CME’s OTC business may get overhaul

By Reuters
Posted Aug. 9, 2010 at 5:44 p.m.

CME Group Inc’s profitable over-the-counter clearing operations may be headed for an overhaul.

The Commodity Futures Trading Commission is putting pressure on the giant exchange operator to change the way its ClearPort unit handles OTC swaps, two people familiar with recent discussions said.

CME treats many of the OTC swaps — which are bilaterally matched away from the exchange — like its exchange-traded futures, a popular feature that has allowed investors to cross-margin, and thus save money on, the two products for years. The treatment requires CFTC approval.

But the CFTC is no longer comfortable with this set-up, and would rather CME treat futures like swaps, one source said.

CME has not won approval to margin — or collect funds to back — any new products together with futures since March 2009, records show. OTC products that won approval before then continue to get the special treatment.

CME is busy working on a way to margin swaps and futures together that would be palatable to CFTC, involving the creation of a new type of account for OTC swaps.

But a more sweeping change — converting ClearPort into a Swap Execution Facility, or SEF — could be in the works, said one of the the sources, who requested anonymity because talks are ongoing and no final decision had been made.

An SEF is a new type of platform created under the Dodd-Frank Wall Street reforms that will also require the clearing of most OTC derivatives. CME has scrambled in the last two years to take advantage of the coming reform by prepping its swaps clearinghouse, seen as a key source of growth for the Chicago-based company.

But CME ran into resistance when it petitioned the CFTC to allow it to include credit default swaps in futures clearing accounts. Some brokers were worried that CDS — products blamed for exacerbating the 2007-2009 financial crisis — represented too serious a risk to be lumped in with traditional futures.

CME withdrew its application in June, and told customers that starting Sept. 13, all swaps that haven’t received CFTC approval for futures-like treatment must be held in new “sequestered” accounts earmarked specifically for OTC products.

Once CME begins clearing interest-rate swaps — the biggest part of the OTC market — CME will petition the CFTC to allow margins for interest-rate futures to be held in the OTC accounts.

“Suppose Eurodollars is in a customer (segregated account) and (interest rate swaps) is in an OTC account class, we will go to the CFTC and ask to take futures out of segregation and put it into the OTC account class,” CME Group Managing Director Tim Doar told the Professional Risk Managers’ International Association on July 22.

A spokesman said CME had no comment beyond Doar’s remarks.

The ClearPort overhaul is in the planning stage, the source said, adding that CME and the CFTC have held meetings on the issue, including talks on converting ClearPort into an SEF.

While smaller rival IntercontinentalExchange Inc. has said publicly it plans to apply as an SEF, CME Chief Executive Craig Donohue said last week his company would instead concentrate on providing clearing services for other SEFs.

A central clearinghouse stands between two counterparties and guarantees their trades, a solution lawmakers have endorsed to avoid a repeat of the financial crisis in which Lehman Brothers and others collapsed.

Traders use ClearPort, which CME took over when it bought the New York Mercantile Exchange in 2008, to buy, sell and clear energy and other over-the-counter swaps.

Any change to ClearPort would be a delicate one.

The rate CME charges per contract is far higher for ClearPort than for any of its exchange-traded products. The unit accounted for about $71 million in revenue in the latest quarter, or 10 percent of total transaction fees, even though it handled just 3 percent of trading.

ClearPort was launched in the wake of Enron Corp.’s collapse to guarantee energy deals in a central marketplace, and protect energy firms from credit downgrades. The CFTC at the time allowed CME to clear OTC products as if they were futures.

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