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1 North End Avenue New York, NY 10282 T 212 299 2200 F 212 299 2299 christopher.bowen@cmegroup.com cmegroup.com

Christopher Bowen

Managing Director and Chief Regulatory Counsel

Legal Department

April 6, 2016

VIA ELECTRONIC MAIL 

Mr. Christopher J. Kirkpatrick

Office of the Secretariat

Commodity Futures Trading Commission

Three Lafayette Centre

1155 21st Street, NW

Washington, DC 20581

RE: CFTC Regulation 39.5(b) Notification of Acceptance of USD Interest Rate 

Swaptions for Clearing. CME Submission No. 16-132

Dear Mr. Kirkpatrick:

Pursuant to Commodity Futures Trading Commission (“CFTC” or “Commission”) Regulation 39.5(b), 

Chicago Mercantile Exchange Inc. (“CME “) hereby notifies the CFTC that CME will begin accepting

options on interest rate swaps (“Swaptions”) for clearing on April 11, 2016. Initially, CME will accept 

European style Swaptions for physical exercise into the corresponding underlying interest rate swap

(“IRS”) exposures, for which the maximum term to option expiration is two years and 10 calendar days,

and for which the corresponding underlying IRS are denominated in US Dollars, referencing USD 

LIBOR as the floating rate, with maximum term to maturity of thirty years and 10 calendar days.

39.5(b)(3)(i): Eligibility to Clear Swaptions and Compliance with the DCO Core Principles

On March 3, 2015, the CFTC determined that CME is eligible to clear Swaptions.1 While central clearing 

of Swaptions provides several important risk management benefits, including transparency in prices, at 

least daily mark-to-market and systemic risk reduction, CME does not believe that Swaptions should 

become subject to the clearing mandate. If, however, the Commission were to determine that Swaptions 

are required to be cleared, CME would be able to maintain compliance with the DCO Core Principles set 

forth in section 5b(c)(2) of the Commodity Exchange Act. 

39.5(b)(3)(ii)(A): Outstanding Notional Exposures, Trading Liquidity and Pricing Data

CME is providing the CFTC with details regarding the existence of significant outstanding notional 

exposures and trading liquidity in Appendix A hereto. With respect to the end of day settlement price 

process, please refer to CME Submission #14-327, which includes a description of the settlement model 

for Swaptions.2

 

1

See letter from Christopher J. Kirkpatrick, Secretary of the Commission to Christopher K. Bowen, Managing 

Director and Chief Regulatory Counsel of CME, dated March 3, 2015 (the “March 2015 Letter”). 

http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/cmeswaptionsletter3-3-15.pdf.

2 CME Submission #14-327 was provided by CME as an advance notice to the Commission of a rule change in 

pursuant to Commission Regulation 40.10. In a letter dated, December 15, 2014, from Phyllis Dietz, Acting 

Director, Division of Clearing and Risk (“DCR”) of the Commission to Jason Silverstein, Executive Director & 
2

39.5(b)(3)(ii)(B): Rule Framework, Capacity, Operational Expertise and Resources, and Credit Support 

Infrastructure

The terms and conditions for Swaptions can be found in new CME Chapter 902 (Swaptions). Chapter 

900 (Interest Rate Products) is being amended to include other Swaption specific terms. New Chapter 

902 and revised Chapter 900 were submitted to the Commission in CME Submission #16-131.3 Enclosed 

with this submission and marked with a request confidential treatment is the document titled “OTC IR 

Swaptions Specification“ which contains Swaptions specifications and enhancements to CME’s IRS 

clearing processes for Swaptions. Details regarding CME’s capacity, operational expertise and resources, 

and credit support infrastructure are provided in the document titled “CME Clearing Risk Management 

and Financial Safeguards”

4

.

39.5(b)(3)(ii)(C): Effect on Mitigation of Systemic Risk

A key goal of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) is 

the reduction of systemic risk through the use of central clearing for over-the-counter (“OTC”)

derivatives. The Commission has noted that the central clearing of IRS would likely reduce systemic risk 

in the swap market and the financial system as a whole.5 As a central counterparty, CME interposes itself 

between counterparties to the IRS (and other derivatives products) that it clears, becoming the buyer to 

every seller and the seller to every buyer. For each swap that it clears, CME provides all clearing house 

services, including a mark-to-market function, on a daily basis.

The size of the Swaptions market is significant.6 According to the most recent data published by the Bank 

for International Settlements (“BIS”), as of mid-year 2015 the outstanding notional amount of US dollardenominated OTC Swaptions was approximately $15.562 trillion. Central clearing of Swaptions provides 

several important risk management benefits, including transparency in prices, at least daily mark-tomarket and systemic risk reduction. Additional benefits of clearing include:

 Risk reduction. Swaptions represent the price risk of positions in the underlying swap, contingent 

upon Swaption exercise, which means that a portfolio that includes options and swaps may have 

less market risk, depending on its specific composition. Bringing these risks into the cleared pool 

may reduce market risk for the CME as well as the original bilateral counterparties. This risk 

reduction may come from directly offsetting price risks (i.e. duration dollar and dollar delta) and 

also indirectly through standardized pricing, regulatory, margin, and collateral systems.

 Centralized clearing. Clearing OTC Swaptions through CME enhances risk management through 

the daily mark-to-market process, which ensures mutually consistent valuation of swaptions and 

the swap exposures into which such swaptions are exercisable, and which includes objective 

pricing, margining, and collateral management.

 

Associate General Counsel of CME, DCR notified CME that following DCR’s review of CME Submission #14-

327, DCR did not object to the acceptance of Swaptions for clearing.

http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/cme401012-15-14.pdf. 

3

http://www.cmegroup.com/market-regulation/files/16-131.pdf. 

4

http://www.cmegroup.com/clearing/files/financialsafeguards.pdf. 

5

See Clearing Requirement Determination Under Section 2(h) of the CEA, 77 Fed Reg 74284, 74312 (Dec. 13, 

2012). 

6

See Semiannual OTC Derivatives Statistics, Interest Rate Derivatives, Table D7, BIS, 6 March 2016, which is 

available at http://www.bis.org/statistics/derstats.htm.
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 Operational efficiencies. Centralized clearing of Swaptions reduces operational burdens in 

several ways. Standardization and centralized clearing enables consolidation of collateral 

management and cash flows and eliminates the need for novations or tear-ups.

 Ease of position adjustment. In non-cleared markets, the only means to completely eliminate the 

risk of a swap is to (i) enter into a tear-up agreement with the swap counterparty, or (ii) enter into 

a novation (i.e., find another entity willing to assume its side of the swap). In either case, the tearup or the novation must be approved by the bilateral swap counterparty.

 Portfolio risk management. By accepting Swaptions for clearing, CME would provide market 

participants the opportunity to manage risk associated with IRS and Swaptions on a portfolio 

basis, by combining cleared IRS and Swaptions portfolios, which would mitigate risks and 

inefficiencies present in the OTC Swaptions market due to mandatory clearing of IRS. Swaptions 

and IRS demonstrate strongly correlated responses to changes in interest rate levels. For this 

reason, prior to the Dodd-Frank Act, IRS and Swaptions were risk managed on a portfolio basis, 

with IRS hedging the risk of changing interest rates (“delta”). One negative consequence of IRS 

transitioning from OTC to clearing is that as IRS have become centrally cleared, these IRS delta 

hedges have been separated from Swaptions. This separation complicates portfolio-based risk 

management, leads to mismatched risk profiles, and potentially increases risk during default 

situations. Without portfolio risk management, market participants post margins for their cleared 

IRS and uncleared Swaptions without any offsetting benefits. Clearing Swaptions will provide 

portfolio based risk management and its associated benefits. 

As described in CME’s advance notice to the Commission of its intention to accept swaptions for clearing 

and associated enhancements to the IRS margin model, CME has the necessary resources available to 

clear the Swaptions that are the subject of this submission.7 In accordance with CFTC Regulations 39.11 

and 39.33, CME maintains financial resources for IRS products (including Swaptions) sufficient to enable 

it to meet its financial obligations to its IRS Clearing Members notwithstanding a default by the two IRS 

Clearing Members (and their affiliates that are IRS Clearing Members) creating the largest combined loss 

to CME in extreme but plausible market conditions.

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 CME maintains such financial resources for IRS 

products (including Swaptions) through its IRS financial safeguards, which include IRS performance 

bonds, the CME IRS Contribution, the IRS Guaranty Fund, and IRS Assessments (each as defined in 

Chapter 8G of the CME Rules). CME is keeping the structure of the IRS Guaranty Fund unchanged, as 

the existing framework for constructing an appropriate safeguards package is flexible and can 

accommodate additional IRS products, including Swaptions. 

39.5(b)(3)(ii)(D): Effect on Competition – Fees and Charges

CME does not believe that the acceptance of Swaptions will have any material effect on competition. It is 

possible that as a result of the benefits of clearing Swaptions, including the mitigation of systemic risks as 

noted in the preceding section (39.5(b)(3)(ii)(C): Effect on Mitigation of Systemic Risk), market 

 

7

See CME Submission #14-327. http://www.cmegroup.com/market-regulation/files/14-327.pdf. 

8

See March 2015 Letter where the Commission found that: (i) CME's financial resources are sufficient under 

Commission Regulations 39.11 and 39.33; (ii) CME has demonstrated that it would be able to manage the risks 

associated with clearing swaptions under Commission Regulations 39.13 and 39.36; and (iii) CME has demonstrated 

that, if CME accepts swaptions for clearing, CME can otherwise maintain compliance with the core principles 

applicable to DCOs as described in Section 5b(c)(2) of the CEA and Part 39 of the Commission's regulations.
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participants could increase the amount of their existing interest swap business at CME. The fees for 

Swaptions were included in CME Submission #16-131. 

39.5(b)(3)(ii)(E): Reasonable Legal Certainty in DCO or Clearing Member Insolvency

The bankruptcy of a DCO is governed by subchapter IV of Chapter 7 of the U.S. Bankruptcy Code (11 

U.S.C. §§ 761-767) and by Part 190 of the CFTC's regulations (Bankruptcy Rules). Also relevant in the 

event that CME were to enter into bankruptcy proceedings is CME Rule 818 (Close-Out Netting)

included in Chapter 8 (Clearing House and Performance Bonds) of the CME Rulebook. Chapter 8 of the 

CME Rulebook is available at http://www.cmegroup.com/rulebook/CME/I/8/8.pdf.

The bankruptcy of a clearing member that is a U.S. futures commission merchant (“FCM”) would be 

governed by subchapter IV of Chapter 7 of the U.S. Bankruptcy Code (11 U.S.C. §§ 761-767) and the 

Part 190 of the CFTC's regulations (Bankruptcy Rules). If an FCM is registered as a broker-dealer, 

certain aspects of its insolvency proceeding may also be governed by the Securities Investor Protection 

Act. Further details regarding the legal certainty provided under the relevant U.S. insolvency laws are 

provided in the document titled “CME Clearing Risk Management and Financial Safeguards.”

39.5(b)(3)(iii): Product Specifications

The specifications for the Swaptions CME will accept for clearing are included in the document titled 

“OTC IR Swaptions Specification” which is being marked with a request confidential treatment.

39.5(b)(3)(iv): Participant Eligibility Standards

To be eligible to clear Swaptions, a clearing member must satisfy CME's standard criteria applicable to 

clearing members that clear any IRS products pursuant to CME Rule 8G04 (a member satisfying such 

criteria, an “IRS Clearing Member”). An IRS Clearing Member must satisfy additional criteria pursuant 

to proposed CME Rule 8G18.A, to be approved by CME as eligible to clear Swaptions (a member 

satisfying such criteria, an “IRS Swaptions Clearing Member”)

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. 

CME has established objective, publicly disclosed, and risk-based admission and continuing participation 

requirements for IRS Swaptions Clearing Members. To become an IRS Swaptions Clearing Member, a 

clearing member must be an IRS Clearing Member and satisfy the additional criteria in CME Rule 

8G18.A. These additional criteria include: a demonstration of operational capabilities to clear Swaptions; 

the ability, commitment, and expertise to manage risk associated with clearing Swaptions; a requirement 

to provide traders to the IRS Default Management Committee; and other questionnaires and diligence. 

Pursuant to CME Rule 8G18.B10, IRS Swaptions Clearing Members will also be required to submit 

Swaptions pricing data on a daily basis to CME and will be subject to certain penalties for failure to 

provide the required submission as further described in proposed CME Rule 8G18.B. 

39.5(b)(3)(v): Pricing Sources, Models and Procedures

Pursuant to CME Rule 8G18.B, IRS Swaptions Clearing Members will be required to submit Swaptions 

pricing data on a daily basis to CME and will be subject to certain penalties for failure to provide the 

required submission. Additional information regarding pricing sources, models and procedures was

included in CME Submission #14-327. 

 

9

See CME Submission #14-327. 

10 Id.
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39.5(b)(3)(vi): Risk Management Procedures

CFTC Regulation 39.13(g)(2)(i) requires a DCO to establish initial margin requirements that are 

commensurate with the risks of each product and portfolio. As described in CME Submission 14-327, 

CME is enhancing IRS margin model Historical Value at Risk (HVaR) based performance bond and 

liquidity/concentration add-on models for IRS to cover the additional risk factors presented by the 

clearing of Swaptions and will margin existing IRS and Swaptions on a portfolio basis. CME will 

continue to use a minimum liquidation time that is five days for IRS portfolios that include Swaptions. 

CME's Swaptions margin model is designed to meet an established confidence level of at least ninetynine percent as required by CFTC Regulation 39.13(g)(2)(iii). The existing IRS financial safeguards will 

be utilized to cover exposures from IRS Swaptions Clearing Members and will include stressed volatility 

scenarios to size the IRS Guaranty Fund. CME will include Swaptions related stress scenarios in the IRS 

Guaranty Fund sizing methodology. CME’s Swaptions margin model is back-tested using various types 

of IRS and Swaption risk profiles to assess the adequacy of the model and to meet a confidence level of at 

least ninety-nine percent.

Pursuant to CFTC Regulation 39.14(b), CME effects a settlement with each IRS Clearing Member, and 

will effect a settlement with each IRS Swaptions Clearing Member, at least once each business day and 

has the authority and operational capacity to effect a settlement with each IRS Clearing Member on an 

intraday basis either routinely, when specified thresholds are breached, or in times of extreme market 

volatility. CME will settle Swaptions using a proprietary model based on the Swaptions market 

information provided by IRS Swaptions Clearing Members pursuant to proposed CME Rule 8G18.B. 

This proprietary model will calibrate a settlement price for Swaptions of different expiries, tenors, and 

moneyness. Additional detail regarding the settlement model and the processes that will be used to price 

Swaptions was provided in the confidential materials included in CME Submission #14-327. 

To ensure proper management of defaulted Swaptions portfolios, CME will follow an approach to the 

default management process currently in place for IRS under the IRS Default Management Guidelines, 

with appropriate modifications such that portfolios of IRS and Swaptions across different risk profiles can 

be successfully closed out within the margin period of risk. As required by CFTC Regulation 39.16(c), 

CME's default management procedures—including the default management procedures applicable to 

Swaptions—permit it to take timely action to contain losses and liquidity pressures and to continue to 

meet its obligations in the event of a clearing member default. CME has adopted rules that set forth its 

default procedures and makes these rules publicly available. CME will require an IRS Swaptions 

Clearing Member to provide prompt notice to CME if it becomes the subject of a bankruptcy petition, 

receivership proceeding, or the equivalent as detailed in CFTC Regulation 39.16(d). 

39.5(b)(3)(vii): Applicable Rules, Manuals, Policies and Procedures

Links to applicable rulebook sections are included in this submission. Revisions to CME Chapter 900 

and new CME Chapter 902 were submitted in CME Submission #16-131. 
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39.5(b)(3)(viii): Notice of Submission

Notice of this submission (without enclosures, many of which have been designated for Confidential 

Treatment) has been concurrently posted on CME’s web site at http://www.cmegroup.com/marketregulation/rule-filings.html.

If you require any additional information regarding this submission, please contact me at 212-299-2200 or 

via e-mail at CMEGSubmissionInquiry@cmegroup.com.

Sincerely,

Christopher Bowen

Managing Director and Chief Regulatory Counsel 

Enclosure marked for confidential treatment
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Appendix A

Swaption Outstanding Notional Exposures and Trading Liquidity

Estimated Open Interest: As of 6/30/2015, the BIS reported the size of the global US dollardenominated swaptions market as $15.562 trillion in terms of notional amount outstanding. Of this, 49.5% 

was held by reporting dealers, 43.0% was held by other financial institutions, and the remaining 7.5% was 

held by non-financial customers. 11

Estimated Notional Volume: The most recent compilation of triennial OTC derivatives statistics 

published by the BIS indicates that during April 2013 trading volume in the market for OTC US dollardenominated swaptions ran $89B per day (in terms of notional principal amounts exchanged), signifying 

13.5% of the total notional value of US dollar-denominated OTC derivatives traded during the same 

month. During 2015, the global volume of trade in cleared US dollar-denominated OTC derivatives was 

approximately $598 billion per day in terms of notional value, accounting for 91.0% of the entire market as 

reported by the BIS.12

Breakdown by Maturity and Expiration: We estimate that more than 80% of these have an option 

expiry of less than 2 years and therefore may be eligible for clearing under CME’s proposed offering. 

Total Transaction Count in 2015 

Maturity of Underlying Swap

0 to 1Y 1Y to 2Y 2Y+ to 5Y 5Y+ to 10Y 10Y+ Total

Option 

Expiry

0 to 3M 99 67 304 1,738 394 2,602

3M+ to 6M 198 136 204 765 261 1,564

6M+ to 1Y 118 104 120 195 170 707

1Y to 2Y 224 165 178 327 209 1,103

2Y+ to 5Y 281 183 276 168 339 1,247

5Y+ 2 10 334 248 261 855

922 665 1,416 3,441 1,634 8,078

Source: DTCC Swap Data Repository, as accessed through ClarusFT’s SDR View

 

11 http://www.bis.org/statistics/derstats.htm

12 http://www.bis.org/statistics/derstats3y.htm
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APPENDIX B

OTC IR Swaption Specification

(attached under separate cover)