Talk:CDS clearing

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The long-expected establishment of a central counterparty (CCP) for credit default swap clearing is the latest initiative to become enmeshed in squabbling between industry and the regulators. Central clearing has been on the cards for CDS for some time (see Credit default swaps: On dangerous ground, Euromoney August 2008) and several consortia have come up with proposals for clearing entities. But a dispute has erupted over whether or not there should be a global CCP or separate CCPs in Europe and the US, threatening to delay the entire process.

The European Commission has tried to persuade the industry that a separate European solution is preferable because it does not want the CCP to operate under a regulatory regime over which it has no control. The Commission apparently secured verbal agreement to the scheme late last year but dealers have subsequently been reluctant to sign up to it. In a terse comment issued in early January, a spokesman for Charlie McCreevy, internal markets commissioner for the EU, stated that "We haven’t got a commitment to move to central clearing... so now we feel that since there isn’t the engagement by the industry, the project as such has failed and, therefore, the Commission has to consider the appropriate next steps."

Regardless of whether or not a CCP is required, the proposal to somehow divide the process along geographical lines seems curious. "The advantage of a global solution is more efficient netting and thus the probability of an even smaller notional," says Michael Hampden-Turner, structured credit strategist at Citi. "Typically, US and European CDS investors take exposure to both markets and there is a high degree of correlation. It would be inefficient not to have a single CCP." He adds, however, that the scale of the challenge in getting parties to agree to a global CCP should not be underestimated. "The more people you have around the table, the harder it is to come to an agreement. But the efficiencies of having a single global solution should outweigh the practical issues, and hopefully in this environment we can be a bit more revolutionary."

The Commodity Futures Trading Commission (Commission) has issued an Order with respect to the multilateral clearing activities that Eurex Clearing AG (Eurex) intends to undertake in the United States for over-the-counter (OTC) derivative instruments. Eurex is a central counterparty licensed by the Bundesanstalt für Finanzdienstleistungaufsicht (BaFin) of the Federal Republic of Germany. In the Order, the Commission determined that the supervision that BaFin, in conjunction with Deutsche Bundesbank, provides with respect to the multilateral clearing activities of Eurex satisfies appropriate standards within the meaning of Section 409(b)(3) of the Federal Deposit Insurance Corporation Improvement Act. Accordingly, the Order permits Eurex to operate a multilateral clearing organization for the clearing of OTC derivative instruments in the United States. BaFin and the Commission have entered into agreements providing for the sharing of information regarding the clearing activities of Eurex.

This Order is the fourth action that the Commission has taken on the basis of Section 409(b)(3) of FDICIA, which was added by the Commodity Futures Modernization Act of 2000 (CFMA). Section 409 provides that an MCO for over-the-counter derivative instruments, such as Eurex, may operate in the United States if, among other alternatives, the MCO is supervised by a foreign financial regulator that the Commission, or one of several other United States financial regulators, has determined satisfies appropriate standards.

  • "The regulatory drive to shine a light on the complex and opaque world of credit derivatives has brought into focus the links between pricing and clearing. Regulators have expressed a clear desire to push credit derivatives on to central clearing houses as a way of bringing transparency to the market in the wake of the financial crisis. But pricing is crucial - particularly in the credit default swaps market, one of the fastest-growing segments of the derivatives universe and an engine for Wall Street profits in the last decade. If you have the right price for a CDS, you can assess the risks properly. If you have the wrong price, there could be a loss once the "real" price comes to light. Importantly, companies that own the best pricing data can sell it. The start last week of an investigation into anti-competitive practices in the credit derivatives market by the US Department of Justice has highlighted these issues. Hence an intensified effort to establish "closing prices" in a CDS market now worth about $26,000bn in outstanding contracts."

Financial Times, July 24, 2009

"Whereas last summer the major dealers and rating agencies, and their political tools in Washington, were unapologetic in defending the status quo in the retrograde market for OTC derivatives, including derivatives and complex structured assets, now the French retreat from Moscow seems a more apt metaphor. Horror of horrors, Members of Congress are discussing the issue of "price discovery" with respect to OTC. And the hungry politicians on both side of the issue smell blood in the water, prompting a "fund raising frenzy."

Last week saw House Financial Services Committee Chairman Barney Frank (D-MA) throw an outright ban on "naked" speculation via credit default swaps or "CDS" on the political table. This was followed by the even more remarkable spectacle of New York Senator Charles Schumer calling for limits on program trading, a direct attack on Goldman Sachs (NYSE:GS.

We are shocked, shocked to hear reports that the GS firm, which controls half of all program trading in the New York equity markets, has been accused of "stealing" money from the markets by gaining privileged access to trading ahead of other investors. Perhaps the managers of GS forgot to make their monthly payment?

As in many other parts of the economy, the flow of political largess seems to be ebbing from peak levels, thus Members angling for votes overtly "throw" issues on the table much like a striped bass on the fish monger's table. Just imagine Chairman Frank in a rain slicker and hat, covered in fish slime, crying out the price for his fresh "catch" on the Boston waterfront.

This week's special is "Naked CDS." As Chair of the House Financial Services Committee, Frank has a monopoly very much like that of the dealer bank in the CDS bazaar. But you understand that, like the dealer market for CDS, the inside of Frank's office in Washington is competitive and the fish goes to the highest bidder.

Aside from the complete absence of transparency and true price discovery in markets such as CDS, one of the outrages of our time is the fact that politicians will not stay bought. Despite engaging in shameless commerce for their political assent - that is, asset -- Members of Congress like Frank, Schumer and, frankly, most constituents of the "national" parties, will embrace multiple partners during the political season, sometimes on more than one occasion in a single day and often in the same room. Exchange of gratuities (or at least the promise of same) have been witnessed in the hallways and lavatories of congressional office buildings...."

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