In the new world of cleared trades for over-the-counter (OTC) derivatives, efficiencies have naturally risen to the top as chief concerns for those required to comply with the new regulation. The costs in question deal with soon-to-be required margins for participants in the OTC market. In fact, the Office of the Comptroller of the Currency in 2011 estimated that more than $2 trillion in collateral will be held at third-party custodians over the course of a year due to the new margin requirements.
It is therefore no surprise Risk magazine looked at efficiencies when it evaluated clearing houses for its 2013 clearing house of the year, which it awarded to CME Group.
In its article on the award, Risk sums up the environment and the reasons for its choice:
“The result is intense competition to develop low-margin products and services, and CME Group led the way in both respects during 2012 – first offering margin savings across cleared OTC and futures positions, and then launching a new swap futures contract that promises to mimic an OTC swap, but has lower margin requirements.”
The swap futures contract they refer to are deliverable interest rate swap futures, which were launched in December 2012 to provide a solution for market participants looking to obtain interest rate swap exposure in the new environment, but who want the efficiencies and margin savings of standardized futures contracts.
In a post by Jack Callahan at the launch of the product, Tom Lee of Clifton Group, an asset management firm, voiced the cost efficiency case for swap futures:
“We have clients that are margin constrained. For example, pension clients often need duration to hedge their estimated liabilities but lack large pools of qualified collateral. With centralized clearing, they will be challenged to hold interest rate swaps due to the associated collateral requirements. Treasury futures offer one solution but, depending on spreads, they may not always offer the best solution. Deliverable swap futures provide a viable alternative for gaining swap exposure in a capital efficient manner.”
Risk points out a telling anecdote in their story: The average webinar for a new product at CME Group attracts about 60 people. The webinar for swap futures attracted 900.
Cross-margining is the other area Risk highlighted as a place where savings can be found. The service allows posting of an amount that covers the net risk at any given time across products that are highly correlated. Risk notes why this is especially valuable at CME Group:
CME has the advantage of a huge pool of cleared interest rate futures, so allowing offsets with OTC swaps ought to make it cheaper for users to do everything in one place.
CME Clearing President Kim Taylor notes in the story that depending on a portfolio’s duration, risk offsets of as much as 90 percent can be achieved. Currently the solution at CME Group allows market participants offsets between interest rate futures and OTC interest rate swaps, but has plans to expand the service to energy and foreign exchange.
Stories about OTC clearing these days are filled with references to the regulatory-inspired “rush to clear.” This also could be called the rush to save. And though margin savings are important for OTC market participants, some have argued that this is only good for clearing houses who want to attract the rush of buy-side participants. But as Laurent Paulhac, CME Group head of OTC products and services, pointed out to Risk last August, capital efficiencies are in the best interest of customers too.
“If no capital-efficient solutions are brought to market, the increase in margin requirements could just keep some participants out of the market, and they would not be able to hedge their positions or run their business effectively. So the consequences are very meaningful.”
Watch Umesh Gajria and Jack Callahan discuss CME Group’s Clearing House of the Year award from Risk magazine: