So far, the Intercontinental Exchange (ICE) has emerged as the volume winner among exchange efforts to clear credit default swaps (CDS). ICE US Trust, which has the backing of major investment banks, had total volume of $84 billion at the end of May. Meanwhile, CME Group’s clearing venture, CMDX, has stalled, and its backers are starting to question why.
On May 29 Samuel Cole, COO of BlueMountain Capital Management, one of the firms backing CMDX, sent an e-mail to bankers and traders suggesting the dealers and the buy side need to work closely together to develop a clearing solution that is in the broader interest of the market.
“ICE is owned by the dealers, so ICE has an upper hand because of that. CME is going to the buy side and trying to convince them that their offering is competitive and the buy side should basically be telling the broker side where they want to clear their credit products. That strategy makes sense, but the market really is controlled by a small group of dealers. BlueMountain is trying to [say] that this is a closed marketplace and there’s not enough transparency and they [might] want the trading to be on a central order book the way futures trade,” says Paul Zubulake, senior analyst for Aite Group.
Kevin McPartland, senior analyst at Tabb Group, says, “The buy side feels that ICE is completely run and controlled by the dealers and they want [to] have a little more say on what goes on and how it’s developed.”
A spokesperson for CME Group says, “We continue to work with buy and sell participants to demonstrate the value of our offering.”
Zubulake says that although some regulators and politicians want to put CDSs onto an electronic platform, “CDS contracts cannot be standardized. That’s not going to happen because it can’t. The business will end if that happens.”
On May 13, the U.S. Treasury released a proposal for regulatory reform, requiring clearing of all standardized OTC derivatives through regulated central counterparties.
“ICE and CME stock has been rallying because they’re talking about bringing all OTC derivatives onto [a central clearing] model. If that happens, it’s a huge benefit for the CME. The hedge funds like Blue Mountain want to have a transparent trading market because they will feel more comfortable participating,” Zubulake says, adding, “The [CDS marketplace] is not large. Right now the natural way is to go through ICE and I don’t see that changing.”
McPartland says, “Until the legislation is sorted out, it’s too early to say who will come out on top. One central clearer is too few, four is too many.”
Gary DeWaal, general counsel for Newedge, points out that the ICE Trust clearing arrangement is not a traditional clearing arrangement, but rather a closed situation where only the relevant dealers can participate. “If the regulators are just looking for clearing and they don’t care what clearing is, then the dealers who participate in ICE Trust have every incentive to stay where they are. If Congress or Treasury pushes the industry to move towards a more traditional model of clearing and exchange trading, ICE Trust will have to adapt, rather than see the liquidity migrate somewhere else,” he says. “Once the standardized products are put on an exchange, the spreads will narrow and price will become more transparent. ICE wants to ultimately migrate towards a more traditional network, but this is a way of capturing liquidity to begin with.”