By the time you read this there will be another competitor for U.S. Treasury futures business as NYSE Liffe U.S. announced a March 21 planned launch of its fixed income complex. The announcement came the day New York Portfolio Clearing (NYPC) received final regulatory approval of its "one-pot" cross-margining arrangement between cash fixed income positions cleared by the Depository Trust & Clearing Corporation’s (DTCC) Fixed Income Clearing Corporation (FICC) subsidiary and interest rate futures positions cleared by NYPC.
NYSE Liffe will launch Eurodollar futures on March 21, followed by a full suite of Treasury futures a week later. They will be the third exchange offering fixed-income futures. The Chicago Board of Trade, part of CME Group, has withstood many challenges to its Treasury complex, and CME has maintained dominance in Eurodollar futures since introducing them in the 1980s. ELX futures, which launched in 2009 and offers a full suite of fixed-income futures, recently has set volume records but hasn’t been able to produce more than single-digit market share.
While there have been many challenges to the Chicago exchanges’ dominance in Treasury futures, the most recent brings something new to the table — the ability to clear cash and futures positions in one pot.
NYSE Liffe U.S CEO Tom Callahan said, "We fully understand that competing in the interest rate arena against a franchise as well established and well defended as CME would take a really big idea. For us NYPC is that big idea."
NYPC is a 50/50 joint venture between DTCC and NYSE Euronext.
The clearing structure, two years in the making, looks to add a margin efficiency advantage over the CME Group’s fixed-income complex that other challengers did not have. "We believe our efforts are transformational," says NYPC CEO Walt Lukken. "[By] bridging the securities world and futures world together for the first time at the clearinghouse level [we] will bring significant efficiency to firms that are trading through [NYSE Liffe] and clearing through NYPC."
CME Group managed to steal some of NYPC’s thunder by announcing, the day before NYPC received final approval, a new type of membership that would provide many of the same margin offsets to customers trading fixed-income futures.
The Financial Instruments Clearing Membership (FICM) is actually an old structure that was originally used to manage cash and futures currencies.
"We have allowed firms to set up self-clearing accounts that directly face the CME for their futures business," says CME Director of FX and Interest Rate Products Derek Sammann. "They utilize a facilities manager, who is a CME clearing member, and also an FICC clearing firm. [That] facilities manager handles and backstops both their futures business at CME as well as clearing some of their cash securities."
Sammann says the membership would offer a maximum margin offset of 65%; through nearly six months of beta-testing the average margin savings for potential FICM members was in the 40% to 45% range on the futures leg.
NYPC estimates capital savings of 15% to 30% over existing clearing structures but Lukken cautioned that because of the different risk structures, such estimates could not be compared on an apples-to-apples basis.
While NYSE and NYPC officials said there was not sufficient information on the CME membership to comment specifically, they suggested that it would add another player in the mix that could increase counterparty risk. "Anytime you introduce a new [entity] into the equation that is just more operational complexity and potentially more counterparty risk. If you look at the NYPC solution, we clearly decrease operational complexity and risk by harmonizing the collateral movements between futures and cash," Lukken says.
Sammann disputes this. "If you look at the risk that these FICM firms present, it is no different than other self-clearing firms. They face directly CME clearing and on the futures side of that transaction everything reverts back and is handled by the facilities manager which is a CME clearing firm," he says, adding, "When firms take on the FICM membership one of the things they have to do is make a contribution to the guarantee fund that scales up [based] on the size of their positions."
John Coleman, managing director of R.J. O’Brien’s fixed income division, says the NYPC one-pot method is a little more of a thorough cross-margining arrangement, especially because it will include repos, but adds, "Nothing is complete until you have liquidity. At the end of the day nobody is going to go anyplace that isn’t liquid."
By Daniel P. Collins