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CME in Chicago shifts clearinghouse access as new rules reshape derivatives industry

CME Group will broaden access to its clearinghouse, letting investors bypass banks in what could be a major step toward reshaping how the derivatives industry works.

Starting Friday, asset managers who trade futures and swaps can post collateral directly in the clearinghouse run by CME, operator of the world’s biggest derivatives exchange, rather than go through a bank such as JPMorgan Chase Co., Morgan Stanley or Goldman Sachs, which pool their collateral with other customers’ funds.

The change comes as rising costs from new regulations are cutting into banks’ profits from the business. Goldman Sachs has recently been assessing its derivatives customers to weed out any it determines have become too costly, according to people familiar with the matter. Those decisions have been conveyed to customers in meetings over the past few months, the people said. Investors benefit because they’ll no longer be exposed to the risk of their bank — or one of the bank’s customers — collapsing and imperilling the money they set aside as protection from losses.

“This is something the big buy-side players have wanted for a while,” said Dan Berkovitz, the former general counsel at the Commodity Futures Trading Commission, who is now a partner at Wilmer Cutler Pickering Hale Dorr LLP. “They’re trying to minimise their dependency” on the banks and “the possibility that if there’s a failure of someone else, they’ll be taken down with it,” he said.

Regulations put in place after 2008 have crimped banks’ profits from clearing customer derivatives trades. The Basel Committee on Banking Supervision now requires banks to count customer collateral pledged to back trades as adding to a bank’s leverage ratio, cutting into profit margins. Global banks must also now set aside more of their own capital to back their trades. The cost of doing this business for banks is important because they provide the vast majority of resources that clearinghouses use in the case of a trader default. The fewer banks there are supporting clearinghouses, the weaker they are.

CME’s new system offers relief to those banks because the customer margin won’t trigger regulatory capital measures. That will help the banks earn enough money to justify their continued involvement as members of the clearinghouse, which is funded through bank contributions and the contributions of their customers.

From CME’s perspective, the new system — in which investors dubbed direct funding participants can access its clearinghouse — was a way to improve bankruptcy protection for its customers without having to change US law, said Suzanne Sprague, a managing director in the company’s credit risk, risk policy, banking and solutions group.

“The main desire for the programme is individual segregation,” she said in an interview. Sprague said she doesn’t expect a large number of users to become direct funding participants right off the bat, as it will take time for them to set up the necessary back office systems and settlement bank relationships the programme requires.

Interest rates near zero per cent are also reducing the amount of money that banks can earn from this business since they can no longer earn a spread on the client assets they hold as collateral. MF Global, one of the few futures brokerages to exist outside a bank before it declared bankruptcy in 2011, earned US$1.26 billion in interest income for the three months ended September 30, 2007, when the Federal Funds overnight interest rate was 4.75 per cent.