Futures and OTC Worlds Coalesce

Terry Flanagan

Eris Exchange ‘futurizes’ swaps transactions.

Constructs from the futures trading world are being applied successfully to the world of OTC derivatives, as regulators around the world implement reforms mandating central execution and clearing for most swaps contracts.

Technology exists today to implement the execution and clearing of derivatives, as with Eris Exchange, which is operational for the execution and clearing of interest rate swap futures.

“We ‘futurize’ a swap, and our product is cleared at CME,” Stephen Humenik, general counsel, and chief regulatory officer at Eris Exchange, at Markets Media’s Chicago  Trading and Investing Summit on Thursday. “We operate an order book and can also process block trades.”

Eris Exchange is a futures exchange that has applied to the CFTC to be a Designated Contract Market (“DCM”).  Eris Exchange anticipates that it will be designated on Oct. 18.

As a DCM, Eris Exchange will be permitted to list both traditional financial futures, such as its interest rate swap futures contract, as well as, swaps subject to the
Dodd-Frank Act.

“As such, Eris Exchange will satisfy the Dodd-Frank execution mandate and will compete with swap execution facilities (“SEFs”) in the cleared interest rate swap space,” said Humenik.

The business model reincorporates characteristics of  both a swap execution facility and an exchange, and thus bridges worlds of OTC and futures.

For example, Eris Exchange maintains both a central limit order book (CLOB) and a voice-based trading facility for off-exchange block trades.

Under the SEC’s proposed rule, if a securities-based SEF operates a CLOB and a separate RFQ mechanism, then any trade would need to interact with existing interest on the central limit order book at the same or better price before interacting with interest on the RFQ platform.

Market participants are concerned that if a block trade were required to interact with other trading interest on an SB SEF, there might not be  enough liquidity on the SB SEF to execute the entire block trade, leaving a portion of the block trade unexecuted.

The central idea of the Eris Exchange business model is a the linkage of execution and clearing. On Eris Exchange, an executed trade is a matched and cleared trade.

“Trade execution and clearing are simultaneous events,” said Humenik.  “Eris Exchange participants receive immediate confirmation that the trade is completed, that is, execution and clearing certainty.”

Eris Exchange applies clearing firm-established credit limits in real-time prior to trade matching.

Participants and clearing firms are able to view their real-time overall limits and status on Eris Exchange.  Should a credit event occur, Eris Exchange provides the participant and clearing firm with a real-time message and email notification.

As an additional risk-management feature of the futures model, the clearing house, CME Clearing, is responsible for monitoring and modifying the clearing firm’s credit limits. This permits management of the overall credit exposure of the clearing firm.

Pursuant to the CME Clearing House and Eris Exchange Rulebooks, a participant’s clearing Firm can be any of 60+ CME FCMs with $50 million in minimum capita. The clearing Firm is able to accept financial responsibility because it controls the participant’s credit.

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