2nd UPDATE:CME To Rework Financial Safeguards For CDS Clearing Platform

CME Group Inc. (CME) is planning to rework financial safeguards for its derivatives clearing platform for credit default swaps over the next quarter or two, establishing a separate default fund for CDS clearing, the company said Tuesday.

When CME first launched CDS clearing Dec. 15, 2009, it was backed up by its roughly $8 billion futures and options default fund, which benefited from capital contributions from the exchange's CDS clearing members.

The change won't have a big operational impact on customers, said Laurent Paulhac, head of OTC products and services at CME Group, in an interview.

"We will be relaunching our CDS clearing solution using a separate default fund structure," Paulhac said. "It has been a learning process; originally we thought there would be more benefits and efficiencies by putting it all together."

CME so far clears CDS only in the U.S., preferring to focus on energy and agricultural over-the-counter derivatives in Europe. The volume of CDS cleared by CME so far is in excess of $260 million, most of which has been trades between customers and dealers rather than dealer-on-dealer trades.

It also clears interest-rate swaps in the U.S., a much larger piece of the OTC derivatives pie, and that asset class will be next up for CME in Europe, Paulhac said. Rates clearing at CME in the U.S. had a separate default fund from its launch on Oct. 18 last year.

There have also been different capital requirements for members of CME Clearing on the rates side versus CDS. On top of a series of default management and sophistication tests, members of CME's clearinghouse need $1 billion in adjusted net capital on interest rate trades and $500 million for CDS clearing.

CME has been criticized for lagging behind its main rival ICE Trust, the CDS clearing arm of exchange operator IntercontinentalExchange Inc. (ICE). Some industry professionals have attributed that to the dealers on CME's clearing risk committee also serving on the risk committee for ICE Trust, in which they have a profit-sharing agreement.

Paulhac said he believes it is a net positive to have dealers on multiple clearing risk committees as long as confidentiality agreements aren't violated.

"As we expand our services, we have a great opportunity to capture business. This is much more a marathon than a sprint," he said.

CME is separately looking at aggregating electronic prices captured by entities called "swap execution facilities," which were brought about under the 2010 Dodd-Frank financial overhaul law.

Regulators are still writing rules to implement that law, but the statute ultimately forces all standardized OTC derivatives that are eligible for clearing to be executed either on designated contract markets like exchanges or swap execution facilities, or SEFs.

By aggregating prices from different SEFs, starting with energy swap trades, CME can help its customers compare their execution costs to others' in the market.

"We're not registering as a SEF for rates or CDS but we can connect to a lot of SEFs so we are assessing if it makes sense to become involved," said Paulhac.

-By Katy Burne, Dow Jones Newswires; 212-416-3084; katy.burne@dowjones.com

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