OTC Markets Eye Regulatory Changes

Terry Flanagan

The transition from a mainly bilaterally cleared OTC business to a centrally cleared OTC derivatives market is likely to be accompanied by an increase in exchange-traded derivatives that are the economic equivalent of OTC transactions.

For example, OneChicago (OCX), a security futures exchange, provides a marketplace for trading over 2,800 futures in more than 1,500 individual equities and exchange-traded funds.

OCX’s Exchange Future for Physical is the economic equivalent of OTC equity swaps, specifically stock lending and equity repo transactions.

Securities lending and equity repos, which are secured lending of stock for cash or the lending of cash for collateral, are covered by a binding ISDA agreement, which provides for the terms of the loan.

“We look at our product as a futures product which is the economic equivalent of an equity repo,” said Thomas McCabe, chief operating officer at OneChicago. “We compete with security-based swaps that are traded OTC.”

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.

“The Dodd-Frank Act is all about managing risk in an appropriate way, whether it’s an OTC swap or an exchange-traded future,” said McCabe.

Different rules governing clearing and margin requirements that are adopted for SB-based swaps and swaps could be detrimental to the markets.

“I can have the same risk exposure whether I have a swap that’s based on the S&P 500 Index, or a security-based swap based on an ETF,” McCabe said. Similarly for single name CDS and CDS indexes. The CFTC and SEC have separate jurisdictions, but it’s critical that those margin and clearing requirements are the same whether trading a security-based swap a swap that’s based on a broad index.”

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.

MarkitServ, an electronic trade processing service for OTC derivative transactions, has built connections to multiple clearing houses to help the swaps industry comply with the mandate to clear OTC derivatives.

MarkitServ provides middleware for OTC derivatives trade processing for cleared and non-cleared trades, across electronic execution venues and off-facility execution in credit, rates, equity and foreign exchange derivatives.

MarkitSERV Credit Centre, a pre-trade credit checking solution for the OTC derivatives market. MarkitSERV Credit Centre provides clearing certainty for trades executed in electronic marketplaces, including swap execution facilities.

“There’s no standard across all FCMs as to how they manage risk, and there’s no standard across clearinghouses,” said Jeffrey Maron, managing director at MarkitSERV. “So we’ve had to create a very flexible system that allows clearinghouses and FCMs to select the methodology of risk measurement that suits the asset class in question, and their client.”

MarkitSERV Credit Centre provides buy-side firms, regional banks and other institutions that access clearing through futures commission merchants (FCMs) with a consolidated view of the credit available to them from their FCMs. It also helps institutions determine how they deploy their credit lines among multiple clearing venues.

OneChicago’s McCabe noted that the CFTC is further along in its Dodd-Frank rulemaking than the SEC, which could create potential for regulatory arbitrage.

“The SEC has pushed much of its security-based swaps regulation out until 2014,” he said. The CFTC is a good six months ahead of the SEC. We would like to see the SEC pick up the pace, in order to avoid confusion in the security-based swaps market.”

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