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Cleared OTC Interest Rate Swaps Security. Neutrality. Transparency.
May 2012
© 2012 CME Group. All rights reserved
OTC Product Progression
2
CME Group OTC Clearing CME Group is the industry leader in OTC Clearing, delivering a broad offering spanning Interest Rates, Credit, FX, Energy, Metals, and Ags
Founded in 1898 as CME
#1 derivatives exchange in the U.S. and globally by volume
Global leader in exchange-traded markets with $3B in revenue
Leading liquidity / volumes in global benchmarks across all asset classes
Extensive and diverse distribution network and customer base
International linkages with leading global exchanges
Launched in 2002 to provide risk mitigation in energy markets following the Enron collapse
Market leading OTC Clearing venue for a diverse range of commodities asset classes
1,700 listed contracts
10,000 registered users around the world
500,000 contracts cleared daily
FX
2004 2008 2009 2010 2003 2011
Coal
2012
Electricity IRS, Freight, Iron Ore Natural Gas, Crude
CDS, Ags, Gold Ferrous Metals
2002
ClearPort Established
2007
Metals
CME Clearport CME Group
© 2012 CME Group. All rights reserved 3
CME Group OTC Clearing
Allows the unique opportunity to offer unparalleled capital efficiencies via margin offsets of IRS positions against Eurodollar and Treasury Futures
Builds on the strength of CME Group’s market leading interest rate products business, which had an average daily volume of $3.6 trillion in 2011, and over $28 trillion of notional outstanding
Provides customers full transparency through direct access to daily valuation reports and the CME CORE margin tool
Operational flexibility of a multi-asset class solution for IRS, CDS, FX, and Commodities via one clearinghouse
Protects the confidentiality of trading relationships, while enabling customers to terminate positions with any market participant
CME Group has worked closely with buy side and sell side participants to build a multi-asset class, market leading OTC clearing solution
Over $558 billion in notional has cleared since launch and open interest is over $299 billion
Successful new product launches of EUR IRS which has cleared over €88.6 billion since launch, GBP IRS which has cleared over £11.1 billion since December 5th, CAD IRS which has cleared C$6.5B since December 5th, and the CDX HY Indices which have cleared over $18.1 billion since November 7th
1,800 active customer accounts with cleared trades, and an additional 2,500 customer accounts testing through our 16 clearing firms
Overview and Background
Benefits of the Solution
© 2012 CME Group. All rights reserved 4
Record Customer Clearing Activity
Total Volume Cleared = $441.7 billion
Open Interest = $262.2 billion
Total Volume Cleared = $116.9 billion
Open Interest = $36.9 billion
Credit Default Swaps Interest Rate Swaps
Note: Data current as of 5/8/12
CME Group has built the leading OTC IRS and CDS clearing service by U.S. customer volume
EUR IRS cleared €88.6 billion since it launched on October 17th
GBP IRS cleared £11.1 billion since it launched on December 5th
CDX High Yield Indices have cleared $18.1 billion since they launched on November 7th
Strong Performance of Newly Launched Products
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Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12
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IRS Volume IRS Open Interest
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Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12
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CDS Volume CDS Open Interest
© 2012 CME Group. All rights reserved
EXISTING PRODUCTS
• USD Fixed/Float out to 50 years- 1M, 3M and 6M LIBOR indexes • EUR Fixed/Float out to 50 years- 3M and 6M EURIBOR indexes • GBP Fixed/Float out to 50 years- 3M, 6M LIBOR index • CAD Fixed/Float out to 30 years- 3M CDOR index • JPY Fixed/Float out to 30 years- 6M LIBOR index • CHF Fixed/Float out to 30 years- 6M LIBOR index • AUD Fixed/Float out to 30 years- 3M, 6M BBSW index
2012 EXPANSION
• OIS Product: USD, GBP, EUR, and JPY OIS out to 30 years • Zero Coupons Swaps: USD, GBP, EUR out to 50 years
• Maturity out to 30 years for SEK, DKK, NOK, HKD, NZD, SGD
• Basis Swaps, and Zero Coupon Swaps in USD, EUR, and GBP
• Amortizing Swaps in all currencies
OTHER FUTURE PRODUCTS
• Additional Currencies
• Swaptions, Caps, Floors, FRAs, Cross Currency Swaps, and Inflation Products
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CME has delivered a comprehensive global product scope that includes the 7 currencies that account for 95% of vanilla IRS market
* Notional amounts outstanding received from Bank of International Settlements, December 2010
IRS Product Rollout
CHF AUD JPY USD EUR GPB CAD
July
4th Quarter SEK DKK NOK HKD NZD SGD
© 2012 CME Group. All rights reserved 6
CME Clearing
Bank of America Barclays
Open Access Clearing Solution Several market leading affirmation platforms and Swap Execution
Facilities have already connected directly to CME Clearing
BNY Mellon
BNP Paribas Credit Suisse Deutsche Bank
Goldman Sachs JPMorgan Morgan
Stanley Nomura
RBS PLC
UBS
RBS Securities
OTC IRS/CDS Clearing Members
Additional OTC IRS Clearing Members
Negotiate, execute, and submit trades through multiple venues to CME Clearing
Straight through processing and real-time confirmation once the trade is cleared
Protects the confidentiality of trading relationships, while enabling customers to terminate positions with any market participant
Operational flexibility of a multi asset class solution for IRS, CDS, FX, and Commodities via one clearinghouse
Citigroup
ICE Link CME ClearPort Javelin MarkitSERV Bloomberg CDS Migration Utility TradeWeb
Wells Fargo HSBC
© 2012 CME Group. All rights reserved
Trade Workflow Mechanics
7
Straight Through Processing allows for real-time clearing and trade confirmations
1 – Dealer and Client agree to trade
2 – Dealer alleges swap to Client through the Affirmation Platform
3 – Client selects Clearing Member and verifies the swap through the Affirmation Platform
4 – Affirmation Platform sends the matched trade between Dealer and Client to CME Clearing House
5 – CME checks for validation of the product, account and applies credit limits set by Clearing member(s), and then accepts the swap for clearing
5 – CME sends “Cleared” notification back to the Affirmation Platform which displays the “Cleared” Status to each party
5 – CME sends a Clearing Confirmation to Clearing Member(s) once all is validated
Client Dealer
Affirmation Platform
1
2 3
4 5
Clearing Member (Client)
Clearing Member (Dealer)
CME Clearing House
Product Account Credit 5 5
© 2012 CME Group. All rights reserved
Transparent Valuation and Reporting
VALUATION OVERVIEW USD IRS positions will be marked to market once per day at 3pm EST
Pricing inputs obtained from wire service feeds
CME Group utilizes OIS discounting, monotone convex interpolation, and Bootstrap Generator to produce a Zero Coupon curve
PRICING INPUTS LIBOR: O/N, T/N
FRA: 0 x 6
CME Eurodollars – first 6 Quarterly Eurodollar contracts, convexity adjusted
Par Swap Rates: 2Y – 10Y, 15Y, 20Y, and 30Y (SA, 3M LIBOR)
REPORTING CME Group provides customers with full transparency including direct access to daily
reports showing curve inputs, daily discount factors, and valuations for each cleared swap position
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Customers have full visibility into CME Group’s swap valuations
© 2012 CME Group. All rights reserved 9
Details of Customer Reports
Report Description Time Available in Testing
Available in Production
Preliminary Trade Register
Includes new and open trades as well as corresponding cash flows on positions cleared prior to 4:45pm EST on that day
4:45pm EST
End of Day Trade Register
Includes new and open trades as well as corresponding cash flows on positions cleared on that day
8:00pm EST
Curve Input Report
Contains the curve inputs of the CME Swap Curve
4:30pm EST
Discount Factor Report
Displays the daily discount factor out to 31 years
4:30pm EST
CME Holiday Calendar
Shows the CME Holiday Calendar 3:00pm EST
Price Alignment Interest (PAI) Rate File
Provides the rate used to calculate PAI 1:00pm EST
The above reports can be accessed through a secure FTP site. Please contact CME’s Onboarding Team at (312) 338-7112 or onboarding@cmegroup.com to gain access.
© 2012 CME Group. All rights reserved
• Expected to cover extreme scenarios that are optimally addressed using a mutualized pool rather than margins
• GF Sizing considerations include risk, capital usage and charges , stakeholders’ incentives, and portability concerns during periods of default
• Additional collateral that can be called upon should all previous layers of the waterfall are exhausted
• Caps the limited resource waterfall
• Contribution set aside by CME to help cure a default prior to dipping into the survivors’ funds
• Each Member’s contribution to the GF
• Liquidity charge accounts for protecting large concentrated portfolios whose closeout could cost more or take longer than baseline timeframe
• Initial Margin is used to cover day-to-day P/L moves
1 The actual amounts will be based on the sum of the third and fourth largest net debtor profiles
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IRS Non-Defaulting CMs Guaranty Fund
General Assessment Powers for IRS1
CME Contributed Capital for IRS $100M
Defaulting Member IRS Guaranty Fund
Baseline Initial Margin
Liquidity Charge
FUN
DE
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UN
FUN
DE
D
DE
FAU
LTE
R P
AY
S
SU
RV
IVO
R P
AY
S
Robust Financial Safeguards CME structured the IRS risk waterfall to protect our customers during times of market stress and mitigate systemic risk
© 2012 CME Group. All rights reserved
Superior Customer Protections
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CUSTOMER PROTECTION STANDARDS The same customer protection standards apply to cleared OTC derivatives as to exchange-traded futures
Clearing Member Firms are monitored and audited for risk, capital adequacy, and compliance with customer protection rules and regulations
Strong history of risk innovation, crisis management, and a deep understanding of issues related to customer protection in the US agency model
Comprehensive approach towards default management, utilizing industry best practices, industry expertise, and default exercises to ensure readiness in a market crisis
ROBUST GUARANTY FUND Key layer of protection in the US Clearing market that serves as a “capital reserve” buffer during times of
market stress and protects against systemic risk associated with catastrophic market events
Sized to cover the simultaneous defaults of the 2 largest FCMs, according to the results of stress tests, which include all extreme historical events as well as “black swan” stress scenarios
Allocated between different FCMs pro-rata according to the residual risk not covered by margins. This allocation mechanism further provides incentive to risk diversification across FCMs
CME Clearing is the industry leader in mitigating risk for customers through the US FCM clearing model
© 2012 CME Group. All rights reserved
Customer Account Portability
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Portability of customer positions and collateral is a cornerstone of CME customer protections
• Clients maintaining accounts at multiple clearing members are able to control the timing and pacing of their porting transactions
• In the agency model, clients “own” their positions
• The agency model supports portability; at CME this is a matter of routine and standard practice
CUSTOMER CONTROLLED PORTABILITY “TRANSFERS”
Establishing and managing accounts at multiple clearing members
• In September 2008, CME seamlessly ported all $2.2 billion of customer funds and 2.5 million customer positions from Lehman Brothers to a solvent clearing member
• In wholesale porting transactions, CME balances the need to assure client safety with recalibration of financial safeguards to minimize stress in the financial system
PROVEN SUCCESS IN CUSTOMER PORTABILITY
Wholesale porting from stressed to solvent clearing members
• Portability is essential to customer protection, both in times of market stress and during the normal course of business
• Portability is underpinned by CME Rule 853, governing transfers of trades
© 2012 CME Group. All rights reserved 13
IRS Portfolio Margining
CME will offer capital efficiencies via portfolio margining for OTC IRS and
select Interest Rate Futures
CME CORE will be enhanced to calculate: IRS HVaR, Futures with SPAN and Portfolio
Margin of Futures and IRS with HVaR
Trade Execution workflows in Interest Rate Futures and OTC IRS remain the same
CME working with Clearing Members on Straight Through Processing Solutions
CME Interest Rate Swaps
Portfolio Margining expected to launch for house accounts on May 7th, 2012
Portfolio Margining
U.S. Treasury Futures
Eurodollar Futures
*Customer Portfolio Margining is targeted for 2H 2012 pending regulatory approval.
Customers will have the ability to move select CME Interest Rate Futures into
Cleared Swaps Customer Account
© 2012 CME Group. All rights reserved
Methodology
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IRS Margin Methodology
Historical VaR
Margins built to provide 99% coverage over a 5-day closeout period Historical scenarios are: Generated using a 5-year look back period Synchronized across all observed tenors on the zero curve, across all currencies Scaled using Exponentially Weighted Moving Average (EWMA) based volatility forecasts
Margin is currently the 99.7th % of portfolio changes (loss) across all scenarios
For cross margining Eurodollar and Treasury Futures with IRS, CME will leverage the current multi-currency Historical VaR framework
Reasoning
CME uses Treasury Future prices and Eurodollar prices (themselves) as an underlying risk factor, as it accounts for risks including: Switch of the Cheapest-to-Deliver (CTD) (applies Treasury Futures) Delivery timing (applies to Treasury Futures) Changes in the convexity adjustment (applies to Eurodollars) Covers extremely well-hedged portfolios (applies to Eurodollars)
Application Apply HVaR methodology to Eurodollar and Treasury futures prices Create a rolling time series of returns (prices)
*Customer Portfolio Margining is targeted for 2H 2012 pending regulatory approval.
© 2012 CME Group. All rights reserved 15
Portfolio Margining Examples
Portfolio Portfolio Details Margin Savings Margin Savings Details ($M)**
Max* Average* Margined Separately
Margined Together
2Y Invoice Spread
2Y Treasury Note Futures vs Equivalent Invoice Swap 79% 64% .8M .2M
5Y Invoice Spread
5Y Treasury Note Futures vs Equivalent Invoice Swap 79% 68% 1.9M .4M
10Y Invoice Spread
10Y Treasury Note Futures vs Equivalent Invoice Swap 75% 58% 4.9M 1.2M
30Y Invoice Spread
Treasury Bond Futures vs Equivalent Invoice Swap 67% 41% 6.5M 2.1M
2Y Swap vs ED Hedge 2Y IRS vs Weighted Eurodollar 2Y Strip 89% 72% 100K 10K
5Y Swap vs ED Hedge 5Y IRS vs Weighted Eurodollar 5Y Strip 86% 78% 230K 30K
10Y Swap vs ED Hedge 10Y IRS vs Weighted Eurodollar 10Y Strip 85% 71% 420K 60K
30Y Swap vs ED Hedge 30Y IRS vs Weighted Eurodollar 10Y Strip 69% 50% 890K 280K
Maximum savings is up to 89%, based on back testing of portfolios from 2006 to 2011.
* Savings = [Gross Margin – Net Margin] / Gross Margin, where Gross Margin is the outright swap HVaR margin plus the futures SPAN margin (no offset benefit) and Net Margin is margining both swaps and futures in HVaR (with offset benefit).
** Values are rounded to nearest hundred thousand or ten thousand Dollars. These values do not include transaction costs and are subject to change, depending on market volatility.
*** Customer Portfolio Margining is targeted for 2H 2012 pending regulatory approval.
© 2012 CME Group. All rights reserved
Transparent Margins Through CME CORE
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CME CORE (CME Online Risk Engine) enables customers to calculate and evaluate their initial margin requirements for IRS and CDS
Create New or Load Existing
Portfolio
Validate and Calculate Initial
Margin Requirement Analyze and Review
Results
PHASE I: Transparency • Margin computation • PNL reporting • Curve scenario reporting
** Future enhancements
PHASE II: Analytics** • Delta ladder • Stress testing • Incremental VaR • Analytics to support back-loading
ENHANCE REPORTS TO INCLUDE ELIGIBLE DISCRIPTIVE DATA
© 2012 CME Group. All rights reserved
Flexible Collateral for Initial Margin
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CME Clearing accepts a broad array of collateral for the Customer OTC Account Class
Collateral Haircut
US Cash None
Non-US Cash (EUR, GBP, CAD, AUD, JPY, CHF)* 5%**
Sovereign Debt of UK, Germany, France, Canada, Japan, and Sweden
5%-10.5% (maturity based) Additional 1.5% for off-the-runs
US Treasury Debt 0.5%-11% (maturity based) Additional 1.5% for off-the-runs
US Agency Debt 3.5%-7% (maturity based) Additional 1.5% for off-the-runs
US Agency Mortgage Backed Securities 11%
Corporate Bonds (IEF4) 20%
Money Market Mutual Fund (IEF2) 3%
Bank Deposit Program (IEF5) None *The last three currencies are available for IRS only. ** Haircut is only applied when cash is used to meet a margin requirement based in a different currency.
© 2012 CME Group. All rights reserved 18
Corporate Bond Collateral Program Clearing Members can transfer securities into a tri-party account controlled by CME at either bank* as a term pledge to receive initial margin credit
*The Corporates Collateral Program, IEF4, is supported by a partnership with Bank of New York and JPMorgan Chase
• Allows corporates bonds to be pledged as initial margin collateral for both Cleared IRS and futures • Reduces costs of clearing for customers and creates further efficiencies for Clearing Members
Overview
• High quality bonds, at least A- rating by NRSO • USD denominated, both domestic and global issuances • Vanilla Bonds (Fixed rate bullet, callable, or putable) • Over $300M in principal outstanding • TRACE eligible
Bond Requirements
• Haircut: (20%) • Concentration Limits: The lesser of 5% per issuance and 5% per issuer or $200M • Level II industry diversification (up to 25%)
Program Parameters
• CME Clearing will publish a list of eligible CUSIPs at the beginning of each month • CUSIP list will likely remain static except bonds that mature, and bonds that are deemed ineligible due to
changes (i.e. rating downgrade, distress, etc)
Eligible CUSIP List
© 2012 CME Group. All rights reserved 19
Customer On-boarding Resources CME CORE Margin Tool
Web-based margin tool that enables customers to generate initial margins for IRS and CDS portfolios
CME CORE can be accessed by doing the following:
• Create a CME SMART Click ID at https://cmecore.cmegroup.com/span/
• Once a SMART Click ID is attained, please email cme.core@cmegroup.com to request entitlements to CME CORE. Specifically, in an email please provide the user ID and specify the request for the IRS/CDS asset classes.
• Please ensure your desktop is equipped with a recent version of Microsoft Silverlight (MS Add On): http://www.microsoft.com/getsilverlight/Get-Started/Install/Default.aspx
CME On-boarding Team
Team of on-boarding experts who work with buy side clients to help them prepare to clear IRS and CDS, and engage in testing the clearing process
Extensive work with the affirmation platforms, and ability to connect customers to the right resources at those firms
The team can be reached at (312) 338-7112 and onboarding@cmegroup.com
© 2012 CME Group. All rights reserved 20
Legal Documentation Documentation between CME Group and Customer
Exchange User License Agreement (EULA)
• New customers must register their firm(s) online via the CME Exchange User License Agreement (EULA), which may be found at: http://www.cmegroup.com/clearport/registration.html
• Investment Advisors and Fund Managers can take advantage of an alternative registration process which offers the flexibility to register managed funds, provided it has the authority to do so, by notifying the CME ClearPort Facilitation Desk via email at custcare@cmegroup.com
Documentation between Clearing Member and Customer
Clearing Member Futures Account Agreement (FCM Agreement)
Clearing Member OTC Addendum
Documentation between Customer and Execution Counterparty
OTC Execution Agreement
The FIA and ISDA published a template that market participants can use as a basis for negotiation: http://www.futuresindustry.org/fia-and-isda-publish-documentation-for-cleared-swaps.asp
© 2012 CME Group. All rights reserved
Establish a relationship with a participating CME IRS Clearing Member Select affirmation platform and work with Clearing Member throughout testing cycles
Complete required Clearing Member Customer Documentation
Begin clearing trades
For any questions regarding On-Boarding and Testing, please contact : On-boarding Team 312 338 7112 onboarding@cmegroup.com
For general information, please contact: Jack Callahan 312 454 8312 jack.callahan@cmegroup.com Steve Dayon 312 466 4447 steven.dayon@cmegroup.com
Europe Jonathan Boyd +44 20 3379 3726 jonathan.boyd@cmegroup.com
Asia Way Yee Bay +65 6593 5560 wy.bay@cmegroup.com
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Next Steps and Contact Us
© 2012 CME Group. All rights reserved
Firm Contact Name Email Phone Number Bank of America Merrill Lynch
Todd D’Agosta (US) Ed Allen (EMEA)
merrill.otc.clearing@baml.com 646 855 9813 646 855 6506
Barclays Sandy Fleischman Patrick Corrigan
sandy.fleischman@barcap.com patrick.corrigan@barcap.com
212 526 6548 212 526 7101
BNP Paribas Avi Pemper Gavin Dixon
avi.pemper@americas.bnpparibas.com gavin.dixon@americas.bnpparibas.com
212 841 3753 44 20 7595 8417
BNY Mellon Sanjay Kannambadi Vipul Pal
sanjay.kannambadi@bnymellon.com vipul.pal@bnymellon.com
212 635 6927 212 635 8359
Citigroup Chris Perkins Mariam Rafi
christopher.perkins@citi.com mariam.rafi@citi.com
212 723 5943 212 723 4074
Credit Suisse Neil Burke John Guthrie
neil.burke@credit-suisse.com john.guthrie@credit-suisse.com
212 538 0761 212 325 4535
Deutsche Bank Elliot Barr Luciana Miranda
elliot.barr@db.com luciana.miranda@db.com
212 250 9831 212 250 8845
Goldman Sachs Mike Dawley Jack McCabe
michael.dawley@gs.com jack.mccabe@gs.com
212 902 7582 212 902 3037
HSBC Julianna Salazar Nick Marcelle
julianna.x.salazar@us.hsbc.com nick.marcelle@hsbcib.com
212 525 2353 44 20 7991 9132
JPMorgan Piers Murray Catherine Bartzos
piers.murray@jpmorgan.com catherine.bartzos@jpmorgan.com
212 270 5445 212 834 3105
Morgan Stanley Jason Swankoski Mark Bortnik
jason.swankoski@morganstanley.com mark.bortnik@morganstanley.com
212 761 5206 44 20 7677 9685
Nomura Sandeep Kohli Stephen Scalzo
sandeep.kohli@nomura.com stephen.scalzo@nomura.com
212 667 2037 212 667 8981
RBS Brian Halligan (RBS SI) Madlen Dorosh (RBS SI)
brian.halligan@rbs.com madlen.dorosh@rbs.com
203 897 2504 203 897 9869
UBS Ed Pla Reinhardt Olsen
edward.pla@ubs.com reinhardt.olsen@ubs.com
203 719 2602 203 719 3408
Wells Fargo Jeff G. Gore Dan Thomas
jeffrey.gore@wellsfargo.com dan.thomas@wellsfargo.com
704 715 0528 704 374 2103
Cleared OTC IRS Clearing Firm Contacts
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© 2012 CME Group. All rights reserved
Disclaimer
Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.
All references to options refer to options on futures.
CME Group is a trademark of CME Group Inc. The Globe Logo, CME, and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. CBOT and the Chicago Board of Trade are trademarks of the Board of Trade of the City of Chicago, Inc. NYMEX is a registered trademark of the New York Mercantile Exchange, Inc. All other trademarks are the property of their respective owners.
The information within this brochure has been compiled by CME Group for general purposes only. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, CBOT and NYMEX rules. Current rules should be consulted in all cases concerning contract specifications.
Copyright © 2012 CME Group. All rights reserved.
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