Launched in the wake of the collapse of Enron to serve the natural gas market, CME ClearPort is now poised to lead the way in over-the-counter clearing.
Markets are built on a number of pillars, but none is stronger than "confidence" - as in the contract executed between two parties is free from credit or counterparty risk concerns.
Yes, there are many other supports that make for a solid marketplace - transparency, integrity, efficiency and fairness. But the foundation that builds and holds a market together comes from knowing that a transaction is guaranteed by a clearing house. Central counterparty clearing is the cornerstone of futures markets and is poised to play a significant role in the over-the-counter (OTC) markets.
One market service that is bringing confidence to OTC markets has been CME ClearPort, a comprehensive set of flexible clearing services first launched in May 2002. Initially, the service filled a major void in the aftermath of the Enron collapse, particularly in the OTC market for natural gas, which was left without a central OTC marketplace. Not only did the clearing service provide a way for bilateral natural gas trades to meet and flow through a clearing house but also offered the flexibility to accommodate many of the OTC contracts that were not offered on listed futures markets.
Enron's fall also pushed "credit and counterparty risk" clearly to the forefront of financial concerns. Along with that came a significant reduction in leverage and liquidity from market participants. There was a call for more financial statements and more uniform credit standards, according to a New York Mercantile Exchange presentation from February 2003 at the joint Federal Energy Regulatory Commission and Commodity Futures Trading Commission (CFTC) Conference.
Months earlier, in a May 2002 report, Moody's had called for "the establishment of a clearing system that would provide liquidity, transparency and a more efficient transfer of credit risk." Other rating agencies called for similar measures.
Flash forward to today where history’s head-scratching replays are on display.
Credit markets basically froze in the fourth quarter of 2008 and into 2009. Counterparty risk once again became a major issue for firms. When Lehman Brothers collapsed last September and fear gripped many of the largest names in the financial world, some firms quickly found that CME ClearPort was a great solution to enable continued OTC trading. Philip Wiper, director, PVM Oil Associates in London, says the credit crunch led many participants onto the service. "The market went through a very difficult period last year when many looked carefully at counterparty risk with their traditional trading partners," says Wiper, whose firm first began submitting trades to CME ClearPort in 2005. "There were some well-known counterparties who would not deal with one another and that left a pretty big hole in the wholesale business. CME ClearPort really stood out in being able to offer a clearing service for a multitude of OTC products that enabled business to continue in a counterparty risk-free environment."
Wider bridge
But CME ClearPort has grown well beyond its energy market roots and is steadily adding new contracts across multiple commodity sectors. What began seven years ago with just natural gas and electricity contracts now includes the entire spectrum of energy products, as well as ethanol, softs, uranium, plastics, steel and emissions contracts. In 2008, 141 new products were cleared through CME ClearPort. This year, 220 new products cleared through the service, including OTC grain swaps and S&P GSCI swaps. And this fall, CME Group will add OTC London Gold Forward contracts to the platform.
CME ClearPort now offers more than 700 different contracts to more than 10,000 users. The customer base continues to grow rapidly as well, with new registrations in the first quarter up 51 percent from a year earlier.
Volume growth has been stellar. In 2003, the service's average daily volume was 23,137 contracts. Three years later, CME ClearPort averaged 313,128 contracts per day. And through June 2009, the service averaged 509,000 contracts per day (See chart, below).
Revenues generated from CME ClearPort show that customers are using contracts beyond natural gas, the strongest product on the platform.
In first-quarter 2009, natural gas volumes represented 54 percent of CME ClearPort revenues. That was down from 71 percent a year earlier. Crude oil markets rose to 24 percent of revenues, up from 19 percent, and petroleum markets accounted for 15 percent, up from 5 percent a year earlier (See pie chart). CME Group is looking to branch outside commodities as well. It is developing new contracts for credit, foreign exchange and interest rate markets.
"The strategy for CME Group has been to provide central counterparty clearing in markets where they have not had that before," says Kim Taylor, CME Group managing director and president of CME Clearing. "With CME ClearPort, customers still have choice on where to execute the trades, but then can use the clearing guarantee. It is flexibility with security."
The ability to offer multiple contracts across a wide range of commodities, and eventually financial, sectors is what attracts many users to the platform. Will Babler, a principal at First Capitol Risk Management, whose firm is one of the first to use CME ClearPort's grain swaps contracts, works with producers and processors to hedge their risk.
"The benefit of CME ClearPort is that it brings a very wide product slate that often matches up well with the underlying risks our customers have," Babler says. "This allows them to hedge that risk if a traditional futures contract does not fit exactly. And with central counterparty clearing there isn't any concern with third-party credit risk. That's become much more important."
Port in the storm
Systemic risk is much more important for the government as well, which is looking to change regulatory rules and move the more standardized OTC derivatives market onto cleared exchange platforms and give CFTC authority to regulate them.
"Understanding counterparty risk will be a critical element going forward for the government," says economist Joel Naroff, president of Naroff Economic Advisors. "It's logical for them to take that stance."
U.S. Treasury Secretary Timothy Geithner testified in July that the United States must increase its oversight of the $592 trillion derivatives market with laws that are "difficult to evade." He, along with CFTC Chairman Gary Gensler and members of Congress have been pushing to move OTC derivatives onto regulated exchanges or trading platforms.
"As the markets become more standardized it becomes more compelling and economically efficient to move toward central clearing," Geithner testified.
Given that, CME ClearPort now is considered by many observers to be the right solution at the right time, especially as it broadens its product mix across multiple commodities and multiple asset classes.
"The energy contracts they started with are a good fit for an OTC clearing platform like CME ClearPort," says Andy Nybo, principal and head of derivatives at the Tabb Group, a financial markets research and consulting firm. "Another driving force behind putting these types of instruments onto a centrally cleared platform is the transparency and ability to see what positions are outstanding and see where systemic risk could possibly lie."
Back to Summer 2009 Issue Home Download a full PDF version of this issue here.
