First Non-Traditional OTC Swap Dealer Begins Swap Clearing on CME

Terry Flanagan

Brokerage and clearing firm Newedge has cleared its first OTC interest rate swap on the CME, marking a turning point in the firm’s history with derivatives transactions.

The transaction, the first to be cleared on CME Clearing by a non-traditional OTC swap dealer, is supported with a default management agreement between Newedge, a futures commission merchant (FCM) member of CME, and its two bank shareholders—Societe Generale CIB and Crédit Agricole CIB.

“It’s a continuation of our expanding presence in the OTC markets that goes back at least 10 years, when we began clearing OTC energy contracts on the New York Mercantile Exchange [Nymex], which is now part of CME,” said Marc Katz, director of OTC strategy at Newedge.

“Our clearing of IRS [interest rate swap] contracts is consistent with the market’s evolution towards expanding the class of products that are subject to clearing through regulation, or made available for commercial reasons,” Katz said.

Newedge’s expansion is in response to regulatory changes—principally the U.S. Dodd-Frank Act and European Market Infrastructure Regulation in Europe—to the $441 trillion IRS market that is paving the way for a shift in the bilateral OTC market to a centralized clearing model.

“We are pleased that Newedge has cleared their first client IRS trade with CME Clearing,” said Kim Taylor, president of CME Clearing, in a statement. “We continue to work with both the buy and sell side, including FCMs such as Newedge, to identify capital and operational efficiencies that ease their transition to central clearing.”

The objective is to increase central counterparty clearing, drive greater transparency and reduce counterparty risk for the benefit of end customers.

“The service that we can offer as a clearing member of CME means that clients can clear trades bilaterally and submit trades for clearing at CME,” Katz said. “CME offers a deliverable swap future which can be transacted on exchange or in blocks, and can be transferred to a cleared swap.”

The Commodity Futures Trading Commission has largely completed swaps market rule writing. On October 12 last year, the CFTC and the Securities and Exchange Commission’s foundational definition rules went into effect with the CFTC now seeking to consider and finalize the remaining Dodd-Frank Act swaps reforms later this year.

Once the final rules associated with running a swap execution facility (SEF) arising from the Dodd-Frank Act are published by the CFTC, Newedge intends to operate in compliance with the rules and regulations.

“While the anticipated regulations around SEFs are still pending, we are fully capable of clearing a trade that would be transacted on a SEF sometime in the near future,” Katz said.

At a roundtable on the “futurization” of swaps held by the CFTC last month, Chris Ferreri, chairman of the Wholesale Market Brokers Association, a trade body, said: “In setting a framework for swaps, Congress adopted something different than the non- fungible futures model. OTC swaps, with their more episodic liquidity, required a different market structure, the futurization of the swaps market perhaps but not the futurization of swaps.”

As the result of CFTC rules completed in the first half of last year, 71 swap dealers are now provisionally registered. This initial group of dealers includes the largest domestic and international financial institutions dealing in swaps with U.S. persons. It includes the 16 institutions—the largest derivatives dealers—commonly referred to as the G16 dealers.

The CFTC is working to finish the pre-trade transparency rules for SEFs, as well as the block rule for swaps. SEFs would allow market participants to view the prices of available bids and offers prior to making their decision on a transaction.

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