In a move to gain share of the over-the-counter swaps clearing market, CME Group (NASDAQ:CME) has announced that it will allow customers to cross margin positions in over-the-counter interest rate swaps and Eurodollar and treasury futures, thereby reducing the margin required to back their positions.  The commodity exchange has received regulatory approval for portfolio margining for customer accounts and will offer the same beginning November 19.
CME is laying the groundwork to accommodate the $1.2 billion a year revenue opportunity that will open up once the Commodity Futures Trading Commission’s (CFTC) new rules requiring central clearing of all OTC trades come into play.  CME earned $2.7 billion of its $3.2 billion revenues in 2011 from trading and clearing services and is expected to build on its reputation as one of the largest commodity exchanges in the world.
Our $60 price estimate on CME Group’s stock is in-line with the current market price.
The Dodd-Frank Consumer Protection and Wall Street Reform Act of 2010 has set guidelines for clearing of OTC swaps, which are executed bilaterally outside the traditional exchanges, to reduce counter-party risk and increase transparency in the $648 trillion derivatives market.  The CFTC has faced many hurdles in implementing the mandate, but regulations are expected to be in place by early 2013. With the new regulations in place, we expect an increase in the volume of OTC trades cleared by CME across all asset classes.
OTC transactions are cleared via CME’s ClearPort platform which was launched in 2002 following the Enron debacle. So far, this year, the average daily volume of contracts cleared by ClearPort has declined from 582,000 in January to 370,000 in September, a decline of 15% from the volume in September last year. The decline can mostly be attributed to a slump in investor confidence caused by the uncertainty prevalent in the U.S. economy and the prolonged European sovereign debt crisis which has influenced trade volumes in general. Increased competition from IntercontinentalExchange Inc. (NYSE:ICE) has also led to the decline in volumes.
The newly introduced portfolio margining, which was earlier offered to bank members such as JPMorgan Chase (NYSE:JPM), will reduce the capital requirement for interest-rate futures by up to 90%.  This is just one of the initiatives that the company has taken to lure buy-side customers to its clearing platform. We forecast an increase in the average daily volume of interest rates contracts executed via CME, primarily driven by the clearing mandate and a general recovery in the economy. You can modify the interactive chart below to gauge the effect of a change in the forecast on our price estimate.Notes:
- CME Group Extends Portfolio Margining for OTC Interest Rate Swaps and Futures to Customer Accounts, Press Release, 16th October, 2012 [↩]
- Analysis: Commodity exchange battleground switches to “swaps”, Reuters, 11th October, 2012 [↩]
- Clearing for OTC derivatives market finally in sight, Reuters, August 15th, 2012 [↩]
- Cleared OTC Interest Rate Swaps, CME Group [↩]