Even though the exact timeline for EMIR (European Market Infrastructure Regulation) has yet to be finalized, CME Clearing Europe is not resting on its laurels. Towards the end of March this year, it announced the launch of interest rate swap clearing; the firm’s first foray in clearing OTC financial derivatives in Europe. In doing so, CME Clearing Europe (which launched in May 2011) became the third main player to support European buy-side firms, along with Eurex and LCH.Clearnet.
“We had been clearing a selection of energy products at CME Clearing Europe prior to March such as bio diesel swaps,” explains Derek Sammann (pictured), Senior Managing Director, Interest Rate & FX Products at CME Group.
“We’ve rolled out our IRS clearing capability in Europe not because it’s mandated - it’s probably still six to 12 months away - but because we’ve learned that through the process of IRS clearing in the US you need to get to market and have a solution available well in advance of the mandate to let firms pre-mandate begin to clear if they wish. European clients might put one or two trades in, see how the cash flow works, see how it impacts their trade books. It’s important that we’re there to support them. That’s why we’ve accelerated our ability to commence IRS clearing in Europe well ahead of the EMIR mandate.”
In the US, of course, the regulatory juggernaut that is Dodd-Frank has already started moving. The requirement for market participants to clear swaps and CDS is being phased in. Phase 1 commenced in March – this applies to swap dealers or major swap participants trading 20 swaps a month – with Phase 2 scheduled for June followed by Phases 3 and 4 in September and December.
Sammann confirms that in the US, CME Group was clearing around USD3.5billion a day in Q1 last year. “We’re now averaging close to USD20-25billion this quarter so our volumes are up nearly eightfold.”
The bulk of that volume is short-dated IRS in US dollars, followed by euros, sterling, Swiss francs and yen. This shows that volumes are dominated by short-term vanilla IRS that are the most liquid and which are also the most highly traded.
“For CDS we’re focused on the indexes, we’re not clearing single names at the moment. The index part of the CDS market in the US is captured under the CFTC whereas single name CDS falls under the SEC. We’ve heard that there’s less desire for single name CDS primarily because of liquidity. If it’s patchy, firms might shy away.”
To get operationally ready to clear OTC derivatives has been a massive effort for CME Group. Through the acquisition of NYMEX in 2008 the firm had the capacity to clear OTC derivatives within the energy space. It then leveraged heavily on this energy clearing infrastructure to get itself ready to clear contracts in a wider OTC context.
As Sammann explains: “There was a realization back in 2010 that the infrastructure that we’d built for OTC energy could form the backbone for clearing all OTC derivatives under Dodd-Frank. Fast forward to today and we’ve got all the ClearPort API (Application Programming Interface) functionality at the back-end, we’ve got institutional capability and knowledge in our clearing house for how to clear, handle, manage OTC transactions. OTC energy clearing point since when we’ve been building functionality to support IRS, CDS, and, eventually, FX clearing.”
The shift towards OTC clearing is a huge collective undertaking for clearing houses, clearing firms and buy-side clients. The use of a CCP is a mutualised risk model that shifts the market away from what were exclusively bilateral arrangements to one where both the FCM (as a clearing house member) and the buy-side client will be required to post margin into the CCP. It’s a radical departure, with many still coming to terms with the concept that derivative contracts like IRS will now be cleared on daily mark-to-market basis, just like exchange-traded futures.
Sammann says that the firm is spending as much time consulting with clearing firms and their clients as it is onboarding clients and connecting them to the infrastructure. With daily mark-to-market, margining requirements and use of eligible collateral, buy-side firms face a lot of decisions as they move into this new world of OTC clearing.
“Customers are going to have to consider, among other things, what their portfolio margining is going to look like at CME Group versus someone else,” says Sammann.
“We’ve got portfolio margining for clients that trade futures and swaps. They can put those in a single portfolio and if the manager is long a swap, short a future that can be netted down close to zero. Customers have to weigh that benefit of portfolio margining at CME versus not being able to do portfolio margining anywhere else.”
Knowing that CME Clearing Europe is up and running ahead of EMIR will no doubt help European hedge fund managers when it comes to choosing which CCP to partner with going forward.