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Clearing Amp Settlement
Europe attracted by US derivatives pull
From the Financial Times of Thu, 06 Nov 2014 11:56:13 GMT

European derivatives trading has had a distinctly American flavour in recent months.

Earnings reports from CME Group, the world’s largest futures exchange, and Intercontinental Exchange, its close rival, have shown a rise in both interest rates trading and credit default swaps (CDS) clearing to the US from the old continent.

First CME Group, owner of the actively-traded eurodollar futures contract, said electronic average daily volume from European clients was 2.1m contracts in the three months to September 30, up 22 per cent year-on-year. That outperformed North America, which rose 13 per cent.

Then ICE reported that 40 per cent of the $4.9tn of buyside gross notional cleared came from European buyside customers clearing through its US CDS clearing house in September.

Both trends are notable, albeit for differing reasons. The CME put the influx down to greater demand for its US interest rate products. Its eurodollar futures contract is widely used by banks to hedge their exposure with dollar swap interest rates and of course, the Federal Reserve has just ended quantitative easing. By contrast, the European interest rate curve is dead.

What is perhaps more surprising is that traders appear to be ignoring the bickering between US and European regulators over equivalence of each other’s derivatives clearing rules.

For European banks the non-recognition of US clearing houses could mean applying onerous capital charges to balance sheets. The CME has estimated the charges could be in excess of 30 times current levels for some deals. While nothing is official yet, traders expect regulatory sense to prevail (once every other avenue has been exhausted). Nevertheless, that transatlantic volume flow could easily flow back again should the European Central Bank – hopefully – one day raise rates.

More revealing is what is happening with ICE. The Atlanta group said investors’ behaviour was down to uncertainty over plodding legislation such as the European Market Infrastructure Review and Mifid II, the review of Europe’s main capital markets legislation.

Emir will be introduced first but only from late next year while Mifid II will not kick in until 2017. Some parts of it will not come in until 2019. By contrast much of Dodd-Frank is done, and that has allow the CME and ICE to invest and focus on their US clearing houses.

Bryan Durkin, CME’s chief commercial officer, noted new services such as coupon blending, compression and portfolio margining were “really bearing fruit”.

But there is more to it with ICE. Behaviour is driven by incentives and ICE has deliberately sought to entice more CDS business to its US operations. There, investors can clear both index and single names and give back huge savings to customers on their collateral requirements by cross-margining their portfolios. CME does it too, but its eurodollar clearing business has always been in the US. ICE’s CDS business has been supplemented by clearing in London.

“It’s surprising to see the European business leaving Europe and coming to the US. That isn’t something we really could’ve predicted even two years ago,” said Jeff Sprecher, chief executive of ICE, on the analyst call.

Behind this lies another consideration. Post-financial crisis, Europe mandated to make its markets more competitive. That included opening access to clearing houses, allowing investors to open contracts on one trading venue and closing them on another.

This is fine in theory but brings hazards if no other country is doing it. Exchanges such as CME and ICE have warned that policy would discourage innovation, or rather, shift it to a more favourable jurisdiction. As an insurance policy exchanges such as CME, ICE and Deutsche Börse are investing in the US and Singapore, which do not have the same definition of competition in their markets.

ICE’s experiment with CDS has perhaps provided the first illustration of how it can be moved.

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