Regulators approved in late December a proposal from NYSE Euronext Liffe and a separate proposal from CME Group and Citadel Investment Group to provide centralized clearing of credit default swaps, setting the stage for competition between the clearing solutions.
The approvals follow a tumultuous year in the financial markets that saw the collapses of Bear Stearns in March and Lehman Brothers in September, which raised fears over global systemic risk in the credit derivatives markets fueled by counterparty exposure. Regulators pressed the industry to set up a centralized clearing facility for CDSs to mitigate counterparty risk, setting a deadline of Dec. 31, 2008.
Days before Christmas NYSE Euronext's derivatives group, Liffe, and LCH.Clearnet, the London-based clearing facility, received approval from the Securities and Exchange Commission to offer their CDS clearing solution to qualified U.S. investors. The central clearing solution is available through Liffe's Bclear platform, which went live in Europe on Dec. 22.
A day after the SEC approved Liffe's platform, CME Group, the world's largest futures exchange, said its clearing solution, CMDX, which is a joint venture with Citadel Investment Group, completed regulatory reviews with the Commodity Futures Trading Commission and the Federal Reserve Bank of New York. In a statement CME added that it has had extensive discussions with the SEC and is well along in the SEC review process.
A rival proposal from Intercontinental Exchange, the energy and soft commodities exchange, reportedly has the support of large Wall Street dealers following its acquisition of Chicago-based The Clearing Corporation (CCorp). While ICE is thought to be the front-runner among dealers that prefer to keep the trading of CDS and index products over-the-counter, the Atlanta-based exchange owns Creditex, an interdealer broker that matches trades between dealers and offers trade processing technology via T-Zero.
"There's definitely a first-mover advantage here," comments Kevin McPartland, senior analyst at TABB Group in New York. "The regulators are pushing so hard to get something live."
But, McPartland adds, he doesn't expect regulators to endorse a particular solution. "It would be pretty unprecedented to mandate the use of a particular provider, though anything could happen," he says.
CME was the first to announce a CDS clearing facility, in October. Hedge fund manager Citadel Investment Group's broker-dealer arm is participating as a market maker. According to McPartland, both CME and ICE originally had targeted the end of November to go live.
And Eurex, the derivatives unit of Deutsche Boerse, he notes, is not looking to go live with clearing of over-the-counter CDS trades until the second quarter of 2009. Eurex Clearing currently offers clearing and risk management procedures for credit futures contracts based on iTraxx indices. Eurex launched trading in credit futures contracts in March 2007, making Eurex the first regulated global market to offer credit derivatives. Eurex Clearing is now working to expand its clearing services to OTC CDSs that are registered in the DTCC Trade Information Warehouse, starting with iTraxx and CDX indices, followed by iTraxx/CDX tranches and then single-name CDSs.
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