Eurex’s launch is notable for two reasons: its intention to target the client clearing side and the cross margining of OTC interest rate products against its portfolio of exchange traded interest rate contracts.
Client clearing
The G20 mandate to clear OTC derivatives through CCPs was set for the beginning of next year. While the details of the mandate are still being thrashed out by regulators across the globe and only certain instruments will ready for the deadline, the race for dominance is most certainly on.
Interest rate swaps, by far the largest of the OTC markets, is unsurprisingly one of the key early battle grounds and lie at the heart of Eurex’s launch (it is also proposing to clear OTC equity derivatives). In Europe, LCH.Clearnet has a dominant position in the dealer-to-dealer IRS market having launched SwapClear in 1999.
LCH launched a client clearing service in 2009 but is yet to build up a dominant position in the market: the real demand from the buy-side is only beginning to build up now as the mandate nears. Most buy-side are only now beginning to select their clearing members.
CME, which launched CME Clearing Europe last year, is planning an expansion from commodities into IRS later this year.
So the market for clearing IRS in Europe is looking pretty crowded. Eurex are betting that the offset of their portfolio of exchange traded interest rate products, such as the schatz, bund, bobl, buxl German yield curve as well as their focus on the client side will give them a USP.
Central to this is the new Prisma portfolio-based risk margining system, a conservative enhanced VaR-based calculation. Prisma will calculate the collateral required once OTC and ETD exposures have been netted. On the face of it the ability to net across a client’s full portfolio will be a key advantage considering that cross-asset class margining rightly remains taboo.
Other battlegrounds
Eurex is on a firm footing in Europe in its core markets of equities and interest rates. However, it has previously struggled in another key OTC clearing battleground: CDS clearing. Eurex launch a CDS clearing service in 2009 but it has been mothballed since 2010 after take-up was poor.
Re-entry into that market, while technically possible, is unlikely. ICE Clear and LCH are aggressively expanding CDS clearing in Europe and CME has plans to move into the space. Considering the inefficiencies of disinteroperable multiple clearing houses in the same asset class, any new entry is unlikely to gain traction in an already crowded marketplace.
The other key battleground for Eurex is the US. It is currently applying for DCO status with the CFTC. Assuming its path to approval for clearing is smoother than its path to approval to launch an exchange in the early 2000s (a move that was vehemently opposed by the Chicago incumbents), it could be soon be joining LCH to fight the CME and ICE on their home turf.
Currently LCH offers a nascent client clearing service in the US through LCH FCM and, if successful, its bid for IDCG will bolster its standing against the CME in this market. LCH is also growing its FX clearing service in the US to rival CME. ICE remains dominant in CDS clearing in the US but has plans to expand into FX as well.
Eurex’s success in Europe will be based upon the appeal of cross margining OTC and ETD instruments. It has little competition in this space and Liffe has a fight on its hands to accelerate its clearing programme to compete. Eurex currently looks solid in Europe.
In the US, the competition will be tougher. CME will be far further down the line offering a similar service when Eurex gears up to launch. Its unhappy past in the US could be set to continue.
Whatever, happens, the OTC clearing market is shaping up to be quite a fight.