On April 16, Chicago Board of Trade and Chicago Mercantile Exchange, Inc. announced a historic agreement, the CME/CBOT Common Clearing Link. This agreement is historic because it changes the landscape in the U.S. futures industry, where in 2002, approximately 85 percent of all futures and futures options volume in the U.S. was executed on CME and CBOT. This link will provide operational, performance bond (margin) and capital efficiencies to common CME/CBOT clearing members and all customers in a manner that has not been seen in the history of the U.S. futures markets.
The Benefits of the Link
Clearing Members of CME/CBOT have asserted that their operations would improve tremendously if they could achieve the following five things:
1. Have all positions in a single location
2. Have all collateral in a single location
3. Receive risk offsets to the extent possible for themselves and their clients
4. Deal with only a single set of interfaces
5. Contribute to a single Guarantee Fund
The Common Clearing Link, when operational by Jan. 2, 2004, will provide all of the above to the clearing members of CME and CBOT. Specifically, the link will provide the following savings for joint firms of CME and CBOT:
Recognition of risk offsets between corresponding CBOT and CME productsfor example between the Treasuries and the Eurodollars, and the S&P 500 futures and the Dow Jones futureswith a corresponding reduction of performance bond requirements
A single performance bond requirement for the combined portfolio of CBOT and CME positions, to be met by a single pool of collateralbringing new efficiencies to firms management of assets deposited as margin collateral
Combined settlement and banking, reducing funding and transaction costs
A single guarantee fund, saving on capital requirements
Common processing, with a single set of interfaces working exactly the same way for CBOT products as for CME productsmeaning that firms can save on both systems and staffing costs.
Overview of the Common Clearing Link
The link is essentially a comprehensive outsourcing agreement, with CBOT establishing itself as a Derivatives Clearing Organization under CFTC regulations, and then outsourcing clearing services to CME. The provided services include both clearing processing and the clearing guarantee, for all existing and future CBOT futures and futures options contracts.
Firms which are currently clearing members of CBOT but not CME will be able to continue as clearing members of CBOTs new clearinghouse under the new arrangement. These firms will meet CBOTs requirements and be admitted into membership in the CME Clearing House as special-purpose CME members, at their current capital and membership requirements, and with eligibility only for CBOT products. Other than these restrictions, such special-purpose member firms will have the same rights, access, and service levels afforded to all CME clearing members.
For the 51 clearing firms which CME and CBOT currently have in common, the link will simply be a matter of using CMEs clearing applications for both CBOT products and CME products. For example, firms will receive trade confirmation messages for their electronically-executed trades for both CBOT products and CME products. They will use CMEs Clearing 21 system for all clearing-related functions from trade matching to banking and settlement. The C21 applications will handle both exchanges products, and will work the same way for both exchanges. To make the switch as easy as possible, traders will continue to use their existing CBOT trader IDs, and firms will continue to use their existing CBOT trading firm numbers.
Common Clearing Link Processing
Common firms should benefit from having a single settlement cycle and a single guarantee pool. Besides reducing performance bond requirements, the link will reduce funding costs by netting settlement obligations during the intra-day and end-of-day settlement cycles, and it will reduce banking costs. And a single guarantee pool is likely to reduce the total capital contribution needed to back the clearing guarantee.
From an operational point of view, processes will be streamlined, with a single set of deadlines for trade submission and collateral substitution. Some examples include:
Firms will have the flexibility of choosing whether to receive a single Trade Register in each origin, with CBOT products broken out from CME products, or separate registers. Firms can make this decision according to whatever makes the most sense operationally. Regardless of whether firms choose separate or combined registers, positions will be combined for margin calculation, collateral, and settlement processing.
Position reporting will be accomplished through CMEs Position Change System, thereby eliminating the need for next-day open interest reporting and open/close indicators.
For calculating customer-level margin requirements, there will be a single, combined SPAN file, which will contain data for both CBOT products and CME products. Most importantly, the file will contain a single, combined pool of recognized intercommodity spreads. This will make it easy for common firms to calculate customer margin requirements which provide the same margin offsets between CBOT products and CME products as are available to the clearing firm.
For cross-margining with the Options Clearing Corporation and the New York Clearing Corporation for positions in broad-based equity index futures and options, CME and CBOT will combine the separate agreements which currently exist into a single portfolio of positions. The same will occur for the separate agreements currently in place with the Government Securities Clearing Corp. for cross-margining of positions in interest rate futures and options against physical Treasury securities. Doing this will provide the maximum savings possible to common firms.
Existing clearing-level margin practices wont change. In the house origin, both CBOT products and CME products will be margined on a fully net basis. In the customer origin, CBOT products will be margined on a net basis and CME products on a gross basisexactly as they currently are.
Deliveries processing is probably worth a mention here as it is the single greatest difference between the operations of CME and CBOT.
CMEs delivery applications already support processing for TreasuriesCME and CBOT will be confirming requirements with users in the coming weeks. CME is currently extending the delivery systems to handle the CBOT grain contracts and other physically-deliverable futures, with full support for the electronic receipts processing currently used. CME will work closely with CBOT and member firms to implement deliveries processing in CMEs new Web-based delivery application no later than Jan. 2, 2004.
Note that, although CME will provide the applications, CBOT will retain overall responsibility for deliveries of its products, as it currently does. Similarly, although firms will send their large trader data to CME for both CBOT products and CME products, responsibility for market regulation for its products will remain with CBOT.
A Final NoteFees
CBOT will charge the same fees that firms currently pay for clearing services. CBOT will continue to calculate exchange fees for its products, while CME will collect clearing fees on behalf of the CBOT for CBOT products.
From the perspective of reducing costs and increasing efficiency, the savings from the clearing link could be dramaticlower systems costs from standardized systems and interfaces, lower staffing costs, lower performance bond (margin) requirements, collateral efficiencies, banking cost reductions.
In the coming weeks, CME and CBOT will be publishing more detailed information about the testing and cut-over process, with the commitment to providing sufficient testing time and ensuring a smooth transition.
Bryan Durkin is senior vice president of the Chicago Board of Trade and Edward Gogol is director, Clearing House Systems for the Chicago Mercantile Exchange, Inc.