Phase 3 of OTC Clearing: What Does it Mean for Markets?


September 9 marked the third phase of the OTC clearing mandate that is required under the Dodd-Frank legislation, following the first two phases on March 11 and June 10.  This has resulted in the mandatory clearing of four currencies of interest rate swaps (U.S. Dollar, Euro, British Pound Sterling, and Japanese Yen) through a central counterparty clearing house.

We spoke to Jack Callahan, Executive Director, OTC Products at CME Group, to find out more about how these changes have affected market participants, and the impact on non-U.S. clients.


How are customers adapting to changes in the OTC landscape?

During the first half of 2013, clients were intensely focused on complying with their specific clearing mandate, but now they have transitioned from a compliance mindset to an innovation mindset, and they are looking for a clearinghouse that will deliver innovation and provide the greatest operational and capital efficiencies.  For us at CME Group, we have been increasing our cleared volume market share in 2013 because market participants know about the advancements we have already delivered and they are confident in our abilities to continue to innovate when it comes to portfolio margining swaps and futures, clearing IRS in non-deliverable currencies, futures that can replicate swap exposure, and operational enhancements like automatic netting and seamless terminations.

In August 2013, over 55 percent of the buy side trades cleared globally were cleared at CME, and this represented over $60 billion of notional per day during a month that is typically a slow month in the rates market.  Our open interest has grown to $5.4 trillion, up from $2 trillion at the end of May.

This addition of $3 trillion in open interest represents over 75 percent of the total growth in buy side open interest across all interest rate swap clearinghouses over this period, as there has been a clear shift in client activity to CME.  Over 330 market participants have cleared with CME, including a large number of hedge funds, insurance companies, swap dealers, asset managers and regional banks.  This broad array of clients speaks to our approach of working directly with our customers to design, build, and deliver our OTC clearing solution.


How have you navigated the intersection of swap clearing and the listed futures business? 

Many global swap users are also active in our futures markets.  Both buy side clients and our dealer clearing members are intensely focused on achieving capital efficiencies, and our portfolio margin solution can deliver margin savings of up to 90 percent for certain portfolios.

At the moment, four of our clearing members are live with portfolio margining, and we expect that number to double in the coming weeks as more firms and their clients start taking advantage of this solution.  Clients have been eyeing this for quite some time; and with the three phases of the clearing mandate now behind us, clients and their clearing members now have more capacity to push this forward.

Deliverable Swap Futures (DSFs) have been well received by our customers, and DSF open interest has grown to over $9 billion (90,000 contracts).  Customers like the simple and standardized nature of the contract and the flexibility of executing in a central limit order book or with one of their existing dealer relationships via the block market.  Interest in DSFs has increased this summer, particularly as clients prepare for the Dodd-Frank swap execution mandate, as these clients are already quite comfortable with how they execute futures and they are not yet certain how they’ll execute swaps.


In the past, CME has been perceived as a U.S.-only solution for U.S. clients clearing U.S. Dollar business.  How are your globalization efforts going? 

We are pleased with how many non-U.S. clients are already clearing with us every day and with the volume we are seeing across the 16 currencies we clear, including nine European currencies (EUR, GBP, CHF, SEK, DKK, NOK, HUF, CZK, PLN) and  Asia Pacific currencies (HKD, JPY, AUD, NZD). For example, in August 2013, over 37 percent of our volume was from non-USD currencies, and this is testimony of the global diversification of our business.

We have worked diligently to increase our global product coverage, and this has been a key driver of our market share increase.  Our global client base needs the ability to clear their entire IRS portfolio so they can realize margin offset opportunities and operate under a single operational framework across their entire portfolio during all time zones with clearing available for 23 hours & 45 minutes every business day.


There has been some recent news on CME’s efforts in London.  What is happening with interest rate swap clearing in CME Clearing Europe? 

We have spent a great deal of time with our global customers discussing what they would like from their ideal clearing solution.  Based on feedback from market participants, we have launched interest rate swap clearing in CME Clearing Europe (CMECE), which is a London-based Recognized Clearinghouse regulated by the Bank of England.

The first interest rate swap was cleared in CMECE in March 2013. This facility enables clients to clear locally relevant products like Inflation Swaps in addition to our global suite of products and have multiple choices of collateral segregation under English Law.

Even though the European Market Infrastructure Regulation (EMIR) clearing mandate is likely to go into effect in mid to late 2014, there is a great deal of interest to clear before then to reduce counterparty credit risk and receive better capital treatment, particularly with Basel III implementation in January 2013. Currently, there are also plans to launch a European Trade Repository to help our clients comply with the EMIR trade reporting requirements in the most efficient and cost-effective way possible.

You mentioned the Basel III and EMIR considerations.  How are global customers digesting regulatory uncertainty? 

In July 2013, the CFTC finalized its interpretive guidance on cross-border rules, clarified the definition of a “U.S. Person,” and set October 9, 2013 as the compliance date for certain swap clearing regulations.   Uncertainty around the U.S. Person definition and on cross-border implications were two of the biggest areas of discussion among market participants. Since July, many participants are relieved that they now have clarity on the rules and the timelines.

The CFTC also announced its plan to implement regulations covering all Principles for Financial Markets Infrastructure by December 31, 2013.

It’s fortunate for us that we meet the criteria established for a Qualified CCP at our U.S. and European clearinghouses, and the combination of the CFTC implementation, the CME licensing efforts, and the guidance provided by the Basel Committee on Banking Supervision should allow all EU and Asia-Pacific banks to treat their exposures to CME as Qualifying Central Counterparty (QCCP) exposures, which qualify for preferential capital treatment.


What do you think will be some of the regulatory challenges facing Asian market participants?

It’s difficult to paint clients in the region with a single brush because there are different product and trading preferences throughout the region, and each country has their own view of the regulatory landscape.

A common thread of the clients we work closely with in Asia-Pacific is that they appreciate the operational efficiencies of working with a single clearinghouse for multiple asset classes, and many of them are concerned about the prospect of being forced to clear only in local jurisdictions. This will limit choices for market participants, fragment liquidity, reduce the potential for netting and ultimately and increase clearing costs.

We are working through a number of proposed recognition frameworks and proposals so that global clearinghouses with strong risk management philosophies and track records can continue to operate in Asia for many years to come.  We are in the midst of applying for foreign clearinghouse recognition across various jurisdictions within Asia to provide as much certainty as we can to Asian clients.


Read More:

The Impact of Phase 2 of OTC Clearing


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