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With six weeks left until the second over-the-counter derivatives clearing deadline hits the US, the industry appears to be hurtling towards a brick wall. Up to 2,000 firms are expected to qualify as so-called category two firms, which are required to clear selected interest rate swaps and index credit default swaps (CDSs) from June 10, but estimates of the number that will be able to start clearing at the deadline range from 200 to 300. That’s primarily because futures commission merchants (FCMs) – which provide access to clearing houses – are focusing on a relatively small set of top-tier clients.
Even this subset of firms may overwhelm banks’ ability to bring them on board, and FCMs worry the sudden influx of new clients will see a surge in the operational glitches that marred the first phase of mandatory clearing in the US, on March 11.
In addition, firms that make it on board may find their choice of product and clearing house limited. At this point, LCH.Clearnet’s SwapClear is the biggest clearer of interest rate swaps for clients, but all that volume has gone through its UK-based service; its US-based central counterparty (CCP) is scheduled to launch just one week before the second phase of clearing starts. If the clearing house fails to launch on time, clients could still use SwapClear’s UK-based service, but some US firms are uncomfortable with the cross-border risk, and others are barred from taking that exposure altogether. Or, they could use CME Group’s interest rate swap clearing service. The problem with the latter course of action is that some products that are subject to the clearing requirement – such as amortising swaps – are not currently being offered by CME. The Chicago-based clearing house plans to start offering them in time for category two firms to use the service, but no launch date has been set.
And what of the hundreds of category two firms expected to be frozen out of the market on June 10? They have a few options. These entities could start using futures instead – both CME and Eris Exchange say they are anticipating a jump in volume for their swap futures contracts, which aim to mimic the economics of an OTC swap. Alternatively, they could stop using derivatives altogether. Or they could hope the US regulators give them some more time, and a source close to the Commodity Futures Trading Commission (CFTC) makes some comforting noises on that score.
But the bottom line is that the industry – primarily clients, but also CCPs, FCMs and middleware to varying degrees – is simply not ready, in the eyes of many market participants.
In all, that could mean somewhere between 1,000 and 2,000 firms, according to Athanassios Diplas, a senior adviser to the International Swaps and Derivatives Association, speaking at a Risk conference in late March. The number is vague partly because many hedge funds with a US connection are run from offshore tax havens such as the Cayman Islands. Until July 12, these funds benefit from a temporary narrowing of the scope of the CFTC’s guidance on the cross-border application of clearing rules and other transaction-level requirements. Whether this temporary relief is rolled over, and what eventually replaces it, is the subject of fierce debate between the CFTC and foreign politicians and policy-makers, who want to ensure their own firms are not caught within the agency’s net. On April 18, eight foreign finance ministers, including those for France, Germany, Japan and the UK, wrote to a host of US officials, including the CFTC’s chairman, Gary Gensler, to call for US rules to be applied within US borders only.
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