CORRECTED-REFILE-US regulator nears new FX clearing guidelines

Thu Mar 13, 2014 4:57pm EDT

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(CORRECTS 2nd graf about sequence of proposal)

By Mike Kentz

BOCA RATON, Florida, March 13 (IFR) - The first CFTC guidelines for the mandatory clearing of foreign exchange derivative contracts are in the final drafting stages and could come as early as the next six weeks, according to market participants and one of the agency's commissioners.

The proposal, which would then be open for comment and subsequently phased in over several months and three stages, will set in motion a shift of the third set of derivative instruments to be mandated for central clearing via Dodd-Frank legislation.

The first two sets of contracts were interest rate swaps and credit default swaps. The FX mandate will comprise non-deliverable forwards and OTC FX options.

"I don't have an exact date but the proposal seems imminent," CFTC Commissioner Scott O'Malia told IFR on the sidelines of an industry conference in Boca Raton, Florida.

"Judging by some conversations with staff, I would say it will be out in the second quarter."

The movement of FX contracts into clearing will represent a major shift for the NDF and options market, where trades are currently conducted on a bilateral basis.

Previous shifts to mandatory clearing for IRS and CDS contracts were marked by widespread industry disagreements over the form, structure, and cost of clearing.

"There are a lot more players in this market [than IRS and CDS], so it can be really messy," said O'Malia.

"We've really got to drill down and figure out some things around how the infrastructure works."

Some market participants believe the industry has learned its lessons from prior experience, and that the shift will be smoother than last year.

Exchanges point to the fact that traders are already increasingly utilizing cleared products such as futures and exchange-traded options because the products provide reduced counterparty risk and capital efficiencies.

The voluntary shift provides proof for some that the industry is ready for a mandate and will collaborate in setting up market infrastructure.

"We've seen a huge increase in clients looking to trade FX through exchanges and on electronic platforms," said Derek Sammann, head of FX, metals, and options solutions at the CME Group.

"A host of regulations are pushing people to utilize the capital and operational efficiency associated with on-exchange trading."

Exchange-traded FX options are the firm's fastest-growing FX product, with 2013 average daily volume growing 49% year-over-year.

The mandate for central clearing will also start the clock ticking for the movement of NDFs and options onto swap execution facilities - electronic platforms where OTC swaps will be forced to trade as a result of Dodd-Frank.

"All the FX SEFs have been waiting with bated breath for the FX clearing mandate - now we can exhale," said Vikas Srivastava, the CEO of Integral SEF, an FX trading platform.

"This will finally provide the onus to trade NDFs and options on SEFs."

Market participants are highly interested to see how the CFTC structures the clearing of OTC FX options, specifically, though the structure for NDFs is relatively understood.

The expiry of an option brings the settlement of a transaction where two cash flows are exchanged, a process traditionally handled by the dealer-run CLS Bank.

The inclusion of clearinghouses in the mix means CCPs and CLS will have to strike an agreement regarding how the risk is managed around that settlement process. (Reporting by Mike Kentz)

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