Publishers Clearing House began on Long Island as a way to sell bulk magazine subscriptions through the mail. Today, it’s a direct marketing web site peddling all sorts of items to people who presumably are hoping for a shot at a sweepstakes grand prize.

While it won’t be coming in the form of an oversized cardboard check for $50,000, a potential windfall has been laid at the door of U.K.-based LCH.Clearnet courtesy of the financial reform law signed last week by President Obama.

When it comes to over-the-counter derivatives, a clearing house exists not to bundle magazine subscription pitches or to sucker people into thinking they have a chance at an encounter with a prize patrol, but to give investors, whether the portfolio manager at a hedge fund or the head of a pension fund, some backup protection in the event they enter into a swap trade and their broker goes belly up. It’s a straightforward strength-in-numbers premise. Members of the clearing house kick in some cash that sits in escrow to be tapped in the event one of them gets clobbered by some unforeseen blowup event or daisy chain type failure of another counterparty. With the passage of Dodd-Frank, OTC derivatives now have to be cleared centrally. This is, in and of itself, central to reformers’ ostensible goal of averting another destabilizing financial crisis.

The biggest clearing house of OTC derivatives currently is London-based LCH.Clearnet. The company has been operating a clearing house with 32 large swaps dealers as members, for which they are charged an annual fee that has remain unchanged for several years, explained Andrew McGuire, vice president of SwapClear services for the U.S. office of LCH.Clearnet. According to McGuire, who is responsible for delivering SwapClear’s OTC clearing services to U.S. buy and sell side customers, SwapClear manages roughly $224 trillion dollars in open interest represented by 14 currencies (of which $85 trillion is in USD).

Customers who currently want transactions cleared by a clearing house, as opposed to transactions being cleared their broker, do so specifically as a risk reduction precaution, especially in the wake of 2008 failures, and not because they are mandated to do so by law.

Of course, going forward, funds and dealers will have no choice but to have swaps trades cleared.

Not surprisingly, LCH.Clearnet is now readying a 24-hour clearing service and will reinvent itself in the U.S. and offer a Futures Commission Merchant (FCM) model, so as to be subject to U.S. bankruptcy laws.

Currently, LCH.Clearnet members consider themselves as an “SCM” which stands for swap clear member, and which is not subject to U.S. bankruptcy law.

It is worth noting that SCM (”Ess See Em”) sounds a lot like FCM (”Eff See Em”), so there’s that added bit of confusion, but like the new laws, LCH.Clearnet and the rest of the industry will just have to roll with it.

This entry was posted on Tuesday, July 27th, 2010 at 1:11 pm and is filed under The Offering. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.