OTC Migrates Toward Futures Clearing Model

Terry Flanagan

Preparations are underway for mandatory clearing of OTC swaps in accordance with the Dodd-Frank Act, as futures exchanges and potential SEF operators try to stake out their turf in the new regulatory environment.

With firms looking for new ways to bring OTC products to market in response to regulatory mandates including Dodd-Frank, firms with deep derivative industry expertise are assisting market participants at converting existing and new OTC interest rate swap products to the clearinghouse model.

Eris Exchange, a U.S. based futures exchange, has tapped Sapient Global Markets to assist its customer with integration of clearing and trading systems, as well as support for other technology solutions, to help firms take advantage of the Eris Exchange Interest Rate Swap Futures market.

Eris Exchange embeds the cash flows of OTC interest rate swaps into a futures product cleared by CME Clearing and settled to the CME OTC interest-rate swap curve. It allows contracts to be traded as though in an OTC environment while integrating into existing futures clearing and back-office systems, assisting with regulatory compliance and enabling faster time to market.

Sapient will employ its expertise with derivatives clearing and the Eris Exchange product to ensure firms’ clearing strategies are efficient, transparent and compliant under new laws slated to become effective March 11, 2013.

“Sapient will help Eris Exchange clients develop and implement business and technology strategies to achieve faster time to market and reduce the risk and complexity of ongoing regulatory and market change,” said Jim Bennett, managing director at Sapient Global Markets.

Wholesale brokers, meanwhile, are concerned that the “futurization” of the swaps market that’s being fueled by Dodd-Frank Title VII will hamstring corporations that depend on OTC derivatives for hedging risk in commodities, foreign exchange, and interest rates.

“The U.S. futures market, while working very well for a finite set of highly liquid commodities and financial products, restrains competition by limiting methods of execution and having single vertical silos for execution and clearing,” said Christopher Giancarlo, executive vice president of GFI Group, during congressional testimony this week.

“The unabated futurization of the swaps market entrenches the vertical monopolies of the futures industry,” Giancarlo said. “The movement of trading from swaps to futures is a movement toward monopolistic c0ntrold, reduced customer choice, and higher execution costs.”

Neal Brady, CEO of Eris Exchange, said in a statement: “Eris Exchange brings safety, transparency and liquidity to the interest rate swaps marketplace by operationalizing and simplifying the new regulations around OTC swap and derivative clearing.”

Another issue of concern for market participants is the differences between regulatory regimes being adopted in different parts of the world.

International regulators met in New York last month to resolve so-called extraterritoriality issues related to OTC regulations, such as final determinations regarding which derivatives products will be subject to a mandatory clearing requirement, access to data held in trade repositories, and “substituted compliance” for transaction-level requirements.

“We are pleased that global regulator met recently in New York and pledged to harmonize their regulatory reform efforts,” Giancarlo said. “Nevertheless, as operators of global trading platforms, we are observing that U.S. trading firms are being shunned by foreign counterparties in order to avoid having to register with the CFTC as swap dealers.”

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