulatory requirements, less transparency, but pose much higher investor risk, according to Bloomberg.

“Under the Commission’s rule, similar swaps and futures products will be subject to widely divergent margin requirements,” said Eugene Scalia, a partner at Gibson, Dunn & Crutcher who was retained by Bloomberg, in a statement.
“These arbitrary requirements are the result of a flawed rulemaking process and a patently deficient cost-benefit analysis. The rule will have a serious adverse effect on the market, and on reforms put in place by Dodd-Frank to further the public interest.”

Cumulative volume on CME Group’s deliverable interest rate swap futures contracts is 242,000 since they began trading on December 3, 2012.

The contracts, which were created to meet demand from financial market participants including banks, hedge funds, asset managers and insurers, have the same economic exposure as an interest rate swap, the margin and liquidity benefits of a futures contract, and at expiration all open positions deliver into a CME Cleared Interest Rate Swap.

The swap futures contracts are intended to complement, not replace, OTC swaps.

“We are clearing interest rate swaps with up to 40 separate attributes, and that’s just for plain vanilla swaps,” Cox said. “So there will still be demand for bespoke products.”

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