Collateral Management Needed for OTC Trades, CME’s Donohue Says

Demand to transform non-standard collateral for use at swaps clearinghouses is set to grow as new rules take effect for the $601 trillion over-the-counter derivatives market, according to CME Group Inc. (CME)’s Craig Donohue.

Under the Dodd-Frank Act passed last year, investors who buy and sell swaps must post collateral at clearinghouses for most trades. Many swaps users will have to post riskier securities to third parties on derivatives trades in order to receive eligible collateral to pledge. Clearinghouses such as CME’s now accept cash, government bonds and agency debt as collateral to back positions.

“There will be a need and a value for the collateral transformation services,” Donohue, chief executive officer of CME said today during a panel discussion at the Futures Industry Association annual conference in Chicago.

The types of accepted collateral may need to be expanded as thousands of new users seek to back trades. While cash and government securities will always be the least costly way to pay for margin, some who want to pledge “three chickens and an old Ford” will find it more expensive to have non-standard collateral transformed into acceptable form, said Jeffrey Sprecher, chief executive officer of Atlanta-based Intercontinental Exchange Inc.

The demand has created a “cottage industry” of firms and units within banks that will charge a fee to hold securities or other assets for investors in return for acceptable margin, said Richard Prager, managing director and head of global trading for BlackRock Inc. (BLK)

Users in the interest-rate swaps market, the largest OTC derivative asset class, may need at least $1.4 trillion in new margin payments under the Dodd-Frank rules, research firm Tabb Group said in a report yesterday.

Donohue joked on the panel that Sprecher’s assessment of non-standard collateral could use some adjusting.

“I immediately thought four chickens made more sense,” he said.

To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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