CME guaranty fund cut could lure new clearing members

Regional banks and prop shops are eyeing direct membership, but the lower minimum guaranty fund contribution does little for existing FCMs

CME Group cut its minimum guaranty fund contribution by $35 million

CME Group's decision to slash its minimum guaranty fund contribution for interest rate swap clearers by 70% has piqued the interest of would-be clearing members.

CME announced on August 19 it would cut the minimum contribution that clearing members for interest rate swaps must make to its guaranty fund from $50 million to $15 million.

The reduction brings CME in line with the £10 million minimum default fund contribution at rival SwapClear, and is part of an effort to attract more direct members to the Chicago-based clearing house.

"The change could also encourage more entities to apply for interest rate swap clearing membership, which would further the diversification of interest rate swap clearing members and provide additional liquidity to the default management process," Jason Silverstein, executive director and associate general counsel at CME, said in a statement.

CME currently has 24 clearing members, while SwapClear boasts 98 globally.

The gambit has played well with some prospective clients. An Asia-Pacific bank that is already a member of SwapClear may consider signing up as a full clearing member of CME following the changes, according to a senior managing director at the firm.

"We became a member of SwapClear fairly recently and are comfortable with the clearing house and our obligations as a member. At this time, I don't know about our interest in joining CME, but as costs have come down, I would think we will be looking at that," he says.

Proprietary trading firms, some of which are challenging the traditional dealer oligopoly in swaps trading, are also supportive of CME's decision to lower the minimum guaranty fund contribution.

"We would consider becoming a clearing member, and this considerably lowers the bar for those that want to become clearing members at CME in their own right. Proprietary trading firms fall into that category," says an executive at a Chicago-based proprietary trading firm. "CME lowering their requirements means a lot of smaller players can clear for themselves."

CME has been forced to go on the offensive after seeing its client-cleared notionals halve in July. Clients have seen the cost of pay-fixed US dollar interest rate swaps cleared at CME Group rise relative to contracts cleared at rival LCH.Clearnet, which has hurt liquidity in CME cleared swaps and prompted some clients to switch venues.

However, the requirements of direct membership are still too great for some non-banks.

"The hurdle is still very high for non-banks," says an executive at a New York-based proprietary trading firm. "Being a direct clearing member includes the obligation to assist in an unwind in the event of a default of any other clearing member. For futures, this is relatively easy, because they are simple, standard products and easy to liquidate. With over-the-counter swaps, it is more complicated and will require a clearing firm to have the ability to assist in an orderly unwind. Few non-banks are set-up to deal with the complete range of products CME has in its clearing house."

Futures commission merchants (FCMs) that clear client trades at CME also have mixed feelings about the lower minimum guaranty fund contribution. "I don't think this is enough to get [CME's] targets over the line," says a New York-clearing executive at a European bank. "It's a step in the right direction for CME, and it's a logical approach to trying to build up more liquidity there, but I don't think it's going to be enough."

However, it does little to help existing FCMs, which are struggling to remain profitable. The combined effects of the Basel III leverage ratio – and supplementary leverage ratio for US banks – and capital surcharges for global systemically important banks have dramatically raised the cost of providing client clearing services. Four banks have had to shut or scale back their swaps clearing businesses as  result, and the remaining players are looking to raise fees and cut costs wherever possible.

"In terms of benefits for us as an FCM at CME, there really aren't any. The way the minimum guaranty fund contribution is constructed, there aren't going to be many existing FCMs that are just paying the minimum, so lowering it doesn't impact the overall amount we pay," says the head of OTC clearing sales at a European Bank in New York.

Indeed, if any of the smaller clearing members at CME see a reduction in their guaranty fund contributions, larger FCMs may have to make up the difference, he says.

Others worry that an influx of new direct clearing members at CME could make it more difficult for existing FCMs to raise fees. "A surge in new players will not be helpful in terms of pricing. We want the pricing to find an equilibrium that makes sense, which it hasn't yet," says the New York-based clearing executive at the first European bank.

"CME lowering its requirements might mean a lot more people can clear agency business for smaller players like us," says the executive at the Chicago-based proprietary trading firm. "The banks are unlikely to be happy about this because it will give access to a lot more players. The [swap execution facilities], however, want more participants, so they are likely to be quite happy about it."