6.16.2009 |
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Internal affairs-CDS Clearing - - Structured Credit Investor
Different agendas slowing US CDS clearing progress 
By Corinne Smith Speculation has been growing about the details in the Obama administration's financial reform plan ahead of its announcement today. At the same time, however, issues at the two leading US CDS central counterparties could hold back progress.
"My impression is that ICE Trust is doing just enough to keep ahead of the CME in terms of the progress it's making on its own CDS central clearing platform - for example, by establishing segregated funds to hold buy-side collateral - without making too many concessions," says one CDS trader. "Nevertheless, the CME appears to be attracting tremendous interest from the buy-side as it already has well-defined segregated funds based on an FCM [futures commission merchant] model."
But, he adds: "While the exchange is looking to recruit both dealer-backed and independent FCMs for its CDS clearing solution, it appears to be embroiled in its own internal issues. Arguably, the CME's slow progress in coming to the market is related to its failure to tie in FCMs."
To act as an FCM on the CME, an organisation is required to have a certain liquid net worth, a contingency fund and the ability to demonstrate competence in clearing. Few clearing brokers have that sophistication in connection with CDS because it hasn't been done before, but it is certainly possible to create the appropriate infrastructure. However, the CME is said to have not yet made a good-faith attempt to talk to a number of FCMs, including some of the largest global organisations.
Equally, it has been suggested that a number of dealers are trying to hinder the CME's progress towards launching its CDS clearing platform. "But ultimately there is no law forcing dealer-backed FCMs to join up; they can make their own strategic decision about whether the CME platform is compatible with their own market-making activities. Banks aren't looking to slow the CME's progress, but you can't blame them for trying to protect the status quo either," the trader remarks.
ICE says it has surpassed US$1trn in cleared credit default swaps since operations began on 9 March 2009, with the total number of transactions cleared standing at 12,050. The clearer confirms that it is continuing to work closely with industry participants and regulators to expand clearing for buy-side participants, add clearing for single name instruments and deliver its European CDS clearing solution in the coming weeks.
The trader notes that a number of buy-siders are, however, insisting that their current trades with dealers are novated to the CME. "The success of a CCP will ultimately be decided by demand from the buy-side and institutions would be wise to listen to the customer or suffer the consequences."
For its part, the CME confirms that it is continuing to work with buy-side and sell-side customers before launching its CDS platform.
Meanwhile, one potential method of determining which CDS contracts should be centrally cleared under consideration by the Administration emerged last week - labelling contracts as customised or standardised based on their liquidity. But Jamie Cawley, CEO of IDX Capital, says that defining such a liquidity test would be problematic, given the nebulous nature of liquidity and that the market isn't yet fully commoditised.
"There are 450 North American names; some trade every hour, others once a month. But liquidity isn't only defined by bid/offer spread or trade frequency," he explains.
"Who will decide the metric?" Cawley goes on to ask. "The tests could be set up to fail from inception, depending on how rigid the rules are."
The industry accepts that the majority of index products and around half of single name trades can be cleared centrally, representing around 75% of the daily volume traded, according to Cawley. "I think that 25% of the market remaining customised and not centrally cleared is OK - it achieves the goals of transparency and fair dealing for end-users and the removal of systemic risk from the financial system. The industry appears to be doing a reasonable job of educating the authorities about their intention to clear trades to the best of their ability."
Ultimately, unless the market insists that clearing houses become utilities run by the government, it is fair to argue that the government can't wholly dictate what will be cleared. "Clearing is one thing, but forcing CDS to be traded on exchange is another," Cawley argues. "Exchanges prefer contracts to have hard dates, but this would destroy one of the greatest advantages of single name CDS - the ability to customise the trade. You've really got to question the political motives of the sponsor of such initiatives."
Away from credit derivatives, the Administration's financial reform plan is also set to introduce new rules for the securitisation market. The framework is expected to require ABS originators to retain 5% of their deals and issuers to make increased disclosures in public filings, including reporting loan-level data. Transactions are likely to have to be reported on TRACE. http://www.structuredcreditinvestor.com/story.asp?PUB=250&ISS=22271&SID=20700&article=Internal%20affairs
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