In preparation for the regulatory mandate requiring over-the-counter (OTC) derivatives trades to be cleared through central counterparties (CCPs), CME Group (CME) has announced the establishment of a clearing link in collaboration with Bloomberg.

Nondeliverable forward (NDF) trades that are electronically executed on Bloomberg's foreign exchange platform, FXGO, will be cleared through CME's clearing brokers.

The move will help CME expand its OTC clearing services and will allow it to tap into the growing foreign exchange market.

The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in July 2010 made it mandatory for OTC trades through swap execution facilities (SEFs) to be cleared through central counterparties, as regulations were required to check counterparty risk, particularly after the 2008 credit crisis. Although the mandate still requires approval from the U.S. Commodity Futures Trading Commission (CFTC), exchanges are queuing for a slice of the OTC clearing pie, worth about $3 billion in revenue opportunities, according to Morgan Stanley (MS). 

NYSE Euronext (NYX), for its part, has unveiled plans to migrate clearing services from derivatives markets in Amsterdam, Brussels, Lisbon and Paris to a CCP, NYSE Clearing, which will be completed by 2013. We expect a boost in its clearing business in coming years.

CME Group has recently made changes in its price-calculation methodology, which has come under severe criticism from floor traders. A transition is currently in place from open cry trading to electronic trading, which accounts for a majority of the trade volume processed by CME. We expect the average daily volume of commodity contracts to rise through the next few years, as high frequency trading algorithms employed by investors gain popularity.  

Our $285 price estimate on CME Group's stock is about 10% above the current market price. You can gauge the impact of a change in the forecasts on our price estimate by modifying the interactive charts above.

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