Credit default swaps (CDSs) became the “it” product on the clearing landscape in the wake of the credit crisis, but the International Derivatives Clearing Group (IDCG) decided to focus its efforts on the over-the-counter (OTC) interest rate swap market. IDCG launched the International Derivatives Clearinghouse (IDCH) on Jan. 6 to clear OTC U.S. dollar denominated interest rate swap futures, options and other fixed income products. IDCG, a subsidiary of The Nasdaq OMX Group, will petition the Financial Services Authority (FSA) in the U.K. and the European FSA for approval to clear sterling and euro interest rate swaps and plans to move into Canadian dollar and yen interest rate swaps after that.
“While a lot of our competitors were going after CDSs, we decided to be the only one who focused on interest rate swaps,” says John Shay, founder and chief marketing officer of IDCG. “Our competitors are trying to future-ize an OTC market. We’re trying to allow the OTC market to price discover in a mechanism that it’s grown accustomed to and then allow it to clear and settle like a future.”
Joseph Murphy, R.J. O’Brien president of the Americas, sees the new clearinghouse as a positive development. “The [OTC] marketplace has been crushed from a bilateral standpoint [and] it’s far more expensive to do business because the credit premium has gone up quite a bit. IDCG will have to convert the [OTC] market from bilateral to a clearinghouse mentality on the technology and operations side, and they’ve got a good shot at doing it given the fact that anything that reduces risk and creates transparency is being embraced across the board by marketplace customers, broker dealers, investment banks, end-users and regulators,” he says.
The OTC interest rate swap market had traded on a bilateral nature where two counterparties who signed an International Swaps and Derivatives Association (ISDA) master agreement traded bilaterally. In other words between two parties, both would manage price discovery, execution and collateral margining of the trades. IDCH does not fall under ISDA’s jurisdiction. “You don’t need to be an ISDA-compliant institution to clear business with IDCH. You don’t need to have ISDA agreements with counterparties,” Shay says.
Murphy says that although IDCG’s clearinghouse indirectly competes with CME Group, “in the interest rate quadrant, it’s almost a complement and could provide increased liquidity. The OTC marketplace is massive and there’s room for more than one clearinghouse.”
Shay says IDCG has no immediate plans to throw its hat into the crowded CDS clearing ring, as it views clearing OTC euro and sterling-denominated interest rate swaps as a better opportunity.
Gary DeWaal, general counsel at Newedge, sees this as the beginning of an era where clearing takes center stage. “The key to the game is no longer the exchange, it’s the clearing. I see a complete acceleration [of clearing OTC products]. If it’s a derivative product, it’s going to get cleared somehow,” he says.
