Clearing structures for Credit Default Swaps begin to take shape

The current financial crisis, and the collapse of Lehman Brothers in particular, highlighted the previously murky world of credit default swaps, with $64 trillion worth of trades at one point in the ether. To negate this risk regulators on both sides of the Atlantic are pushing for centralised clearing mechanisms, with the Intercontinental Exchange (ICE), following its acquisition of the Clearing Corporation, being the first to receive approval from the US Federal Reserve in March to serve as a clearing house and central counterparty for CDS transactions. Its US rival the Chicago Mercantile Exchange (CME) is also expected to launch a platform, while in Europe there will be competition from LCH.Clearnet, Liffe and Eurex. LCH.Clearnet, whose ownership is currently up for grabs between America’s DTCC and a consortium of European banks and brokers including ICAP, is already on record as saying it will launch a eurozone CDS clearing service by December 2009.

A consortium of nine global banks, including Credit Suisse, HSBC, JP Morgan, Deutsche Bank and Goldman Sachs, have committed to the use of central counterparty clearing for CDSs in the EU after signing a letter of intent with Commissioner Charlie McCreevy. UBS, Barclays Capital, Morgan Stanley and Citi also signed up to the agreement, which the EC wants to see in place by the summer, although year-end seems more likely. The letter commits these leading dealers in the sector to work closely with infrastructure providers, regulators and the EC to resolve any outstanding technical, legal or practical obstacles in the way of building a more globally cohesive framework for CDS clearing.

The Swiss-German derivatives exchange Eurex initially planned to register in the US but is now saying that it will concentrate its efforts on the European market after McCreevy’s intervention. “We’ll offer an EU solution with global products,” said one of Eurex’s board members, Thomas Book, when talking to Bloomberg. “Our priority is not to be the chosen one in the US, but the chosen one in Europe.”

• In a separate move to further aid transparency in the current volatile market conditions, the Financial Services Authority has brought forward the new disclosure regime for Contracts for Difference (CfDs), which will now take effect from 1 June 2009, rather than September. The new rules cover financial instruments in the same company, which give a legal right to acquire shares or have a similar economic effect to shares. Shares and such financial instruments will have to be aggregated and disclosed once over the three per cent threshold. This will ensure that they are not used covertly to influence corporate governance and/or build up stakes in companies. An exemption has also been put in place for CfD writers acting in a client-serving capacity, to prevent unnecessary disclosures to the market. Commenting on the move, Alexander Justham, FSA director of markets, said: “This is a very significant step in improving market transparency and we have brought the implementation date forward to reflect that. The new rules will resolve some of the concerns raised about the risks of market players devising ways to avoid disclosure or over-disclosing.”

• A new Central Counterparty (CCP) service for trading in the 50 most liquid Depository Receipts (DRs) on the London Stock Exchange’s International Order Book (IOB) has been launched, covering securities from Russia, Kazakhstan, South Korea and India. The IOB, which handled $246.2 billion of trades last year, offers specialist investors easy access to international markets via DRs from 46 countries. The introduction of a CCP will support continued growth in trading on the IOB by mitigating counterparty risk, increasing efficiency for participants and ensuring post-trade as well as pre-trade anonymity, claim the LSE. X-TRM, the London Stock Exchange Group’s post-trade router, will be used in the UK market for the first time as part of the service, increasing operational efficiency by ensuring that trades are routed from the IOB to the CCP service provider LCH.Clearnet without manual intervention. LCH.Clearnet will also offer firms the option of netting transactions in the same securities on the same day, in order to reduce transaction management costs and the firm’s financial exposure at settlement level.

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