Most of the people betting that derivatives exchanges have a future in the next millenium argue that the exchanges will have to develop a new generation of products that help them get a piece of the action in the OTC markets. The most promising products these days seem to be RepoClear, a new facility launched by the London Clearing House on August 20, and SwapClear, its highly anticipated sibling, whose launch is just around the corner.

RepoClear is a centralized clearing facility for the European repurchase agreement (repo) market, allowing members to replace their existing bank-to-bank bilateral repo relationships with multilateral netting through LCH. This is expected to reduce bank balance sheet and credit line usage as well as regulatory capital requirements. LCH estimates that RepoClear will enable members to reduce their exposures by more than 60 percent.

At the moment, RepoClear covers only German Bund repos, but the LCH plans to expand into the Italian, French, Belgian and U.K. gilt markets next year. Early trading volumes on Bunds were small, but the LCH isn’t worried. “The German Bund market in general is really quiet at the moment,” says Sara Williams, director of business development at the LCH. “Volumes have varied, but we’re generally doing anywhere from 40 to 50 trades a day, which is more or less what we expected. The more members we bring on, the bigger volume we’ll get.”

So far, eight banks have started using RepoClear: Barclays Capital, Credit Suisse First Boston, Chase Manhattan Bank, Goldman Sachs, Morgan Stanley, Paribas, Salomon Smith Barney and Warburg Dillon Read. Six more are expected to start trading later this year.

RepoClear members are giddy about the long-term prospects. “RepoClear will revolutionize the trading of interbank repos in the European markets,” says Catherine Fitzmaurice, managing director and head of repos at Salomon Smith Barney and chairwoman of the ISMA repo subcommittee.

Besides cutting costs, RepoClear is expected to reduce counterparty risk for its members and increase market liquidity by providing a central, transparent market. In order to become a RepoClear dealer, which allows a firm to deal with clearing members, a company must have a Standard & Poor’s credit rating of BBB or better or be a wholly owned subsidiary of a clearing member. To become a full clearing member, contractually bound to the LCH, a firm must own a share of LCH and contribute to the LCH default fund, which currently stands at £150 million.

SwapClear, meanwhile, is expected to go live this month, offering euro, dollar, yen and sterling interest rate swaps with maturities out to 10 years. Eventually, SwapClear could cover more complicated products, such as cross-currency swaps and caps, collars and swaptions.

The Globex Alliance

The alliance frenzy continues in the quickly changing exchange world. In September, while the Chicago Board of Trade, Liffe and Eurex continued to jockey for position, the Chicago Mercantile Exchange announced that the Montreal Exchange has joined the Globex Alliance, along with the Paris Bourse, the Simex and the Bolsa de Mercadorias & Futuros. The Montreal Exchange also announced that it intends to use the same NSC Electronic Trading System developed by Paris Bourse and used by all of the Globex Alliance partners. Under the GLOBEX Alliance, members of each exchange have direct access to all the products of all the joined markets through one single trading platform, and receive trading privileges for the electronically traded products of the other exchanges, along with cross margining of positions. The Alliance partners are also establishing a harmonized set of electronic trading rules and policies. Each Alliance exchange will connect to the central trading system via a common application programming interface being jointly developed by the exchanges.

Like RepoClear, SwapClear’s mechanics are simple. When two banks have agreed to terms and confirmed a trade with each other, the contract will be sent to SwapClear, which will run a series of checks on the deal and become a counterparty to the trade. From that point on, the banks won’t have any exposure to each other, but rather to the LCH. SwapClear will keep positions, net trades and reset margin accounts and calculations.

The benefits to the two systems appear to be huge. RepoClear and SwapClear should virtually eliminate counterparty risk, allowing members to use the capital they would have devoted to cover such risk in more economically beneficial ways. And operational risk should be reduced as well, since members would have to deal with only one counterparty for all transactions going through LCH.

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