Clearinghouses Gain Ground

Terry Flanagan

The share of credit default swaps being centrally cleared increased in the first half of this year according to the Bank for International Settlements as reforming over-the-counter markets remains important to regulators.

The latest BIS quarterly report said contracts with CCPs rose to 27% of all CDS contracts at the end of June this year, up from 23% in June 2013.

The share of CCPs was highest for multi-name credit derivatives at 34%. The BIS said contracts on CDS indices are more standardised, making them easier to clear than single-name contracts.

The report said: “Central clearing remained an important theme in OTC derivatives markets during the first half of 2014. It is high on the global regulatory agenda for reforming OTC derivatives markets with a view to reducing systemic risks.”

As more credit default swaps have become centrally cleared, there has been an increase in netting as participants seek to reduce counterparty exposure by offsetting contracts with negative market values against those with positive ones.

Net market values as a percentage of gross market values was 23% at the end of June 2014, up from 21% at the end of last year according to the report.

“The prevalence of netting is greatest for CDS contracts with other dealers and CCPs, where it reduced the ratio of net to gross market values to 15% and 16%, respectively, at end-June 2014,” added the BIS. “It is lowest for contracts with insurance companies (85%) and non-financial customers (75%).”

Outstanding volumes of CDS contracts continued to decline to $19 trillion at the end of June this year, compared to peak volumes of $58 trillion at the end of 2007.

The report said: “While trade compression continued to eliminate redundant contracts, the volume of compressions in the CDS segment has slowed since peaking in 2008-09. That said, trade compression made further inroads into other OTC market segments, particularly CCP-cleared interest rate swaps.”

Last month SwapClear, which is part of global clearing house LCH.Clearnet, said it had compressed more than $250 trillion of gross notional outstanding for interest rate swaps by the end of October 2014.

As a result SwapClear is on track to achieve its first ever annual net reduction in notional outstanding in OTC interest rate derivatives. At the end of October SwapClear had $406.9 trillion outstanding, down from start of the year when it had $426 trillion.

Daniel Maguire, global head of SwapClear, said in a media briefing last month: “Reducing notional outstanding in OTC interest rate derivatives in SwapClear to less than $300 trillion is eminently achievable next year.”

The BIS report said that in the first half of this year notional amounts of interest rate derivatives contracts was $563 trillion, about $2 trillion less than at the end of 2013. Outstanding volumes of interest rate swaps fell by 8% to $421 trillion.

“An important driver of the fall in notional values has been the elimination of redundant swap contracts via trade compression, which has expanded significantly in 2014,” added the BIS report.

The report also found a continued shift in activity away from dealers towards other financial institutions. Contracts between dealers and other financial institutions was $463 trillion at the end of June 2014, or 82% of all contracts, up from about half at the end of 2008.

The BIS said: “A potential driver could be the increased use of derivatives by asset management firms and a general shift away from the traditional dealer-centric market structure.That said, the trend towards central clearing of OTC contracts also plays an important role, as it may overstate growth in notional amounts for other financial institutions.”

Once a trade between a dealer and its counterparty is novated to a clearing house, it becomes two outstanding contracts with the CCP.

Featured image via Warren Goldswain/Dollar Photo Club

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