UPDATE: CME Group Rolls Out Interest-Rate Swap Clearing Service

CME Group Inc. (CME) on Monday rolled out a new service that will handle over-the-counter derivatives transactions tied to fluctuations in global interest rates.

Citigroup Inc. (C), Deutsche Bank AG (DB, DBK.XE) and Citadel LLC were among the first to utilize the new service, the companies said.

CME is targeting the interest-rate swap market, estimated at more than $349 trillion in total size globally, as it broadens a range of clearinghouse functions for derivatives that are traded off-exchange.

Regulators and lawmakers around the world have pushed clearing, which involves traders posting collateral against outstanding transactions, as one means of reducing systemic risk in over-the-counter markets.

Monday's introduction of the interest-rate swap clearing service at CME is seen as a "soft launch," according to Fredrik Gentzel, who heads Deutsche Bank's counterparty portfolio management and prime brokerage for rates and commodities.

"Today is more about testing trade capture and reporting systems under fire ahead of clearing any larger volumes, so the trades going through are relatively small," Gentzel said in an interview. "It will be a few days or weeks before we expect to see anyone putting through very large notional trades or backload existing portfolios."

Deutsche Bank said Monday its U.S. broker-dealer arm cleared an interest-rate swap transaction on behalf of hedge fund firm Citadel in among the first transactions handled by the new CME service. Citigroup said Monday it also cleared its first dealer-to-customer interest-rate swap trades at CME.

CME, the largest futures exchange operator in the world by contract volume, means to leverage its dominant position in interest-rate futures trading as it develops its new service for interest-rate swaps, which typically involve two parties striking a private agreement to exchange interest-rate payments.

The venture has secured participation from U.S. mortgage finance companies Fannie Mae (FNMA) and Freddie Mac (FMCC), as well as asset management firms BlackRock, Citadel and Pimco, CME reported Monday.

Besides Deutsche Bank and Citi, bank participants in the new CME service include Bank of America Merrill Lynch (BAC), Barclays Plc (BCS), Credit Suisse Group AG (CS), Goldman Sachs Group Inc. (GS), J. P. Morgan Chase & Co. (JPM), Morgan Stanley (MS), Nomura Holdings Inc. (NMR) and UBS AG (UBS).

CME's interest-rate swap clearing business will compete against an existing offering from London-based clearing entity LCH.Clearnet, which has handled dealer-to-dealer business in the market for a decade and is expanding to accept customer business.

The International Derivatives Clearing Group, backed by Nasdaq OMX Group Inc. (NDAQ), is also building a U.S. offering.

Transactions handled Monday at CME represented trades in U.S. dollars; CME is expected to begin handling euro-denominated swaps in the first quarter of 2011.

CME continues to await regulatory approval for the ability to pool customer collateral posted against interest-rate swap trades with collateral held by CME against related rate futures business, though this is likely to be granted, according to Ticonderoga Securities analyst Chris Allen.

"Given the overall increases in capital requirements for OTC positions, we would imagine the regulators would allow for capital efficiencies in areas where it made sense, such as cross-margining of interest rate derivative positions," Allen wrote in a note to clients Monday.

-By Jacob Bunge, Dow Jones Newswires; 312-750-4117; jacob.bunge@dowjones.com

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