OCC Moves into OTC Derivatives Clearing Space

There's an interesting video on the Financial Times site about the Options Clearing Corporation, based in Chicago, moving into clearing of OTC equity derivatives. With the influence of the recently passed Dodd-Frank Wall Street Reform Act, mandating central clearing for OTC derivatives, Michael McClain, EVP of OCC, tells the FT editor, there's opportunity for member firms to put OTC equity derivatives into the same clearinghouse with listed derivatives.

Since the OCC is the largest U.S. clearing house for listed- equity options, "We're taking on OTC equity derivatives. We believe it is very good opportunity for our members to put OTCs and listed in the same clearinghouse," said McClain in the interview, adding "This is very capital efficient."

Because of the recently passed U.S. legislation, a lot of people have heard about CDS — credit default swaps and interest-rate derivatives — but are less familiar with equity derivatives. "What are OTC equity derivatives", asks the FT interviewer. "They are probably the smallest of the OTC derivatives categories. They are based on underlying of stocks and underlying of stock indices. They are traded a lot by corporates and investors looking to hedge positions. OCC is focused primarily on the U.S. markets.

However, OCC had to go to the Standard & Poor's Corp., provider of the S&P 500 index provider, which licensed the index to trading on listed markets and they also license it to the OTC markets, to each provider individually. "As far as the cleared market, that's a whole new market ."We did have to go to the S&P 500 to get a license in clearing," explains McClain.

"Exchanges that own licenses to indices, such as CME and Deutsche Borse, for instance, can shut people out of the clearing business," contends the FT editor. McClain says, "Rght now there is no solution. the index is owned by the index provider and they can offer it whomever they want to."

OCC's strategy is to offer a utility model and that this will undercut some of the other CCPs such as ICE and CME and other CCPs in Europe. Pointing out that some of the other CCPs follow a for-profit model and can claim they invest more on their technology," the FT editor challenged McClain to defend OCC's technology.

"We are a utility. It doesn't mean we don't spend money on technology," said McClain, adding that it means OCC is very efficient in its processes. He also said member firms have supported spending on technology. "If you look at our technology, I think it's world class leading technology clearing with our Encore front end clearing as well as our world class risk system." OCC is in the middle of redoing its entire Pricus system."

OCC will launch OTC derivatives clearing in summer of 2011. And it's eyeing the other swaps business including variant swaps and equity swaps. "Our risk systems are very good at volatility," says McClain.