4.8.2009 |
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Exclusion Zone - Structured Credit Investor
Challenges remain for CDS clearing for the buy-side 
By Corinne Smith Market participants were last week asked by the New York Fed to broaden the remit of CDS central counterparties to include a wider set of firms and credit derivative products (see News Round-up). They also agreed to report all CDS trades not cleared through a CCP to a central trade repository. However, significant challenges remain for buy-siders looking to clear their CDS trades via a CCP.
ICE Trust, for example, is said to have been considering a plan for including buy-side firms - possibly by developing a separate facility for them - for some time. But one stumbling block is that the margining requirements are typically higher than an investor would pay if they were simply collateralising CDS trades.
One structured credit investor agrees that there are some difficulties for the buy-side in terms of plugging into ICE Trust. He says: "CME, for example, uses an FCM [futures commission merchant] model, where trades are pledged to a clearing broker, along with the requisite segregation of funds. But this doesn't exist for ICE, where the clearing members are dealers."
He also questions whether ICE's US$2bn guarantee fund is big enough, given the potential systemic risk exposure associated with having dealers as clearing members. By way of comparison, CME has a US$8bn guarantee fund - albeit the exchange is reportedly seeking additional stakeholders and a further US$400m-US$500m in guarantee fund money.
"The holy grail is to see fungibility of capital between the different clearing houses, so users are indifferent as to which one they trade with," the investor adds. "But this isn't going to happen any time soon. At the end of the day, investors just want transparency and fair dealing."
IDX Capital ceo Jamie Cawley says that from a competition standpoint the more clearing houses that are established the better because they'll drive prices lower and provide some balance in terms of managing counterparty risk. "Three is probably the right number for the CDS market. Their evolution could ultimately be similar to clearing houses for other asset classes in terms of specialising in certain instruments; for example, one specialising in index clearing, another in tranches and another in single names."
However, he notes that CDS clearing is not a cure-all. "There are plenty of products that fit neatly into the central counterparty solution and others that don't," he explains. "Index trades represent 30%-40% of the market and I'd expect the majority of them to migrate to a CCP, but single name IG trades account for half of the market and around 40% of those are likely to migrate to a CCP. If this turns out to be correct, I would say that the market has accomplished its goal of mitigating counterparty risk."
In order to facilitate transparency, a clearing house could also create a simple, transparent reporting mechanism that enables regulators to protect against potential front-running of the market. Alongside a central repository, a system could be created that logs cleared trades, making it easy to analyse trade activity when it occurs as well as consider exposure at a systemic level.
"Ultimately, the role of the clearing house should be to manage the risk of all counterparties in real time, so that they can margin-call counterparties that are in danger of posing a systemic risk," Cawley notes.
ICE Trust says that it cleared 613 transactions from nine banks totaling US$71bn of notional value and resulting in US$12.7bn of open interest in its first four weeks of operation. Dirk Pruis, ICE Trust president and coo, confirms that he anticipates activity will ramp up in the coming weeks as the clearer continues to actively work with both buy- and sell-side institutions in expanding their participation.
The investor suggests, however, that the bulk of volume to-date comprises existing trades that have been back-loaded onto the platform. The real test, he argues, will come when there is no back-loading left to do and cleared volumes are exclusively new trades.
This article was published by Structured Credit Investor on 8 April 2009
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