Eurex may copy CME swap futures

German exchange seeking legal advice on scope of Goldman Sachs patent behind CME's interest rate swap futures

Eurex is consulting with dealers and buy-side firms on the potential launch of a euro-denominated interest rate swap future contract that may mimic the design of contracts traded on US rival CME Group, Risk has learned. The CME product begins life as a future, but users can opt to be delivered a cleared over-the-counter swap at the contract's quarterly settlement dates.

The German exchange is understood to be seeking legal advice on whether the US patent behind the CME product – which is held by Goldman Sachs and is used by CME under licence – applies only to products traded in the US, according to two people familiar with the matter.

Eurex declined to comment on its specific plans. However, a spokesperson for the bourse in Frankfurt says "sufficient market demand is a key prerequisite for any successful product launch".

The patent used by CME, Method and apparatus for listing and trading a futures contract that physically settles into a swap, was filed by Oliver Frankel, a managing director in Goldman's securities division in New York on June 12, 2007 and granted in 2011.

CME launched its dollar-denominated deliverable swap futures in December, supported by four dealer market-makers, including Goldman Sachs. The contracts have enjoyed steady growth since their launch, generating notional turnover of more than $33 billion so far this year, according to a CME spokesman.

They do not need to license the patent if no US person is to trade or clear it. The patent is a US one, not a global one

But whether the patent is enforceable in Europe – and where responsibility lies for ensuring it is not infringed – is unclear.

"They do not need to licence the patent if no US person is going to trade or clear it. The patent is a US one, not a global one. That said, it would be very hard for them to know no US person was trading the contract," says one industry source.

According to one senior intellectual property lawyer: "A patent grants the holder a monopoly right over a product or a method claim only within the jurisdiction in which it was granted. In order for a party to infringe on a US patent - for example, by a developing a business method based on the method claim that patent protects - the infringing act would have to take place in the US."

If the patent is deemed not to apply in Europe, then it could pave the way for Eurex to develop a contract with a similar delivery model, while avoiding the need for a potentially costly licensing deal of the kind struck by CME in the US. Under the terms of that deal, Goldman stands to collect 15–20% of the revenues generated by CME's contract, sources in the exchange industry have estimated. A Goldman Sachs spokeswoman in London declined to comment on whether the bank had received enquiries from Eurex regarding the patent.

CME is planning to offer a suite of fixed-income futures geared towards European market participants on its soon-to-be-launched European exchange, a move that could come in the second half of this year. The exchange is also considering the launch of a euro-denominated deliverable swap future, initially to be traded in the US.

But while Eurex has been consulting on specifications for a swap futures contract since January – and, it is understood, could be operationally ready to launch and clear such a contract this year – the exchange is said to be in no rush. Its first priority is a revamp of its Euribor futures contract – a market currently dominated by rival NYSE Liffe – which it announced this morning.

Even if Eurex were to launch euro swap futures after CME, however, the exchange could still gain a potentially decisive advantage through its headlock on the market for long-term euro-denominated interest rate futures. It intends to start offering users significant margin efficiencies across portfolios of cleared interest rate swaps and fixed-income futures in the final quarter of this year.

CME declined to comment on the issue of the Goldman patent's applicability in Europe. But Sean Tully, managing director for interest rate products at CME in Chicago, confirmed the exchange was consulting on its own plans for a deliverable euro-denominated swap future.

"We're working with European market participants on the feasibility of launching a euro-denominated deliverable swap futures contract. It's likely something we'll launch in the US before we look at launching it on CME Europe. We have a significant and growing liquidity pool of cleared OTC euro interest rate swaps contracts. We feel the margin savings we can generate across users' portfolios creates a compelling offering," Tully says.

CME's existing contract features quarterly expirations on set dates. At expiration, the holder of a long futures position becomes the fixed-rate receiver and floating-rate payer in an OTC interest rate swap, cleared by CME Clearing.

According to the Goldman patent filing, the futures contract physically settles upon expiration into a reference swap. The reference swap is cleared by a clearing house, so physical settlement requires the holder of a futures contract to take a specified side of the reference swap against the clearing house upon expiration. The patent says the reference swap could be a credit default swap index, a single-name credit default swap, an interest rate swap or a yield-curve swap.