Monday, June 9, 2008

Wall Street Banks Land First Blow in Battle Over Clearing Swaps

(Bloomberg) -- Goldman Sachs Group Inc., Morgan Stanley and 14 banks and brokerages dealt a blow to futures exchanges in the battle to shift trading in the $62 trillion credit-derivatives market to a model the Wall Street firms control.

Clearing Corp., the Chicago-based clearinghouse owned by the companies, will guarantee trades at Depository Trust & Clearing Corp. by September. That gets the Chicago firm and its backers access to fees on trillions of dollars of credit default swaps.

``It will give the dealers an edge over the exchanges,'' said Brian Yelvington, a strategist at CreditSights Inc. in New York. ``The exchanges would have to get to 'critical mass,' which is much harder for them to do without the broker-dealer community using them.''

The banks aim to sidestep exchanges such as CME Group Inc. in the race to use a clearinghouse model for risky trades that led to the demise of Bear Stearns Cos. Clearinghouses, which are capitalized by their owners, diffuse default risk and help create daily prices. Trading is now conducted bilaterally, exposing each side to the possibility of default.

More than bragging rights are at stake. Banks and brokers could have earned a $31 billion profit on the $62 trillion of outstanding credit-default swaps, assuming a 5 basis point spread between bid and ask prices. That compares with the $817 million profit last year at CME, whose earnings are derived from fees on clearing and transacting futures trades.

Exchanges such as CME and Intercontinental Exchange Inc. are striking back by buying credit dealers and servicing companies. Atlanta-based Intercontinental agreed on June 3 to buy Creditex Group Inc. for $625 million to boost processing in the credit derivatives market.

CME's Advantage

``ICE will add another key market to our growing range of asset classes,'' including the credit-default swap market, Intercontinental Chief Executive Officer Jeff Sprecher said on a June 3 conference call announcing the Creditex purchase.

CME, the world's largest futures exchange, bought Credit Market Analysis in March to give its customers pricing information credit-default swaps. It has also begun effort to use its clearinghouse to expand into the over-the-counter market.

The neutral stance CME will take in the markets, compared with the broker-dealers that own Clearing Corp., makes CME a better venue to clear credit trades, said Kim Taylor, president of CME's clearinghouse division. CME has an advantage because of its $1.5 billion guarantee fund and intention to target both the buy and sell side, she said, declining to say when CME may launch a cleared credit product service.

Just Talk

``I'm not sure making announcements creates first-mover advantage, and to date that's all there's been,'' she said.

Both Intercontinental and CME face an uphill battle to gain market share from banks, said Brad Bailey, a director of business development at Knight Capital Group, the Jersey City, New Jersey-based brokerage.

``It's going to be tricky for the exchanges and dealers to work together in some of these markets the dealers have controlled,'' he said. ``There's no doubt there's fundamental competition that exists between the dealers and exchanges.''

Banks, hedge funds and other institutions that trade credit derivatives are under pressure from the Federal Reserve Bank of New York to meet a September deadline for most dealers to use a central processing system that would reduce errors and speed up trading. The New York Fed has prodded banks on the issue since 2005.


The market for credit-default swaps has doubled in each of the previous three years as traders use the derivatives as a cheaper and easier way to invest in corporate debt.

``Timing is of the essence,'' said Eraj Shirvani, a Clearing Corp. board member who is also co-head of European credit at Credit Suisse Group AG and chairman of the International Swaps and Derivatives Association.

Clearing Corp. will bundle all trades from a bank and process them as one exposure to the clearinghouse, eliminating the need to deal with several different counterparties. It struck the deal with DTCC on May 28.

``We want to have minutes of processing, not days of processing,'' Shirvani said. ``We want to be able to put a lot more through the pipe.''

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