Kathryn Zhao
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Five Pillars of Modern Electronic Trading

In this reprint from Global Trading, Cantor's Zhao describes the essential pillars of building a low-touch trading desk.

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March 1, 2014

In the Clearing

Settling trades has always been a challenge for firms, but even more so now in the new post-Dodd-Frank, EMIR and Basel III world.

By Mary Schroeder

New rules like the Dodd-Frank Act in the U.S. and EMIR and Basel III in Europe are presenting buyside professionals with a unique challenge: How do they clear their executed trades in a post-regulatory financial landscape and mitigate their own risk? Like all new regulations, questions abound. Traders spoke with the head of American business of LCH.Clearnet for his take on what the buyside needs to do now.

Change is here. With the rollout of the Dodd-Frank Act's mandatory clearing requirements for parts of the derivatives market-which force traders to post collateral known as margin-broker-dealers, futures commission merchants (FCMs) and clearinghouses have had to adapt to profound changes to the way they do business in a very short period of time.

Mandatory clearing of interest rate swaps and index-based credit default swaps, both regulated by the Commodity Futures Trading Commission (CFTC), was gradually rolled out last year. The Securities and Exchange Commission, which regulates single-name credit default swaps, has not yet set a timetable for mandatory clearing for those instruments.

As Traders' Clearing Quarterly was going to press, the next big regulatory hurdle was due to begin rolling out on February 18. Under CFTC rules adopted last year, any swap that is required to be cleared must be executed on a designated contract market (DCM) or swap execution facility (SEF), unless no DCM or SEF makes the swap "available to trade."

The agency defines an SEF as a "trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system and is not a designated contract market."

Meanwhile, industry observers including Virginie O'Shea, senior analyst at Aite Group, expect to see a shakeout among central counterparties (CCPs) vying for the new clearing business. "You'll get some regional players in specific markets, but I believe there will still be a relatively limited number of CCPs because it's a volume game. It's quite hard to make money out of it if you don't get that volume," she said.

One firm that does have that kind of volume is LCH.Clearnet's SwapClear, an interest rate swap (IRS) clearing service with a 76 percent market share of IRS buy-side activity. LCH also offers CDSClear, a credit default swap clearing service, for the much smaller CDS market. Clearing Quarterly contributor Mary Schroeder recently spoke with David Weisbrod, the CEO of LCH Clearnet's U.S. business, to discuss the impact of the regulatory changes on the dealer and FCM market.


Traders: What has been the impact of the regulations to date?

David Weisbrod, LCH.Clearnet: The impact has been tremendous. The market has transformed from being a largely over-the-counter bilateral type of market to one that's now going to trading venues and clearinghouses. It is really significant. From the dealer side, they have had to introduce new operational processes and technology changes to comply with the new rules. The next milestone will be Feb. 18, when the "made available for trade" rule that requires swap trade execution via SEFs takes effect. We are deeply engaged to ensure this runs smoothly from the clearinghouse side.


Traders: What operational processes have been affected and will be affected when the SEF execution rule goes into effect?