Friday, October 31, 2008

ICE deal signals new clearing house for credit default swaps

(FT) IntercontinentalExchange, the US-based electronic futures exchange, yesterday raised the stakes in its effort to expand in the $54,000bn credit default swap market by announcing a deal to take over The Clearing Corporation (TCC), the bank-operated clearing house.

The move is the latest salvo in a battle between ICE and the CME Group, the world's largest futures exchange, to develop central counterparty clearing infrastructure for the CDS market.

Shares in ICE rose 40.8 per cent yesterday to $87.

US regulators are keen to see a clearing house established for the opaque over-the-counter contracts as soon as possible, since the absence of a central counterparty - which would guarantees pay-outs should a trading party be unable to do so - has exposed the risk of massive market disruption.

Last month the CME struck a deal with Citadel, the hedge fund, to form an electronic marketplace with central counterparty clearing for CDSs.

ICE first signalled its intention to move into CDSs in June, when it paid $625m for Creditex, an interdealer credit derivatives broker.

This month, the company agreed with TCC to create a "global clearing solution" for CDSs - although there has been a question mark over the proposal, since its principal backers are the same financial institutions most affected by the crisis.

ICE's takeover demonstrates both the seriousness of its plan and the extent to which Jeff Sprecher, chief executive, wants to work closely with the Federal Reserve to develop his solution.

The company will form a limited-purpose bank, ICE US Trust, which will be a member of the Fed system and will serve as its over-the -counter derivatives clearing house.

Mr Sprecher said building a separate clearing entity was an important difference between his proposal and that of the CME, which is planning to clear CDSs through its existing futures clearing house.

"We concluded that the [CDS] contract design and the risk profile differed too significantly from that of futures," said Mr Sprecher. "The existing collateral and liquidation provisions of futures-style clearing would not be sufficient, nor would combining CDS with futures positions be prudent in terms of adding systemic risk."

Mr Sprecher said he had signed memoranda of understanding with nine of the biggest traders in the CDS market - Bank of America, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Merrill Lynch, Morgan Stanley and UBS - to clear their global CDSs.

The CME has said that it could begin operations as soon as next week, if regulators allow it.

Mr Sprecher said his solution could start "in the very near term" but said regulatory approval would hold things up.

ICE also announced yesterday its profits increased by 12 per cent in the third quarter compared to the same period last year - in line with analysts' expectations - as the dramatic fall in crude oil prices prompted a jump in the volumes of energy futures.

Net income was $75m or $1.04 per share, up from $67m or 93 cents per share for the third quarter of 2007.

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