Futures Exchanges Ready to Clear Swaps

Terry Flanagan

Futures exchanges are ramping up their clearing subsidiaries to enable corporations, hedge funds and asset management firms to clear their OTC derivatives, as mandated by the Dodd-Frank Act.

Although the bifurcation of the OTC swaps world into cleared and uncleared products holds implications for margin and collateral, both of these models can be accommodated with the structures that are now being put in place.

“We believe that these two models have co-existed, and we don’t have any reason to think those things will change,” said Sunil Cutinho, managing director of clearing operations and systems at CME Clearing.

“CME has worked closely with buy-side and sell-side participants to build a multi-asset class OTC clearing platform, which builds on the strength of CME Group’s Interest Rate and FX futures and options products,” Cutinho said during a panel discussion at the FIA New York Expo on Thursday.

Through the first quarter of 2013, over 75 firms have cleared trades at CME, including asset managers, hedge funds, insurance companies, GSE’s, and proprietary trading firms.

“The evolution is more relevant to OTC than to futures,” said Cutinho. “Previously, OTC has not had clearing. Both SEFs and exchanges will co-exist. Entities providing the best risk management and most efficient trading and execution services will win in the end.”

On April 15, 2013, ICE Clear Credit will being customer-related clearing services for single name CDS instruments.

ICE Clear Credit will clear the single name CDS instruments under rules that permit customer-related single name CDS positions to be held together with customer-related index CDS positions in a single account.

The SEC and CFTC have jurisdictions over separate parts of the swaps market, with the SEC overseeing security-based swaps, or swaps based on a single name or narrow index, while the CFTC oversees all other OTC swaps.

“In the world of CDS, the Dodd-Frank Act split jurisdiction between single name and broad-based swaps between the SEC and CFTC,” said Chris Edmonds, president of ICE Clear Credit, at the FIA Expo.

The SEC requires clearing participants to collect margin at least equal to 200% (or 150%, with respect to customers that present “virtually no credit risk”) of the margin calculated under the ICE Clear Credit portfolio margin methodology.

Clearing participants need to ensure that customers are aware that the 200% margin requirement will apply to the customer’s entire portfolio, including index positions.

“The benefits of portfolio margining cannot be realized under such a regime,” said Edmonds. “[Regulators] have used a blunt instrument to solve the problem. However, I remain optimistic we will solve this in a commercially friendly manner.”

Total volume in CME’s deliverable swap futures is over $21.5 billion, with open interest at $3.4 billon since its December 2012 launch. The product offers futures-style margining and netting by providing margin offsets against Eurodollar and Treasury Futures. All open Positions are delivered into OTC cleared IRS Swaps at expiration.

The CME platform enables firms to negotiate, execute and submit trades through 11 affirmation platforms and SEFs.

“Time lags in the clearing cycle introduces potential credit risk, and with a faster clearing cycle this risk is reduced and leads to more efficient risk management,” said Cutinho.

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.

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