The battle of the clearinghouses is on: LCH.Clearnet versus the CME

The battle of the clearinghouses is on. The key to success is the ability to minimize collateral dislocation by managing margin exposure by portfolio. To do this, clearinghouses must go across as many product types as best they can. It is our old friend collateral management driving the bus.

According to a March 13, 2012 FT article by Telis Demos, Michael Mackenzie and Jeremy Grant on the work the CME was doing, “…So-called ‘portfolio margining’, which allows customers to calculate their net exposure to interest rate risk after combining their exposures in swaps and futures, promises to reduce the expected scramble for quality collateral that is already in short supply. Such margining tools have been in development for some time and may reduce the cost of posting daily collateral adjustments by as much as 85 per cent, CME said….” The article is behind the FT pay wall. A link to a Marketwatch article on the same topic is here.

The CME is combining margining on OTC interest rate swaps and Eurodollar and UST futures. They will start with members firms– which means the broker/dealer community. Importantly the CME has also broadened out what they consider eligible margin collateral and have included certain corporate bonds down to A- ratings. Finadium wrote about this in the March 2012 paper, “Corporate Bonds and Equities as High Quality Assets for Collateral Management and Bank Balance Sheets”. A link to the synopsis is here.

The CME has also been active in forging links to other exchanges. The list is long: Brazil, Dubai, India, Japan, Korea, Malaysia, Mexico, Russia, Singapore, and South Africa. These relationships vary in content, but many include cross listing and licensing. It may not be such a big leap to get to cross-margining agreements, although the cross-jurisdictional bankruptcy issues can be killers.

LCH.Clearnet is also in the space and is by no means standing idle. They announced on March 14, 2012 their own collaboration. A Memorandum of Understanding was signed to explore combining NYSE Liffe interest rate futures already cleared by the NYSE/DTCC joint venture New York Portfolio Clearing (NYPC), fixed income and cash repo trades cleared by DTCC’s FICC division, and LCH’s SwapsClear service. The repo piece, near and dear to us, is an important differentiator. A link to the press release is here.

We should note that a potential complication is LCH.Clearnet’s purchase by the LSE. A March 13, 2012 article in Bloomberg by Nina Mehta and Nandini Sukumar looked at the possible conflicts between NYSE Euronext and a LSE’s owned LCH.Clearnet. A link to the article is here. The authors quoted Ian Axe, CEO of LCH.Clearnet, “NYSE Euronext is an immensely important client…There will be lots of opportunities with NYSE in listed derivatives and other areas…” As consolidation and joint ventures continue in the clearinghouse space, hopefully everyone can see their way to play nicely.

LCH.Clearnet and the CME both look to be using their clearing platforms to get in front of government mandated CCP derivatives clearing regulations. It is very smart to start with the cross-product margin approach. We know that for CCPs that narrowly defined netting pools are easier operationally but can increase margin versus a cross product bilateral world. Both LCH.Clearnet and the CME could easily have critical mass.

Finadium wrote about the risk of narrowly defined product in CCPs vs bilaterally cleared trades in March, 2011. A link to the synopsis is here.



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