From the December 01, 2008 issue of Futures Magazine • Subscribe!

Exchanges mull CDSs

The credit market meltdown stoked efforts to form central clearing facilities and trading platforms for credit default swaps (CDS). CME Group, the Intercontinental Exchange (ICE), NYSE Euronext and Eurex all have proposals in the works. On Oct. 7, CME Group and Citadel announced plans to launch a trading platform fully integrated with a central counterparty clearing facility for CDSs. Its proposal will use CME Group’s clearinghouse to clear the trades. Shortly after the announcement, Citadel gave up its place on the board of the Electronic Liquidity Exchange (ELX), but maintains its ownership stake.

CME Group is touting reliability and financial stability as two advantages of its proposal. “CME Clearing has long-term tested financial safeguards. Our proposed solution, unlike others, also provides customers with choice. Our proposal is to provide a [request for quote] capability that could provide increased price transparency. However, if market participants wish only to use clearing services, they will be allowed to do so,” says CME Group CEO Craig Donohue, adding that pending regulatory approvals, CME Group could launch its platform very soon. “We are operationally ready to begin now,” he says. Regarding regulatory decisions, Donohue says that “We are open to working with any and all regulators.”

For its CDS clearing solution, ICE joined forces with the Clearing Corporation, Markit Group Ltd. and Risk Metrics Group. On Oct. 30, ICE announced it would acquire The Clearing Corporation and form ICE US Trust, through which it plans to clear CDS transactions. Nine investment banks signed agreements for ICE to clear their CDS positions. In June, ICE acquired Creditex, an institution that executes and processes credit derivatives. ICE will use Creditex’s T-Zero CDS trade processing service to facilitate same-day trade matching. An ICE spokesperson says that ICE’s solution, which is expected to launch in the fourth quarter of 2008, has an advantage over other proposals in that it “offers an integrated solution regardless of how trades are executed with the combined technology of CCorp, T-Zero and Creditex.”

While CME Group would use its own clearinghouse to back the CDS trades, ICE CEO Jeff Sprecher said in an earnings conference that ICE decided to create a separate CDS clearinghouse because “the existing collateral and liquidation provisions of futures-style clearing would not be sufficient, nor would combining CDS with futures positions be prudent in terms of adding systemic risk.”

Several CME Group member firms expressed concern over CDSs being cleared in the same pool as the rest of their products (see Top 50 Brokers).

In December, NYSE Euronext plans to launch CDS contracts based on the Markit iTraxx Europe indexes on Bclear. CDS trades will be negotiated and agreed away from the exchange before being processed through Bclear and, until the LiffeClear arrangements come into effect, cleared through LCH.Clearnet, which will stand as the central counterparty to all Bclear CDS transactions.

Eurex expects to roll out its clearing solution in early 2009. Eurex now offers a ready-to-use clearing solution for iTraxx index contracts and single-name CDS products. Eurex will add CDS contracts, subject to signing a license arrangement with Markit. In the first half of 2009, this offering will be complemented by a central clearing solution for OTC credit derivatives documented by the International Swaps and Derivatives Association (ISDA), which will be automatically linked into the DTCC’s trade information warehouse. “The focus of our initiative is on providing a central clearing solution to address the counterparty concerns and risk situation,” says Thomas Book, a Eurex executive board member responsible for clearing. “With our ready-to-use solution, we are already able to deliver today. The central clearing solution for OTC credit products is not positioned against any other proposals. It is positioned to strengthen market integrity for European markets in a global context,” Book says.

In Senate testimony in mid-October, ISDA CEO Robert Pickel called for a greater understanding of credit default swaps and said that their role in the market turmoil had been exaggerated. ISDA “welcome[s] the development of clearing and settlement arrangements [for CDSs], which would provide the benefits of choice and flexibility to participants within [a] sound industry framework that benefits from the significant counterparty credit risk mitigates of legally enforceable netting and collateral arrangements,” a spokesperson says.

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