9.23.2009 |
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Challenging the Status Quo - Structured Credit Investor
 By Corinne Smith As yet unsuccessful attempts by other clearinghouses to capture market share has sparked concern about ICE's dominance in the CDS sector. But the CME finally looks set to challenge the status quo - at least in the US - in the coming weeks.
A significant fraction of new CDS trades referencing on-the-run CDX.NA.IG and iTraxx Europe are already submitted for clearing on ICE on an ongoing basis (about 35% of CDX.NA and up to 50% of iTraxx Europe), according to Tim Brunne, senior credit strategist at UniCredit. But attempts by other clearing houses (CME, Eurex and Liffe) to capture market share have so far been unsuccessful.
"Eurex Credit Clear is apparently lacking the support of the major-dealer community," Brunne notes. "The very small volume of iTraxx CDS that Eurex Credit Clear successfully cleared since 31 July (€85m distributed among three trades as of 3 September) proves the competitive disadvantage of the futures and options exchange. To date, the principle advantages of Eurex - strict third-party compliance and easier access of a variety of CDS counterparties - do not counterbalance the advantages that ICE provides to CDS dealers, namely profit sharing as of 2010."
One CDS trader indicates that broadly speaking the dealers behind ICE have an oligarchy, rather than a monopoly. "They essentially influence the flow of information, decision-making and pricing in the credit derivatives market. But it could be argued that the CME is also an oligarchy, given that around 90% of futures business is done through the exchange and it already has a good network of FCMs in place."
He points out that in any case dealers' historical dominance of CDS market-making is being challenged by new entrants to the sector, who will potentially ally themselves with alternative clearinghouses to ICE. "The definition of 'dealer' has changed over the last 12 months," he explains. "CDS bid-offer spreads are wider now than they were before the crisis because there are fewer market-makers and so the incumbents don't need to be as competitive. This is in turn attracting new participants to the market."
Firms such as Jefferies, Citadel, BTIG, Broadpoint and Cantor are now among the top market-makers in US corporate bonds. "These institutions are using capital to aggressively build out their fixed income businesses and a natural extension of this is to move into CDS market-making," the trader adds. "Then there are another 25 or so boutiques behind them, such as Maxim and Knight Libertas, which could also become alternative liquidity providers to a clearinghouse."
Meanwhile, the CME says the pilot programme of its CDS clearing initiative will roll out in the next few weeks. Products supported at launch will include a range of Markit CDX indices and liquid single name CDS. The joint effort with Citadel Investment Group, known as CMDX, has been restructured to focus only on providing clearing services for the market.
Together with Citadel, the other buy-side founding members of the initiative are AllianceBernstein, BlackRock, BlueMountain Capital Management, the D. E. Shaw group and PIMCO. In addition, a number of sell-side participants - rumoured to be UBS, Barclays Capital and Citi - are in the process of becoming founding members.
"With the increasing collaboration of key founding members from both the buy- and sell-side, we are confident our offering remains the strongest and most effective CDS clearing solution available," Craig Donohue, ceo, CME Group, says. "Our solution offers point of execution clearing of CDS trades, the greatest breadth of products to clear - which includes single name CDS, a comprehensive and transparent risk management system, the security of our approximately US$8bn financial safeguards package and an established regulatory framework to protect customer positions and offer margining efficiencies."
The CDS trader reckons that the CME is aware of Eurex's apparent lack of success in Europe and so will likely open for business with a minimum of US$2bn-US$3bn of trades cleared in both single names and indices. "Liquidity is king," he states.
Whether opening up buy-side access to CDS clearinghouses will impact ICE's dominance remains to be seen. Jamie Cawley, ceo of IDX Capital, suggests that buy-siders will vote with their feet and use the most economic clearinghouse.
"There is a fear that investors will only commit to one clearinghouse and not the other, but I don't think this will happen," he concludes. "Fungibility of trades is a red herring: if necessary, an investor can get out of a trade on one platform by shorting the same contract on the other platform. In fact, I wouldn't be surprised if someone starts quoting ICE/CME basis trades in order to hedge this exposure out."
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