Banks move towards clearing for FX, interest rate and equity

A large part of the over-the-counter derivatives market will shift towards central clearing houses by next year, as the collapse of Lehman Brothers on September 15 forces banks to reassess counterparty risk posed by other dealers.

Moves are already well underway to launch a central counterparty for credit default swaps (CDS), with four groups – Eurex, NYSE Euronext, the CME Group in conjunction with Chicago-based Citadel Investment Group, and the Clearing Corporation in partnership with the IntercontinentalExchange – planning to launch CDS initiatives in the coming months.

But attention is likely to turn to other asset classes, including foreign exchange, interest rates, equity derivatives and commodities. Already, dealers have begun to up their participation in existing OTC clearing houses, or start talks to develop new initiatives.

“I think we will definitely have an acceleration towards using clearing houses,” says one London-based global head of equity derivatives. “I’m going to be looking at various solutions to put in place a shift of our business a little bit away from OTC and over to the clearing houses.”

OTC clearing already exists in the equity derivatives market. For instance, Liffe, the derivatives arm of the NYSE Euronext Group, runs a clearing service called BClear for futures and options on most European indexes, single stocks, and variance futures on the AEX, CAC 40 and FTSE 100 indexes, among others.

The service allows transactions to be conducted on a bilateral basis, before being replaced by an exchange contract, which is submitted with BClear. Traders have the ability to specify contract maturity, exercise price and settlement method. In the year to September, the volume of trades handled by the system was up 62%, to 145.21 million lots.

Similar platforms exist for interest rate derivatives – for instance, SwapClear, run by London-based LCH.Clearnet. It is understood discussions are also underway to work on a central counterparty for the foreign exchange space.

“Once the regulators have finished with credit, they will probably focus on the interest rate and foreign exchange market. We want to resolve this ourselves before we are forced to by the regulators,” says one foreign exchange trader.

An initiative is believed to be underway among the major currency dealers, with a central clearing house for foreign exchange likely to be up and running by the middle of next year, the trader says.

See also: Fed discusses CDS clearing house options