CME Updates on Swap Clearing

Terry Flanagan

Waves one and two for mandatory clearing of OTC interest rate and credit default swaps have washed ashore in the U.S., and with massive sums of notional trades successfully cleared and still on the books in the form of open interest, CME Group is moving on to the next steps.

From the initial March 11 deadline through July 1, “our focus was helping clients meet regulatory requirements and get through a huge amount of work on technology development, processing, legal and capital changes,” said Sean Tully, CME managing director of interest rate products.

“Now, we are getting users to optimize those processes,” Tully told Markets Media.

Many futures commission merchants (FCMs) and their customers are seeking savings through portfolio margining. CME expects more participants to take advantage of cross-margining and offsetting cleared swaps with CME interest rate swap futures, now and beyond the third and final deadline of September 9 for Category III participants.

“The way they hedge interest-rate risk will become the focus,” Tully said.

Common swap spreads used by intra-dealer market participant, such as between a cash instrument and an OTC swap, are considered inefficient because separate margins are needed as two different risk pools are represented. The ‘risk price’ could be lowered as much as 85% by using a cleared swap and a corresponding U.S. Treasury future contract, Tully noted, adding that volume of such ‘exchange for risk’ trades has more than quadrupled in 2013, with a single-day high of 250,000 contracts.

The most efficient portfolio margining would be with futures-only trades, Tully added.

By aggregating all customer transactions to a single clearing house, capital and margin savings for traders will amount to billions of dollars, according to exchange estimates.

Cleared OTC interest-rate swaps volume at CME has totaled $4 trillion of notional value since inception; of that, $1.3 trillion was in June. CME cleared $66 billion per day in OTC rate swaps on average, up 64% from $40 billion per day in May. Peak daily volume in June  was $123 billion, Tully noted. Open interest increased 45% to $3 trillion, and 187 new clients cleared these trades last month, the exchange said.

Tully said the OTC interest-rate swap cleared product is the second-most successful interest-rate product launch in the bourse’s history, after the Ultra T-Bond futures which began trading in January 2009.

Some Category II clients, including commodity pools, private funds, and banks, started clearing OTC rate swaps before the Dodd-Frank-mandated deadline of June 10. Many of the lessons learned occurred in the earlier tranche from the first deadline of March 9 for Category 1 entities, which included swap dealers and major swap participants.

“We are not aware of any major glitches since June, and it was helpful that so many did not have to rush through the door,” Tully said. CME expects to see more market participants coming in who don’t trade every day or even every week.

The two-year endeavor for CME and trading entities to implement clearing and adhere to new regulations has been “a huge amount of work,” Tully said, spanning new-product development and launch, education, technology, and new hires. One lingering uncertainty is harmonization of global regulations, he added.

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