New Clearing Rules to Benefit CME

Yesterday, CME Group Inc. (CME - Analyst Report) announced the receipt of regulatory approval for reducing its portfolio margins within the clearing and cross-selling of interest rate futures and over-the-counter derivatives. This approval seeks to bring in cost synergies for the company and new business for clearing services offered by it.

November 19, 2012 onwards, CME Group will be able to allow different types of trading firms and hedge fund managers to pool their trades in diverse products in a single basket. These products include interest rate swaps (IRS), Treasury futures and Eurodollar futures, among others. In March this year, the company commenced the offering of portfolio margining services to the banks such as JPMorgan Chase & Co. (JPM - Analyst Report).

Previously, these contracts were traded individually with less collateral as some IRS would be offset with its futures’ position. This process was also adding to the cost of the company. Thus, the latest regulation will compel traders to back all the contracts by the required collateral but with reduced initial margins, thereby enhancing capital efficiencies for CME Group and traders.

The new rules also impel the traders to get their contracts cleared by the authorized clearinghouses, which also includes CME’s clearinghouse. Hence, this rule will allow the company to tap the $400 trillion clearinghouse business.

Additionally, the portfolio margining will generate transparency and manage risk effectively, which is expected to be beneficial to the customers. The technological upgrade and a central clearing will mitigate the risk and reduce margin requirements, thus augmenting the scope for cost synergies.

Growth remains a huge driver for CME Group. While the company has been expanding its IRS clearing portfolio, last week it also received the due approval from the regulatory bodies in London to launch its currency futures in Europe as well.

CME Group has already been operating its clearinghouse in London since May last year. The company now intends to launch 30 new currency futures by June 2013. CME Group also plans to initiate more products in other asset classes in the future.

We believe these positives should drive growth in the company’s IRS portfolio primarily due to the ongoing interest rate volatility in the global economy. Additionally, such products enhance transparency and risk-management features to the trading, which should help in gaining the confidence and attracting the untapped customer-base.

The latest offering will further enhance CME Group’s market retention capacity in the presence of arch-rivals such as NYSE Euronext Inc. (NYX - Analyst Report) and IntercontinentalExchange Inc. (ICE - Analyst Report), also reflecting sound utilization of its capital.

CME Group carries a Zacks Rank #4 that implies a short-term Sell rating, while the long-term recommendation stands at Neutral.