Swap Clearinghouses 'New Too-Big-to-Fail' Post Dodd-Frank

Some bankers and academics are concerned about concentration of risk.

On a good day, 27-year-old Bobby Timberlake at CME Group Inc. in Chicago rounds up $2.5 billion from the world’s biggest traders and banks such as JPMorgan Chase & Co. to cover their losses in the $639 trillion derivatives markets.

What happens on a bad day will test new rules in the Dodd- Frank Act designed to prevent a repeat of 2008’s credit crisis. Starting in March, as much as 79 percent of derivatives trades known as swaps must be backed by collateral and go through clearinghouses such as CME Group. Traders may have to post $927 billion with Timberlake and his peers at LCH.Clearnet Group Ltd. and IntercontinentalExchange Inc., whose role as middlemen is to ensure participants get paid.

Systemic Threat

The risk is that a powerful new crisis burns through those firewalls and leaves cash-strapped banks unable to come to the rescue, triggering a Fed bailout. Lloyd Blankfein, chief executive officer of Goldman Sachs Group Inc., has said clearinghouses could be the world’s biggest systemic threat, and the Fed acknowledged in an August Federal Register notice that participants or the whole financial system could be damaged.

Stepping In

The Dodd-Frank rules could mean as much as $1 billion in new annual revenue for clearinghouses, New York-based Morgan Stanley estimates. Barclays clears more than $1 trillion a month in swaps now and expects that to increase 10-fold, said Ray Kahn, head of the bank’s over-the-counter derivatives clearing in New York.

Disaster Scenario

Tiffany Galvin, a spokeswoman for Goldman Sachs, said Blankfein’s comments reflect the firm’s current views. Andrea Priest, a spokeswoman for the New York Fed, and Susan Stawick at the Federal Reserve Board of Governors, declined to comment for this article.

Guaranty Funds

LCH held $22.3 billion in collateral and a guaranty fund of $4 billion at the end of September. Intercontinental’s two clearinghouses in the U.S. and the U.K. held $17.9 billion in collateral and $5.08 billion in guaranty funds. CME Group had $7.9 billion in collateral and $1.82 billion in guaranty funds. Morgan Stanley estimates as much as $927 billion in new collateral will be needed.

‘Way Safer’

On balance, clearing is “way safer” than private transactions, Randall Costa, managing director at Citadel LLC, whose Chicago-based hedge fund trades in derivatives, said in an interview. “Banks go down every year,” said Costa, who testified on clearing before federal regulators in March. “Clearinghouses have almost never in history gone down.”

Past Failures

Banks want to make sure they “don’t find out at the moment of maximum fail potential” that clearinghouses haven’t kept enough capital, said Paul Galant, a Citigroup executive who leads the New York Fed’s Payments Risk Committee.

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