By Katy Burne (Dow Jones)
NEW YORK - Buyers and sellers of off-exchange derivatives saw $4.1 billion of interest-rate swaps processed in record time last Thursday, with the average time between execution and clearing taking less than two seconds, according to several market participants.
Javelin Capital Markets, an electronic trading platform for swaps created in response to the 2010 Dodd-Frank financial overhaul law, and CME Group Inc. (CME) , a swaps clearinghouse owner, said Wednesday they were behind the move, which demonstrated that trade clearing can happen in near real time as regulators want to see.
Clearing is when a third party steps in between trading firms and agrees to guarantee their financial obligations. Regulators across the globe have made clearing a key plank of their pending overhaul of the $708 trillion swaps market under Dodd Frank, in a bid to reduce risk to the financial system in the wake of the crisis.
The Commodity Futures Trading Commission, which was tasked by Congress to write many of the new swaps rules in the U.S., has specified that it wants to see swaps processed by clearinghouses, "in a matter of milliseconds or seconds or, at most, a few minutes-not hours or days." Futures conducted on exchanges are processed instantaneously.
The average speed at which the rate swaps were accepted by CME's clearinghouse was just 1.932 seconds, which Javelin and CME called "a market first." The fastest processing time they achieved was 1.32 seconds.
Most rate-swaps clearing is handled by SwapClear, a service provided by CME's London rival, LCH.Clearnet Group Ltd. LCH clears rate swaps in groups, completing 13 cycles per day that can be as short as 15 minutes towards the end of the day, a spokeswoman said. Real-time clearing is a top priority for the firm going into 2012, she added.
Some 21 trades were conducted on Javelin's platform Thursday, Dec. 8, with average ticket sizes of $195 million, then cleared by CME. The trades came in an array of maturities, including $747 million of two-year swaps, a $1 billion of three-year swaps, $985 million of five-year swaps, a $1 billion of seven-year swaps and a total notional $377 million 10-year swaps.
"The large notionals of the trades, combined with them being spread across the swap curve and cleared in seconds, was a first," said James Cawley, CEO of Javelin Capital Markets. He added that the test "shows real-time trade acceptance and puts a time stamp on what is technologically practicable." Dealer banks and investment firms who participated did so anonymously for the most part.
"Counterparty and execution risk have now been dramatically reduced," said Brad Small, head of rates at ING Financial Markets, one of the trading parties. Bob Burke, global head of OTC clearing at Bank of America Merrill Lynch, which cleared some of the trades on behalf of customers, said the firm remains " committed to reducing and eliminating the uncertainty of clearing derivative trades post-execution." The CFTC initially proposed a rule that would have required swaps to be accepted into clearing immediately upon execution.
Some participants had expressed concern, however, that rushing the processing of such trades wouldn't give parties enough time to check that terms had been entered correctly. Nor, they said, would it give dealers time to check whether clients had exceeded any predetermined risk limits in place with their clearing brokers.
As a result, a collection of dealers suggested that the market adopt a third-party platform to monitor such credit lines in real time, something they referred to as a "limit hub." This hub, they said, would reduce the chances of a trade breaking before it was cleared, providing certainty for participants with trades screened in advance of clearing.
A special document addressing the risk of trade breakage was published in June by the Futures Industry Association and International Swaps and Derivatives Association. It was designed to cover what happens in the gap between trade execution and confirmation into clearing-something ISDA separately set up an industry working group to address.Others, however, were worried that this so-called "tri-party agreement" from the FIA and ISDA would interfere with users' ability to trade anonymously.
The commission later updated its proposals, saying that clearing brokers couldn't enter into arrangements that would cause the identity of their customers' executing counterparties to be disclosed, or that would limit the number of dealers with whom a customer would execute its trades.
The CFTC also clarified that it wanted clearinghouses to accept or reject trades submitted for clearing "as quickly as would be technologically practicable if fully automated systems were used."