LCH.Clearnet Ltd., the biggest interest-rate swap clearinghouse, is considering accepting corporate bonds for the first time to meet an anticipated surge in demand for a broader array of collateral in the $601 trillion over-the-counter derivatives market.
“We want to be able to have more clients come to clearing,” Floyd Converse, head of U.S. sales and marketing for London-based LCH.Clearnet, said in an interview in Chicago this week at the Futures Industry Association annual conference.
The world’s biggest swaps clearinghouses are expanding the types of securities they accept as regulations force thousands of new users in the U.S. and Europe to use clearing. Among them, CME Group Inc., the world’s largest futures exchange, is broadening the variety of company debt it accepts as margin for its customers.
With U.S. regulators set to discuss finalizing the clearing rules next week, derivatives market participants are bracing for a wave of changes that will transform their industry. Under the Dodd-Frank Act passed last year, investors have to post collateral at clearinghouses for most swaps trades. The services, including CME Group’s, currently accept cash, government bonds and agency debt to back trades.
“There’s a lot of interest from the end-users to get the clearinghouses to expand their collateral,” said Dave Olsen, global head of over-the-counter clearing at JPMorgan Chase & Co. in New York. With securities being considered for collateral that don’t trade as often as U.S. Treasuries, the firm wants to ensure regulators are fully comfortable with the implications, he said.
“It’s better to have that conversation earlier rather than later,” he said in an interview at the conference in Chicago.
The U.S. Commodity Futures Trading Commission is set to meet Oct. 18 to propose final rules on how derivatives buyers and sellers will have to use clearinghouses.
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 Dodd-Frank, research firm Tabb Group said in a report this week.
Only investment-grade corporate bonds are being considered for use as collateral and the risk committees at the clearinghouse are evaluating the plan now, according to Converse. There will also be limits on posting too many of the same types of bonds to avoid concentrating the risk in one sector, he said.
While CME Group’s clearinghouse already accepts corporate bonds, the list of those securities will grow, according to Kim Taylor, president of the Chicago-based company’s unit. CME Group also recently began accepting gold as collateral, Taylor said.
The expanded collateral under discussion includes corporate bonds and mortgages not backed by Freddie Mac or Fannie Mae, JPMorgan’s Olsen said. The bank has been helping its clients ensure that they have enough collateral, and of the right type, to use derivatives markets, he said.
“We are definitely working with customers to help them manage their collateral needs, but our first priority is to make sure the system is stable in a crisis and doesn’t build in additional pro-cyclical risks,” he said.