Last month four market actors, LCH.Clearnet Limited (LCH.Clearnet), New York Portfolio Clearing LLC (NYPC), The Depository Trust & Clearing Corporation (DTCC) and NYSE Euronext (NYX), announced that they had signed a Memorandum of Understanding to explore how to include clearing interest rates swaps from LCH.Clearnet’s Swapclear platform on the NYPC system. NYPC already provides consolidated margining for both OTC derivative and physical interest rate related products (including treasuries and GC repo). This seems like a step forward in creating a single CCP where all bond and interest rate-centric trades could be cleared (or at least a major competitor to any other individual CCP like ICE). A single CCP is something like the Holy Grail for collateral managers in the OTC derivatives markets, but can it happen? This article explorers some of the opportunities, challenges and important next steps.
First of all, here are the details from the joint press release:
“The initiative aims to enhance NYPC’s proven “one-pot” capabilities to offer:
– Cross product-margining & default management across fixed income, cash, repo, futures and OTC interest rate swaps
– Extended capital and operational efficiencies
– Unified risk management approach”
“The parties’ goal, defined in a Memorandum of Understanding (MOU), is to deliver greater capital efficiency to market participants by combining NYSE Liffe U.S.-traded interest rate futures contracts already cleared by NYPC, fixed income cash and repo trades cleared by the DTCC’s Fixed Income Clearing Corporation (FICC) and interest rate swaps cleared by LCH.Clearnet’s SwapClear service into a single portfolio for purposes of margin netting and offsetting. Netting and recognizing offsetting risk within a multi-product single asset class portfolio would be designed to optimize margin requirements on the combined portfolio.”
NYPC has already proven itself to be very effective in clearing and providing central margining for US-based interest rate futures, treasuries, GC repo, etc. The sharp rise in their volumes and open interest is shown in this graph. This next step with LCH.Clearnet is to potentially incorporate non-US interest rates and government products, and that’s what we think is so interesting. Currently LCH.Clearnet has different mechanics for how US swaps are cleared versus clearing in the rest of the world. These mechanics are very important and cover issues such as risk waterfalls, collateral segregation and regulatory oversight. It would seem to make easy sense for US Swapclear positions to be aggregated on the NYPC clearing platform; this is certain to be phase 1. The more complex phase 2 is how international securities could get there as well.
Now before we are called way ahead of our time, we refer you to a European Union regulation on Central Securities Depositories that was published on March 7, 2012, that not only allows but encourages the interoperability of Central Securities Depository between CCPs and markets. LCH.Clearnet is one of the largest government bond and repo clearers in Europe. DTCC, one of the partners in the NYPC clearing platform, already operates EuroCCP. Both will be directly impacted in the new EU regulation. All it would take is one agreement of interoperability between the US and EU to make all participants have fair game in both regions. Even before that though, if NYPC can figure out how to interoperate with different products and pull in international government bond trades to NYPC, that would go far to creating this central CCP entity and leverage the existing LCH.Clearnet Swapclear MOU.
Given the very serious cash at stake from clearing margin being tied up, we think that anything that pushes for a single interoperable CCP is a development to watch closely.