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Expanding its clearing services in Europe, yesterday CME Group Inc. (CME - Analyst Report) announced the commencement of clearing of over-the-counter (OTC) interest rate swaps (IRS) derivative products in London-based CME Clearing Europe.

Clearinghouses operate as central counterparties or middlemen and guarantee every buy and sell order executed by the trading parties. This reduces the risk in case a trader defaults. Accordingly, CME Group initiated its OTC IRS clearing services with the clearing of seven currencies including sterling, euro, yen, US dollar, Canadian dollar, Australian dollar and Swiss franc.

Thus, the company’s clearing product portfolio in London includes OTC IRS, foreign exchange (FX), credit default swap (CDS) and commodities. Until now, the company was clearing energy and commodity swaps through CME Clearing Europe. CME Group plans to begin the clearing of OTC FX and the CDS products through 2013.

Companies like Goldman Sachs Group Inc. (GS - Analyst Report) and The Royal Bank of Scotland Plc (RBS - Snapshot Report) have already traded through CME Group’s OTC IRS clearing. Going ahead, Citigroup Inc. (C - Analyst Report) and Morgan Stanley (MS - Analyst Report), among others, are also likely to begin trading in the upcoming weeks.

Meanwhile, the latest expanse of product clearing in London not only enhances CME Group’s revenue growth opportunities from international quarters of Europe but also helps gain operating efficiencies and scale. With an achievement of clearing more than $1.75 trillion in OTC IRS through CME Clearing US, the company now looks forward to lead the European market.

Further, the company’s foray into the OTC financial derivatives aims to strengthen its position in the European market, where clearing services are primarily controlled by LCH.Clearnet, which is a leading clearinghouse for swaps in Europe owned by multiple banks and market participants, and Eurex of Deutsche Boerse.

Particularly, LCH.Clearnet enjoys a booming IRS business in London, where it operates through SwapClear and holds over 95% of the OTC IRS clearing market. However, a few competitors on the clearing-side provide CME Group with ample expansion opportunities through its higher capital efficient, transparent, integrated and flexible clearing platform.

Reforms Support Extensive Clearing

The expansion into OTC IRS clearing is backed by the latest approval received by the company from UK’s Financial Services Authority (FSA). CME Group also looks forward to capitalize on the financial reforms in the US that strictly requires clients to clear their swap products. While the first phase of mandatory clearing was rolled out in the US last week, a second phase will likely commence by mid-2013.

As a result, the Dodd-Frank regulations in the US as well as European Union regulations have joined forces to direct the $600 trillion OTC market toward clearing all products. This opportunity once again makes clearing service offering a lucrative business for exchanges.

Overall, we believe that the expansion into international avenues follows CME Group’s organic growth strategy and should boost the company’s financials in the future. This is crucial in the current scenario given that the company is facing restricted top-line and margins’ growth due to continuous low volumes and substantially reduced clearing-transaction fees.

CME Group, Goldman Sachs, Citigroup and RBS carry a Zacks Rank #3 (Hold). However, Morgan Stanley holds a Zacks Rank #1 (Strong Buy).

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