Clearinghouses Transition to OTC Regime

Terry Flanagan

Governance and default management top list of priorities.

Clearinghouse operators are making the transition to a new regulation regime for OTC derivatives born out of the Dodd-Frank Wall Street Reform, Act, including revamped governance and default management.

Under FinReg, most vanilla, or standardized, OTC derivatives contracts must be centrally cleared. The CFTC and SEC are crafting rules aimed at fulfilling the law’s goals of transparency and risk management.

One of the biggest hurdles will be transitioning from a clearing model for listed products to one that encompasses both listed and OTC.

“One-size clearing doesn’t fit all products,” said Chris Edmonds, president of ICE Clear Credit, at the ISDA North American Conference in Manhattan on Tuesday. “Just because someone has experience clearing in a deep and liquid futures market may not qualify them for derivatives.”

ICE Trust U.S., ICE’s North American credit default swap (CDS) clearing house, has complete its transition to a CFTC-regulated Derivatives Clearing Organization (DCO) and SEC-regulated Securities Clearing Agency (SCA) as required by Dodd-Frank. In addition, the clearing house has converted from a New York State Banking Department and Federal Reserve regulated bank and has been renamed as ICE Clear Credit.

A key concern is the protection of collateral in the event of a default by a clearing member.
“Having a proven and workable default management process is a vital part of what we do,” said Andrew Maguire, president of LCH.ClearNet’s SwapCear. “There needs to be a process in pace for an orderly unwind.”

However, despite the fact that the law requires that most OTC transactions be centrally cleared, many swaps are already being cleared today and have been for some time, Maguire said. “About half of the interest-rate swaps contracts are centrally cleared,” he said.

Since its launch in 1999, LCH.Clearnet’s SwapClear has cleared over 1.6 million OTC IRS trades. SwapClear currently has 57 clearing members and its portfolio contains 950,000 trades with a notional value in excess of $300 trillion. A further $66 trillion of cleared transactions were removed through multilateral trade compression.

Clearinghouses are enabling customers to choose whether or not to have their collateral kept separate from that of other customers.

The CFTC has proposed that futures commission merchants (FCMs) and derivatives clearing organizations (DCOs) be required to segregate the cleared swaps of each individual customer and relevant collateral, while permitting FCMs and DCOs to operationally commingle all relevant collateral in one account, known as the legally-separate and operationally-commingled (LSOC) model.

CME Group favors permitting cleared swaps customers that desire or require full physical segregation of their contracts and associated collateral to opt out of the commingled customer account of their FCM.

CME Clearing has engaged in initial customer discussions concerning the structure of an opt-out model. One possible approach would be the use of multiparty agreements among the DCO, a settlement bank designated as custodian, the customer and the customer’s sponsoring FCM clearing member.

ICE Clear Credit will continue clearing the 168 products it offers for clearing across North American CDS indices (CDX) and single-name instruments as a DCO and SCA.

More than $725 billion in open interest has been established since the launch of ICE Trust in March 2009, which will transition to ICE Clear Credit as part of the conversion process.
ICE established ICE Trust, the world’s first operational CDS clearing house, in response to calls from policymakers and market participants for greater transparency in the credit markets.

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