CME applies to create commodities swap execution facility

Exchange targeting $633 trillion OTC derivatives market

CME Group Inc., the owner of the world’s largest futures market, applied to create a new kind of venue known as a swap execution facility that will initially focus on trading commodities derivatives.

The Chicago-based exchange operator said today that it’s seeking U.S. Commodity Futures Trading Commission permission to form the market. Other companies that have asked for or received approval to create one include IntercontinentalExchange Inc., ICAP Plc, Tradeweb Markets LLC, GFI Group Inc. and Bloomberg News parent Bloomberg LP, according to the CFTC website.

The Dodd-Frank Act of 2010 has provisions designed to shift swaps, which helped fuel the 2008 credit crisis, from largely unregulated transactions negotiated off exchanges to more transparent trading on systems including SEFs, which the CFTC and U.S. Securities and Exchange Commission oversee. CME Group is seeking to tap into that market after the CFTC completed rules governing the trades in May, opening up competition in the $633 trillion over-the-counter derivatives market.

The exchange operator has focused more heavily on guaranteeing swaps with its clearinghouse than it has on providing execution services, though it never closed the door to venturing into creating a SEF, Rich Repetto, an analyst at Sandler O’Neill & Partners LP in New York, said in a telephone interview. The dealer banks that created the over-the-counter, or OTC, market 30 years ago have pushed back against some of CME Group’s past efforts to offer trading services, he said.

‘Fine Line’

CME Group’s application “doesn’t come as a complete surprise to me, but it’s a step up in their OTC strategy,” he said. “It gives them a broader opportunity set, but they’re walking a fine line in maintaining a strong relationship with the dealers.”

CME Group has stumbled in past efforts to offer trading for OTC derivatives. In 2009 it said it would provide both trading and clearing of credit-default swaps through its CMDX platform, a joint-venture with Chicago-based Citadel LLC.

Leo Melamed, CME Group’s chairman emeritus, said in 2009 that bank customers resisted that proposal to offer both trading and clearing through CMDX. The banks wanted to trade the contracts among themselves or with clients and then bring them to CME Group to be cleared, he said.

“We started a little wrong,” Melamed said at the time.

Trailing ICE

That led to a delay in CME Group’s credit swap service that gave competitor IntercontinentalExchange, known as ICE, time to take the lead. CME Group has cleared $372 billion in credit swaps since it first offered the service in December 2009. That compares with $44 trillion for ICE since it began its service in March 2009.

In 2008, CME Group and Thomson Reuters Corp. ended their FXMarketSpace joint venture, which offered currency trading, after it faced difficulty attracting business for cleared OTC products from the investment banks that dominate the private transactions.

“In registering as a SEF, we’re providing our customers with the greatest operational flexibility possible,” Damon Leavell, a CME Group spokesman, said in an e-mailed statement. “That has always been a goal. And, even in the early days of Dodd-Frank, we always said we reserved the right to operate a SEF depending on how the market evolved.”

Unlike with futures, swaps users will be able to trade the contracts on one venue and clear them at the clearinghouse of their choice. In futures, exchanges control both the execution and clearing of trades.

The requirement that swaps trade on SEFs becomes effective on Oct. 2. The CFTC has so far approved applications from Bloomberg, GFI, MarketAxess Holdings Inc., State Street Corp. and Tradeweb, which is majority owned by Thomson Reuters Corp., to operate the markets, according to the regulator’s website.

Before trading can start on a SEF, the operator must submit a request to the CFTC for the specific swaps it wants to offer, known as a made-available-to-trade application. That process may take up to 90 days to receive CFTC approval.

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