The Foreign Exchange Markets Subcommittee—a subcommittee of the Commodity Futures Trading Commission’s Global Markets Advisory Committee composed of private company representatives—made recommendations to GMAC related to the mandatory clearing of foreign exchange non-deliverable forwards. Most critically, FEM recommended that the roll-out of mandatory NDF clearing be coordinated by the CFTC with European regulators in order to maintain “a robust liquidity pool.” Among other matters, there should be harmonization of products to be cleared (e.g., currency pairs and tenors), counterparty categories and a timeline for mandatory clearing. FEM recommended that, if the CFTC implements a clearing mandate for NDFs, it should be limited to outstanding maturities no longer than 12 months. This, said FEM, is “to ensure that [clearinghouses] are only exposed to liquid NDFs.” Likewise, FEM advised that, in light of expected proposals by the European Securities and Markets Authority, NDF clearing determinations should be proposed by the CFTC by no later than August 1, 2015, with the first category of participants being subject to mandatory clearing on February 1, 2016. Finally, FEM requested that the CFTC consider the implications of mandatory clearing determinations on NDFs that might be traded on swap execution facilities even before such trading is mandated. As these transactions would be subject to CFTC-required pre-trade risk checking and clearing certainty requirements, there could be disruptions of liquidity if SEFs and their participants were not adequately prepared. Accordingly, said FEM, “the readiness of SEFs and their participants for …pre- and post-trade processes for NDF trading, including support for FCM credit checks, pre-allocated trades and post-clearing allocations (“Bunched Orders”) should be considered when implementing the Subcommittee’s recommended timeline.”

My View: The reference by FEM to promoting a “robust liquidity pool,” reminded me of one of the hidden dangers of exchange-traded derivatives clearing: unfortunately, there is sometimes a belief that because it is cleared it is liquid. Unfortunately, as a few futures commission merchants have experienced, this is not necessarily true. An FCM that maintains customer positions can sadly find out after a customer default, that the customer’s short positions in some specific option strike prices, swap futures, or even cleared swaps are not as liquid as initially thought, or became materially less liquid over time. This is discovered when an effort is made to liquidate the client’s portfolio and the FCM also discovers that the initial margin posted for the positions is not remotely sufficient to cover the duration of the actual liquidation in light of real market conditions.