Swap Compression Continues to Grow

Shanny Basar

CME Group has scheduled its first multilateral compression cycle for sterling interest rate swaps with TriReduce, who has this month also included the first client-cleared trades in a compression cycle.

Compression is a process in which clients can “tear-up” offseting trades in their portfolios to reduce the notional outstanding and number of line items in their portfolio while maintaining the same risk exposure. Use of compression services has increased following the introduction of stricter capital requirements, such as the Basel III leverage ratio, which has led to banks reducing their balance sheets and capital efficiency becoming increasingly important.

Jack Callahan, CME Group’s executive director of OTC products, told Markets Media that this month the US exchange completed its second euro interest rate swap compression cycle with TriReduce. The multilateral compression service is run by TriOptima, the post trade infrastructure provider for over-the-counter derivatives, in collaboration with clearinghouses and CLS, the bank-owned physical settlement system for foreign exchange.

“In total we have done nine multilateral compression cycles – six in US dollars, two in euros and one in Mexican pesos,” added Callahan. “We have two additional TriOptima compression cycles scheduled this year, including our first in sterling.”

CME Group said the TriOptima multilateral compression runs had reduced notional outstanding by more than $10 trillion in aggregate, including €376bn from the euro run this month.

The capital efficiencies from compression have become more important in the European Union as regulatory requirements to clear interest rate swaps have launched and the exchange of margins for bilateral transactions is likely to come into force in the region next year. Mandatory clearing of interest rate swaps for the largest banks, who are also clearing members, began in June this year with the next category of firms following on 21 December and the smallest firms next year.

Callahan said: “We have been pleased by the level of European clearing at CME Group, and have seen a good amount of voluntary clearing coming from our European clients.  Over 80 global clients have cleared euro swaps at CME Group, representing a large and diverse customer base.”

 So far this year 86 participants have cleared euro swaps at CME Group, an average daily volume of €7.2bn, which has led to open interest of €2 trillion. CME said it had cleared €13.8 trillion of euro swaps since launching the offering.

In May Eurex Clearing, Deutsche Börse’s central clearer, also  completed its first TriReduce compression cycle for euro interest rate swaps. That month SwapClear, part of the London Stock Exchange’s clearing house LCH, said it had compressed more than $1 quadrillion of cleared notional since it started offering compression services in 2008.

This month SwapClear and TriOptima announced the inclusion of the first client-cleared trades in a compression cycle. Previously only direct members of SwapClear could compress trades using the multilateral TriReduce service.

Christopher Perkins, global head of OTC clearing at Citi, said in a statement: “Notional optimization and compression are paramount in today’s capital environment, and this capability will help contribute to a safer, more efficient marketplace.”

The client-cleared trades were part of an entire Canadian dollar interest rate swaps cycle with 18 participants who eliminated C$1.38 ($1.05) trillion in notional principal.

The inclusion of client-cleared trades widens the number of trades available for compression, increasing capital efficiencies. Client-cleared trades are from a clearing broker or futures commission merchant who clears on behalf of market participants who are not direct members of a central clearing counterparty. This allows buyside firms to benefit from compression while maintaining the same risk exposure.

John Naud, chief operating officer of global fixed income for Citadel, said in a statement: “We have long supported buyside access to these solutions and look forward to the benefits that this will bring to the market.”

In September the Bank for International Settlements published the latest BIS Triennial Central Bank Survey using derivatives data collected in April 2016 from 52 jurisdictions. The survey did not give a breakdown between cleared and uncleared volumes but Chris Barnes, at analytics and research firm Clarus Financial Technology, analysed the BIS data to calculate how much of the global derivative markets is currently being cleared.

In a post on the Clarus blog, Barnes said he directly compared the volumes reported by the BIS from April to average daily volumes  from Clarus data in that month, which includes all cleared interest rate swaps.

“The take-up of clearing for US dollar IRS is surprisingly low at just 41%,” Barnes added.”The take-up of clearing for Japanese yen IRS is remarkably high at 91%.”

Barnes continued that in the BIS survey the US dollar swap market is over two times than the euro market, but cleared US dollar  swaps are 1.5 times larger than euro swaps in the Clarus data.

“With clearing mandates in different jurisdictions either expanding or just about to come into force, we expect the global uptake of clearing to increase for interest rate swaps,” he said. “From a data perspective, that means more transparency of derivatives markets, with data available on a much more timely basis.”

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