Swaps and Futures Converge

Terry Flanagan

The futures industry is gravitating toward exchange-traded swap futures as a way to enjoy the benefits of cross-margining and clearing as the regulatory environment places new burdens on users of traditional OTC swaps.

RBS Securities Inc. will act as a clearing member of Eris Exchange, a U.S.-based futures exchange offering interest rate swap futures, and as such will provide execution and clearing services to RBS’s global client base via this channel. In addition to supporting client clearing, RBS will offer its clients access to Eris SwapBook, Eris Exchange’s electronic central limit order book.

“For existing and potentially new futures clearing clients, we want to make sure they are aware that we are now a clearing member of Eris,” said Jeff Howard, global head of prime services at RBS. “Therefore, if they choose to execute and clear on Eris, they can choose us as their FCM.”

Jeff Howard, RBS Securities

Jeff Howard, RBS Securities

RBS decided to become a clearing member and offer execution and clearing on Eris Exchange in order to satisfy customer demand for new products, which it felt that Eris can provide. “Due to the ever changing regulatory environment, a swap futures exchange will be the natural beneficiary of these new regulations,” Howard said. “We wanted to be in a position where we can effectively offer these products to our client base. As the mandatory OTC clearing world remains uncertain from a product and volume perspective, our buy side clients are looking at other avenues.”

Eris Exchange’s cash-settled contracts are cleared by clearing firms through CME Clearing. Current open interest on Eris Exchange is 121,000 contracts, the company said in a release.

In May, RBS announced that it was winding down its rates prime brokerage and rates OTC clearing businesses, citing an increasing level of capital, operating costs and investment that would be required for the businesses to be globally competitive in a market with extremely thin margins.

“This announcement by RBS, coupled with their announcement that the bank is exiting OTC clearing, is indicative of a much wider industry trend that we’re seeing here at Eris,” said Neal Brady, CEO of Eris Exchange. “Specifically, our product fits with the new swap market that’s evolving, and our model is very attractive to firms trying to run a profitable FCM clearing and execution business in this new era.”

Some FCMs have traditionally been more focused on clearing in-house business rather than pursuing third-party client mandates, “but the new swap market is causing many bank FCMs, including RBS, to re-think their model and to focus on generating new business opportunities,” Brady said. “RBS started to review their OTC clearing business about a year ago, and since then, has started to successfully build out their Futures & Options and FX Prime Brokerage offerings.”

Eris swap futures are a futures product that is backed by the main financial guarantee fund at the CME, where FCMs have already contributed capital and the default procedures are well-known and time-tested, Brady said.

For clients, Eris requires less margin and therefore FCMs have to hold less capital against these open client positions. “Compared to OTC clearing, Eris is a lower cost and therefore more profitable product for FCMs to offer their clients,” Brady said.

In the futures financial guarantee model, the client is backed by the FCM, which represents that client into the exchange, which in this case is Eris Exchange. Trades on the exchange are then guaranteed by the clearinghouse, which in the case of Eris’ USD IRS futures product is CME Clearing. “It’s a very linear and straightforward model and the client risk is borne by the FCM,” Brady said.

Featured image via freshidea/Dollar Photo Club

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