CME finalising plans for swaptions clearing

Swaptions said to have passed CME’s risk committee, and may now be included in CME Clearing Europe’s application to Esma for reauthorisation

CME Group is close to finalising its launch plans for swaptions clearing, with the service set to be launched at the firm's US and European clearing houses within a matter of months, according to two people familiar with the matter.

The CME's risk committee for interest rate products is understood to have recently approved the specifications for a clearable product, paving the way for the central counterparty (CCP) to begin marketing it to dealers and buy-side firms.

A spokesman for CME in Chicago confirms the company is working on swaptions clearing, but declines to provide further details.

According to one market source, the products are slated for inclusion in CME Clearing Europe's application for reauthorisation to the European Securities and Markets Authority (Esma). Esma requires these applications to include all products a CCP plans to clear within the next six months, in order that they can be assessed by a college of European regulators.

Given the deadline for reapproval submissions is September 15, such a move would mean CME would probably be able to start offering swaptions clearing in Europe by March 2014 at the latest.

Along with rival LCH.Clearnet, the CME has been working on a swaptions solution for some time, with the rough target of a year-end launch date resting on the CME's ability to agree on a pricing benchmark – not a straightforward task in a relatively illiquid market.

So far, all efforts to craft a clearing service for interest rate options and swaptions have foundered on the prohibitively high margin numbers that risk models have demanded. There have also been objections relating to the high degree of tail risk that swaptions would introduce to a CCP's default fund, with exposure mutualised among dealers that do not use the products. That has led to suggestions that default funds be 'verticalised', or split along product lines – a problem the industry is also confronting in its efforts to clear inflation swaps.

But the need to find a solution has also been growing. Many swaptions are hedged with plain vanilla swaps that are currently cleared, and with final rules on the margining of uncleared trades believed to be imminent, market participants face the prospect of netting sets being split up and margined separately. Buy-side firms, particularly pension fund managers, have complained that leaving part of the rates market uncleared will force them to bifurcate their swaps books, causing them to forgo any margin offsets that might be available across the interest rate complex.

LCH.Clearnet is understood to still be working on its own solution, as well as its plans for inflation clearing.