(Bloomberg) -- The U.S. Commodity Futures Trading Commission approved CME Group Inc.’s application to guarantee credit-default swaps with its clearinghouse, potentially generating $400 million in new annual revenue for the company.
“The advent of clearing solutions for the credit default swap market will benefit the financial system significantly,” CFTC Acting Chairman Walt Lukken said in an e-mailed statement today.
CME Group is competing with Intercontinental Exchange Inc., NYSE Euronext and Eurex AG to clear credit-default swap trades in the $28 trillion market. A clearinghouse owner could earn between $100 million and $400 million a year in revenue from clearing the trades, according to estimates by Wachovia Capital Markets and Keefe Bruyette & Woods Inc.
A clearinghouse is part of U.S. efforts to oversee credit- default swap market after the contracts contributed to the demise of Bear Stearns Cos. and the government takeover of American International Group Inc. Banks, hedge funds and other investors currently negotiate credit-default swaps privately in the over-the-counter market.
CME Group has still not received licensing approval from Markit Group Ltd., a bank-owned service that provides the most widely used indexes and pricing methods in the credit swap market. The CME Group also needs an exemption from the Securities and Exchange Commission before it can begin clearing contracts.
A clearinghouse, rather than a single bank, would be the counterparty to trades and help absorb losses should another dealer fail, as Lehman Brothers Holdings Inc. did in September. Funded by its members, a clearinghouse is intended to add stability to markets by becoming the buyer to every seller and the seller to every buyer.
NYSE Euronext began clearing a European CDS index on Dec. 22. Intercontinental Exchange is awaiting regulatory approval from the Federal Reserve Bank of New York. Intercontinental’s clearinghouse, ICE U.S. Trust, was granted a New York state banking license earlier this month. Eurex has said it hopes to begin clearing CDS trades in the first quarter.
Credit-default swaps are contracts that were conceived to protect bondholders against default and are now widely used to speculate on the creditworthiness of companies. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase in the price indicates deterioration in the perception of credit quality; a decline signals the opposite.
The value of the contracts outstanding is determined by weekly data from the Depository Trust Clearing Corp. The market value has come down from over $50 trillion in recent weeks due to netting of trades and counterparties agreeing to exit trades.
The most actively traded contracts in the credit-default swap market are indexes of U.S. and European companies with investment-grade debt ratings. Contracts based on specific companies also trade.
CME in talks with dealers on CDS platform
(Reuters) CME Group Inc (CME.O) is also in advanced discussions with six dealers to take equity stakes in its credit default swaps (CDS) trading and clearing platform, the Wall Street Journal said. (CME could not be immediately reached for comment by Reuters.)
CME's rival IntercontinentalExchange Inc (ICE.N) has said it expects to clear CDS by the end of the year.