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March 25, 2013

Do current client clearing volumes indicate the outcome of the IRS CCP race?

On client clearing notional outstanding, Swapclear has so far outcleared CME in IRS so far by a factor of more than 4 fold ($4.62 trn vs. $1.01 trn as of March 13th).  Note: CME client clearing will be less than $1.01trn to the extent of their dealer to dealer clearing volumes.

On client clearing notional outstanding, Swapclear has so far outcleared CME in IRS so far by a factor of more than 4 fold ($4.62 trn vs. $1.01 trn as of March 13th).  Note: CME client clearing will be less than $1.01trn to the extent of their dealer to dealer clearing volumes.

Where are the figures published?  On the CCP websites.  The links to the information are here (you have to hover over the line on the graphs to get the latest numbers):  Swapclear volumesCME volumes.

What is causing this advantage?  Early adopter client choices.  Mainly the choices of CCP of clients who started clearing in advance of the mandate in 2012 as notionals accumulate over time.  Clients who started clearing near the March 11th mandate won't have built up much notional yet and won't be having much effect yet on cumulative notional.

Will this advantage continue?  Afraid we just don't know.  Past performance is no guide to future expectations as the famous saying goes.  The eventual client cleared population will likely dwarf the current client cleared portfolios of about $5 trillion between these two CCPs.   It may a few years for the outcome to be determined given that uncleared portfolios will take time to mature / be unwound.  During the transition, we will see a complex set of competing elements play out in clients' choices.  Trading economics impacts will likely outweigh clearing infrastructure considerations:

  • trading economics impacts (CCP collateral charges, a larger group of clearing members (enables trades with more dealers), margin optimization tools including portfolio margining and the clearing in future of IR options, CCP-specific pricing (per article in Risk.net see link in the footnote (1) below), CCP-spread trading tools at SEFs (e.g. Trad-X));
  • clearing infrastructure considerations (new IRS CCPs (Eurex, possibly ICE), legal regime compatibility (e.g. Swapclear US launch, CME Europe), product coverage, operational convenience, CCP clearing fees).

Why does this matter?

1.  To the CCPs client clearing is critical to funding revenue.  Despite notionals being smaller for client trades than dealer to dealer, aggregate directional risk and therefore initial margin and the associated funding revenue are higher.

2.  For the OTC market, CCP fragmentation increases systemic risk and cost.  The big picture effect of CCP proliferation is to fragment risk – with a participants IRS portfolio spread around more CCPs the greater is the gross-up effect on the aggregate CCP risk, CCP funding costs and CCP-related bank capital incurred.   Portfolio margining, margin optimization tools, CCP-spread trading won't be perfect antidotes to this risk and cost gross-up.  It feels like the single global IRS CCP ideal has passed into history given in particular regulators' focus on competition and their desire to promote onshore CCPs.  The question now would seem to be how many critical mass IRS CCPs can be sustained per time zone – 1, 2, 3, more?

So don't expect a quick outcome.  Only after US and EU mandates are with us and portfolios have had a couple of years to turnover will we see a stable pattern emerge.  Meantime, the transition may be dynamic.

Note:  (1) Risk.net article: risk.net otc market CCP-dependent pricing (subscription required)


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