In order to guard the financial system from defaults and ensure more transparency, CME Group Inc. (CME) has launched a new service for providing clearing services to the $400 million over-the-counter (OTC) interest rate swaps through its CME Clearing.
Until now, such derivatives were traded privately and the swap markets were controlled by the banks. However, the sweeping Wall Street reform bill passed in July 2010 has compelled most of the $615 trillion interest-rate, credit-default and other swaps to be processed by clearing houses and traded on exchanges or similar systems by mid-2011. In addition, all the trades in the OTC market will be reported to regulators.
The clearing houses would guarantee that all the obligations are met even in the event of a default, as the losses would be absorbed by all the members of the clearing house.
CME Group will work with a group of premier swap dealers, clearing firms and buy-side market participants such as BlackRock Inc. (BLK) and Citadel, a wing of Citadel Broadcasting (CDL); mortgage lenders like Fannie Mae and Freddie Mac, and the bond fund giant Pacific Investment Management Co., who will use the services of CME Group.
On the other hand, BofA Merrill Lynch, a unit of Bank of America Corporation (BAC), Barclays Capital, an arm of Barclays PLC (BCS), Citigroup Inc. (C), Credit Suisse Group (CS), Deutsche Bank AG (DB), The Goldman Sachs Group Inc. (GS), JPMorgan Chase and Co. (JPM), Morgan Stanley (MS), Nomura Holdings Inc. (NMR) and UBS AG (UBS) will act as the sellers of the CME Group’s service.
Though the transition from banks to the exchanges will take some execution time, the bill however gives a great opportunity to clearing house operators like CME Group and IntercontinentalExchange Inc. (ICE) to initiate clearing services to swap markets.
In addition, being the biggest global clearer of interest-rate futures, CME Group will give strong competition to London-based LCH.Clearnet Group Inc., which is the world’s largest interest-rate swap clearing house, as well as International Derivatives Clearing Group, which is largely owned by NASDAQ OMX Group Inc. (NDAQ), because it can offer discounts to the clients on the amount of money they must put up to back their swaps, as long as they have offsetting futures positions.
The company is also working with its regulator, the Commodity Futures Trading Commission, to obtain permission to offer margin reductions.
CME Group has been clearing credit default swaps since 2009, which provides insurance against corporate defaults. Now with the new interest rate swap clearing, CME Group will be able to safeguard the customer funds as well as provide transparency to the system.
This will enhance the stability in the OTC derivatives markets because they will lower the default risk through risk sharing by the members and use daily margining procedures to keep accounts current. In addition, CME Group will try to offer capital efficiencies via cross margining of OTC products with benchmark futures.
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