Wednesday, March 24, 2010

Big clearing houses set for OTC boost

Posted in the Financial Times by Jeremy Grant:

While the shift of over-the-counter (OTC) derivatives on to clearing houses may seem like a great business opportunity, it is one that is likely to benefit the incumbents.

That is because clearing houses tend to be natural monopolies. Business is hard to prise away from a house that already controls clearing of certain products – as the exchange-traded futures markets show.

CME Group clears virtually all US futures contracts, because they are traded on its Chicago Mercantile Exchange unit – and are cleared through CME’s in-house clearer.

Being a “first mover” also helps, as IntercontinentalExchange has shown by quickly dominating clearing in credit default swaps.

The start-up costs associated with establishing a clearing business are huge. A clearing house needs to attract clearing members, which lodge margin with it and contribute to a “default fund”, the ultimate financial backstop. The big clearing houses either owned by or servicing existing exchanges already have these in place, as well as well-developed risk management.

None of this has deterred Nasdaq OMX, which controls International Derivatives Clearing Group, a new clearer for interest rate swaps. It recently signed up as clearing members Newedge and MF Global, two of the world’s largest publicly listed futures brokers.

There are doubts over how much of the OTC derivatives markets it is feasible to clear beyond interest rate swaps, CDS and FX, where the incumbents, including LCH.Clearnet in Europe, have already made their intentions clear.

Anthony Belchambers, chief executive of the Futures and Options Association, says:

“In some cases the smaller, lower-volume OTC markets or ones that are highly volatile are going to be loss-leaders for clearing houses.”

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