Sunday, December 20, 2009

Summary of CDS Clearing Initiatives

From B&B Structured Finance:

  • The first initiatives to set up a central clearing counterparty for CDS originated in the US
  • There were four main initiatives to clear CDS in the US, all of which developed at around the same time in 3Q2008
  • The initiatives for a European clearing counterparty followed US efforts given pressure from the European Commission and the ECB for a European-based clearing mechanism that could be locally regulated
  • Ten banks committed to start using one or more clearing houses in the Eurozone by the end of July 2009
  • The most recent initiatives have been from Asia, with Japan Securities Clearing Corporation (JSCC) and Tokyo Financial Exchange (TFX) working out details on how to clear CDS
  • However, it is unlikely that participants would want or use two Japanese clearing institutions for OTC products, as the Japanese CDS market is a small proportion of global volumes. Currently, Japan accounts for 0.6 per cent of global CDS volumes outstanding
  • Overall, given recent regulatory focus on counterparty risk across derivatives, exchanges and clearing houses are looking to offer centralized clearing services across more derivative products or expand their existing clearing services to include buyside investors where such services were only available to large dealers
  • As of mid-Sep 2009, 15 banks (which include Barclays Capital, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase and Morgan Stanley) have made a pledge to the Fed to clear the majority of credit and interest rate derivatives through central counterparties by the end of the year
  • The banks have pledged to clear 95 per cent of all eligible credit default swaps and 80 per cent of all credit default swaps through a central clearing party. They have further pledged to submit 90 per cent of eligible interest rate derivatives, 70 per cent of new trades, and 60 per cent of all existing interest rate derivatives to be cleared centrally

What’s common among the initiatives

  • All the US based initiatives are from exchanges – CME, Euronext Liffe, Eurex (part of the Deutsche Borse) and Intercontinental Exchange (ICE)
  • The European based initiatives are from clearing providers – Eurex Clearing and LCH.Clearnet – who have been involved in the US effort, Eurex Clearing being the clearing provider for Eurex and LCH.Clearnet being the clearing provider for Euronext Liffe
  • In addition, ICE has set up a European clearing provider so that they can provide a transatlantic solution
  • The Japanese initiatives are from clearing providers - JSCC is 86.3% owned by the Tokyo Stock Exchange and is the clearing house for all Japanese cash equities and derivatives on the Tokyo Stock Exchange; and TFX is owned by its members and specializes in trading and clearing derivatives
  • All the initiatives are focused on applying the central counterparty solution to current CDS contracts rather than creating exchange traded instruments such as futures
  • The plan is for trades to be done under standard ISDAs and linked to the current ISDA auction process for settlement
  • CDS trades will be agreed bilaterally as they are today, but each leg of the trade will be transacted with the central counterparty
  • The central clearing counterparty will then determine a margin amount for each of its counterparties

What’s different among the initiatives

  • Their state of readiness
  • The products they cover
  • Their margin calculations
  • The institutions that are eligible to become clearing members
  • Interestingly some exchanges may only be willing to face the large institutions that meet their criteria for capital and reporting, and crucially, are able to contribute to the fund that guarantees against default by one of the members
  • As a result only the dealers and biggest buy-side firms would qualify as members to such central counterparties
  • It is not clear what criteria each the exchanges will apply, but it is possible that many of the smaller institutions may have to still face a dealer who then trades with a central counterparty, which means that the small institutions may still have counterparty risk to dealers

Where we are now and what’s remaining

  • It seems that the market supports the existence of more than one central counterparty
  • While this is a healthy sign, it is likely that market participants will choose to trade with the counterparty that asks for the smallest margins
  • At the same time, if certain exchanges are only willing to face the largest counterparties, the smaller institutions will be limited to dealing with the central counterparties that are willing to face them – these may be the central counterparties that ask for higher margins
  • The exchanges haven’t gone into much detail yet about how they will calculate margins. This aspect is crucial for the successful implementation of the central counterparty initiative, especially for those exchanges that will trade less standardized CDS contracts where calculating margin is less straightforward.


  • Received regulatory approval to clear CDS in mid-March 2009
  • Has restructured its clearing initiative to focus on clearing-only services and not exchange trading of the contracts
  • Plans to announch the launch of its pilot programme shortly
  • Entered into a joint venture called CMDX with hedge fund Citadel Investment Group to clear CDS
  • Has recently had fund managers AllianceBernstein, BlackRock, BlueMountain Capital Management, the D. E. Shaw group and PIMCO join as founding members, and is in the process of signing on a number of sell-side participants as founding members
  • Will use its existing central counterparty, CME Clearing, to clear CDS in its joint venture with Citadel
  • CME’s execution platform will be regulated by the CFTC as a derivatives clearing organization
  • Expects to trade indices (US and European investment grade, high yield and crossover) and single name CDS (components of indices plus other liquid names)
  • Has the benefit of allowing all counterparties to face it rather than only the largest financial institutions

Euronext Liffe

  • The first to launch their CDS clearing service in December 2008, they placed their CDS clearing intiative under review at the end of June 2009 after failing to clear a single contract
  • Plans to use LCH.Clearnet, an independent clearing house in London, to clear CDS as part of its Bclear service which already clears OTC equity derivatives
  • The primary regulator for LCH.Clearnet is the UK Financial Services Authority (FSA)
  • Initially expects to trade the iTraxx Europe, Crossover and Hi-Vol indices
  • Not known whether all counterparties can face it


  • Off to a slower start than the other initiatives, but is one of the two clearing solutions in Europe
  • Uses Eurex Clearing, its existing clearing provider in Europe to clear CDS in Europe
  • Expects to trade the iTraxx Europe indices, sub-indices and their constituents first (and further European single names subject to eligibility criteria), followed by the CDX index in North America and its constituents
  • Any entity meeting its requirements can face it as a counterparty, the main requirement being EUR 1bn in equity capital, which can substituted in part by a third party bank guarantee, cash or collateral securities
  • Started clearing the iTraxx index and 17 single name contracts at the end of July 2009, and had cleared one iTraxx index trade worth EUR 25mm as of 31 July 2009


  • Started by transfering existing bilateral CDS contracts on the Markit CDX indices to its clearing house in the US as of 9 March 2009 following SEC approval for ICE Trust to clear credit default swaps
  • Existing Markit CDX index contracts are being transferred by way of novation to ICE Trust, which will process and clear the contracts going forward
  • In its first month of operation, ICE Trust in the US cleared approximately $70bn notional of CDS contracts
  • Started clearing new CDS contracts in the US in late April 2009
  • Has the greatest support from dealers (potentially because of their association with The Clearing Corp)
  • Acquired The Clearing Corporation (TCC) in Oct 2008 and has set up ICE US Trust along with TCC and ten major dealers (BofA, Barclays, Citi, CS, DB, Goldman, JPM, Morgan Stanley and UBS) to clear CDS in the US
  • There are currently thirteen clearing members of ICE Trust, the three most recent members being BNP Paribas (Sep 2009), HSBC (May 2009) and RBS (May 2009)
  • ICE US Trust is a limited purpose trust bank that is regulated by the Federal Reserve and the New York State Banking Department
  • ICE has set up ICE Trust Europe to clear CDS. ICE Trust Europe will function within ICE Clear Europe, its existing FSA-approved London-based clearing provider that clears OTC energy futures. ICE is in conversations with the FSA to expand ICE Clear Europe’s remit to clear CDS
  • Started with clearing North American and European indices and plans to add liquid single name CDS clearing in November 2009
  • Any entity meeting its requirements can face it as a counterparty, the main requirement being EUR 5mm in capital
  • Looking to adapt ICE Trust to allow buyside members to access CDS clearing by December 2009. This would be done by getting derivatives "clearing merchants" who would be members of ICE Trust to provide clearing services to the buyside
  • On the 10th of March 2009, ICE US Trust started clearing CDX contracts, following ICE's acquisition of the Clearing Corporation and SEC approval for ICE Trust to clear credit default swaps
  • The European platform, launched in July 2009, cleared 840 contracts worth EUR 37.8bn in its first two weeks, far ahead of its competitors both in terms of contracts and notional volumes
  • As of November 2009, ICE has cleared more than 43,000 CDS index trades in the US and Europe with a notional value of more than $3.5 trillion


  • Initially teamed up its London-based operation with Euronext Liffe to clear CDS in December 2008, but stepped away from the venture after limited business
  • Instead it plans to launch its own CDS clearing platform in the Eurozone by mid-December 2009
  • The Eurozone service will be managed by Paris-based LCH.Clearnet SA, which is a Eurozone bank and regulated by Banque de France, though there have been many discussions around LCH.Clearnet providing a Europe-wide solution
  • The clearing service will initially cover the iTraxx indices
  • Banks rated single A or higher with EUR 3 billion of capital can become clearing members, and the service may later include buyside members
  • LCH.Clearnet has no US CDS clearer but opened an office in New York in mid-March 2009 to pursue opportunities
  • LCH.Clearnet is also preparing to offer centralized interest rate swap clearing services to corporations, governments and investment funds. LCH.Clearnet's SwapClear service currently clears around $85 trillion in interest rate swaps that are transacted between large dealers.

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