Industry Prepares for Buy-Side Clearing
Ahead of regulations, firms are building out their OTC operations.
Dealers and asset managers are preparing for a surge in demand for buy-side clearing of OTC derivatives, prompted by both regulations and market evolution.
Under FinReg, standardized OTC contracts must be traded on an SEF, a trading venue that’s open to multiple participants. In addition, contracts must be cleared through central counterparties (CCPs), which guarantee the contract in the event that one of the parties defaults.
The SEC and CFTC are hammering out rules around critical issues such as defining the levels of capital required of clearing participants and how to protect collateral of cleared swaps in the event of a clearing member’s default. But industry participants are moving ahead in anticipation that clearing volumes will mushroom once the regulations are set.
“Six months from now we will see much higher buy-side participation,” said Supurna VedBrat, managing director and co-head of electronic trading and market structure at BlackRock, said at an industry event on Wednesday. “As we begin to clear, it’s essential that we have in place robust operations.”
For example, BlackRock executes OTC trades in large blocks, which must then be allocated among various investment funds. “The clearing members and FCMs with which we have relationships are providing that allocation methodology,” VedBrat said. “The regulations also will raise margin requirements, so we will need portfolio compression methodology in order to maximize margining efficiency; we don’t see any solutions for that today.”
Sell-side institutions are also building out their clearing capabilities. “We’re ready to support large volumes of buy-side clearing,” said Mariam Rafi, head of OTC clearing, Americas, at Citigroup Global Market. Citi has spent $100 million on its OTC infrastructure, Rafi said.
In the interbank or dealer-to-dealer (D2D) market, the Dodd-Frank Act mandates central clearing and collateral as the principal means for managing counterparty risk, which will spur the demand for buy-side clearing.
“The D2D market has a mandate to increase the volumes of cleared transactions,” said Rafi. The number o products that are centrally cleared will go up dramatically, and that will open the door for buy-side clearing.”
BNY Mellon Clearing has joined CME Group as a clearing member firm in order to clear over-the-counter interest rate swaps.
As a registered FCM, BNY Mellon Clearing provides direct clearing services with major exchanges and central clearinghouses, including the New York Mercantile Exchange and Chicago Board of Trade, which are operated by CME Group, and International Derivatives Clearing Group. The company expects to continue to expand the roster of exchanges it clears through, as well as expand its operations globally.
“There is a desire on the buy-side for clearing,” said Laurent Paulhac, managing director, OTC products and services at CME Group. Institutions like CME are working assiduously with clients to be prepared.
CME has set new daily and monthly records for clearing both interest rate swaps (IRS) and credit default swaps (CDS).
It cleared daily customer volume records of $827 million of IRS on September 9, and over $1 billion of CDS on September 8, the company said.
The company has cleared over $1.5 billion in interest rate swap customer volume in September to date, exceeding the previous record monthly total of $1.2 billion in August. The company also has cleared $2.4 billion in credit default swaps customer volume in September to date, surpassing the previous record monthly total of $287 million in August.
Due to customer demand to clear multi-currency IRS portfolios, the company also announced plans to expand its existing U.S. dollar-denominated IRS offering to include Euro-denominated swaps in October 2011 and British pound, Japanese yen, Swiss franc and Canadian dollar-denominated swaps by year-end.
Phase 5 of the uncleared margin rules (UMR) took effect from September 2021.
Temporary equivalence is set to expire on June 30 2022.
IRS trading volumes have fragmented without an equivalence agreement.
Phase 5 of the uncleared margin rules came into effect on 1 September.
Triparty repos can be executed across U.S. Treasury securities to central clearing.