Morgan Stanley, owner of the world’s largest brokerage, said it started clearing interest rate swaps for customers this week through CME Group Inc.
Morgan Stanley is the third bank to announce it’s clearing swaps transactions through Chicago-based CME on behalf of money manager clients, as regulators write rules that will mandate that much of the privately negotiated derivatives market be backed by clearinghouses such as CME. The New York-based bank said it also plans to begin clearing client trades through London-based LCH.Clearnet’s SwapClear and credit-default swaps through Intercontinental Exchange Inc.’s clearinghouse, according to an e-mailed statement today.
The Dodd-Frank Act, signed into law by President Barack Obama in July, mandates that most interest-rate, credit-default and other swaps be processed by central counterparties and traded on exchanges or similar systems, taking business from the Wall Street banks that pioneered the transactions. All trades in the over-the-counter market will be reported to regulators. Dealers and their biggest clients will face higher capital requirements to use the market.
“We are focusing resources where we see client demand,” Stephen O’Connor, a managing director and head of Morgan Stanley’s counterparty portfolio management group, said today in a telephone interview. “Central clearing is going to be the law. People are now on a more accelerated timeline.”
Deutsche Bank, Citigroup
Clearinghouses, which are capitalized by their members, increase stability in OTC derivatives markets because they lessen the effect of a default by sharing the risk among the members and use daily margining procedures to keep accounts current. The central counterparties, or CCPs also allow regulators to see market positions and prices.
“‘We have to do our own due diligence,” O’Connor said. “The CCPs are the new too-big-to-fail institutions. The risk management of the CCPs is paramount. They are already the biggest counterparties in the market and there’s going to be massive concentration at three or four CCPs to begin with.”
Deutsche Bank AG and Citigroup Inc. have also said they started clearing interest-rate swaps with CME this week.
CME Group cleared $407.5 million in interest-rate swaps in its first three days of operation, said Michael Shore, a spokesman.
Bilateral Rate Swaps
Participants in the CME Group plan include Freddie Mac, Fannie Mae, Pacific Investment Management Co., BlackRock Inc. and Citadel LLC, the Chicago-based company said in an Oct. 18 statement. Freddie Mac and Fannie Mae have more than $1 trillion of bilateral rate swaps between them. Morgan Stanley didn’t disclose the names of the money managers for which it cleared swaps nor the size of the trades. Deutsche Bank said it cleared a swap with Citadel LLC. Citigroup didn’t name its counterparty.
CME Group will compete with International Derivatives Clearing Group LLC, majority owned by Nasdaq OMX Group Inc. and with LCH.Clearnet clearing trades in the $349 trillion interest-rate swap market. Rate swaps make up the biggest class of over-the-counter derivatives.
Banks already clear rate-swap trades among themselves through LCH.Clearnet and credit swaps through Intercontinental’s ICE Trust.