CME chief defends clearing houses" growing role The head of the world's largest exchanges operator, CME Group, has rejected calls from global banks that the growing reliance on clearing houses is posing a new challenge to the stability of the financial system. The risk management houses are becoming a critical part of the plumbing of the world's financial markets after global regulators mandated that more of the vast but opaque over-the-counter derivatives market be processed through central counterparties. That is expected to lead to a higher-profile role for the US's CME Group and IntercontinentalExchange, which own their own clearing houses, and LCH.Clearnet, the transatlantic group controlled by the London Stock Exchange Group. A clearing house sits between two parties in a trade, guaranteeing the deal in the event of a default. Terry Duffy, executive chairman of CME Group, said the shift in moving more OTC derivatives transactions was more profound than just transferring the risk and exposure to a counterparty default from banks to clearing houses. "The difference is with a clearing house we do market-to-market [risk management], either twice daily or have the ability to do it much more often," he said on a visit to London. What's important is making certain the pays and collects are done on a risk basis and not a mark-to-myth or anything else. Because of that, we have a much easier time doing the pays and collects than the banks do if it was a bilateral transaction. In turn, I think some of the banks are just not used to the model of clearing. Some banks have raised concerns about the relatively low capital reserves of clearing houses. Indeed, tougher European rules have forced the region's two largest clearing houses - Deutsche Börse's Eurex and LCH.Clearnet - to increase their capital reserves to about €250m and €744m. However, capital reserves form only one of a series of barriers employed by clearers if one of their members fails. Guarantee funds, which a clearing house would exhaust first, are typically far larger. CME has more than $4.5bn as a guarantee fund and LCH nearly €6bn. Industry executives also acknowledge that those reserves will be raised again when Iosco, the umbrella group of financial regulators, finalises global principles governing the operation of clearing houses next year. "I think what was critically important, under Dodd-Frank, we made certain we were not forced to accept all bilateral swaps into our clearing house, that if we felt we couldn't risk manage them we wouldn't accept them," said Mr Duffy. If we do take them, we make certain that we have adequate capital so we can do their risk management. So I think it's a little bit of a misdirecter. Some observers such as Paul Tucker, deputy governor of the Bank of England, have warned that clearing houses must also develop recovery and resolution plans should one default.