Jeffrey Hogan Comments: CDS Clearing Kicks Off In Europe - Financial News

Financial News, August 3, 2009

Two derivative exchanges have started clearing credit default swap trades in Europe, signalling that dealers have met a self-imposed deadline aimed at allaying regulatory fears over systemic risk. Eurex, the European derivatives market co-owned by the German and Swiss exchanges, said it had begun clearing CDS trades through Eurex Credit Clear, a new service that went live yesterday.

Thomas Book, head of clearing at Eurex, said: “I am very pleased that our first credit clearing members used our new clearing solution for CDS at the earliest opportunity.”

A spokeswoman for Atlanta-based IntercontinentalExchange, which has cleared CDS trades worth more than $1.6 trillion (€1.1 trillion) in the US, said its European CDS service, introduced Wednesday, has also started processing trades.

The clearing of the first CDS means derivative dealers have met a self-imposed deadline to begin the process of reducing risk in the market. Europe's banks and brokers reached an agreement with the European Commission in February that would start clearing their CDS trades by the end of this month.

This agreement was made after the collapse of Lehman Brothers raised fears that the failure of a major dealer could cause a devastating chain-reaction. Clearing houses insure buyers and sellers against default and allow regulators to monitor dealers' positions.

David Clark, chairman of the Wholesale Markets Brokers' Association, a trade body for derivatives dealers, said: “We congratulate Eurex and ICE on the work they have done...to meet the industry-agreed deadline. We are hopeful that clearing will re-establish liquidity and volumes in the CDS market, which together will benefit market participants and end users alike.”

A third exchange - Liffe, the London-based derivatives division of NYSE Euronext - launched a CDS clearing system in December alongside LCH.Clearnet, but has said it is reviewing the service after it failed to attract users.

Meanwhile, Chicago-based CME Group has secured US regulatory approval to clear CDS trades, but has yet to announce a launch date for the service or to win approval for its expansion into Europe.

Meeting today's deadline will take some of the political heat off over-the-counter derivative dealers, who are being pressed to change their trading practices after lack of transparency in the OTC markets was blamed for worsening the financial crisis.

Jeff Hogan, a managing director at interdealer broker BGC Partners, said: “The immediate need for a political response has been reduced with CDS clearing operations beginning on Friday's target date.”

Nevertheless, concerns over the market remain. The US Justice Department is conducting a probe to determine whether CDS dealers have engaged in anti-competitive practices. Meanwhile the Federal Reserve Bank of New York is looking at how to boost competition for CDS clearing in the US, where Ice operates the only system to have cleared any trades, according to Bloomberg.

“A competitive environment, at least in the short run, is beneficial,” Theo Lubke, an official at the New York Fed, told Bloomberg. “We don't want the first mover to be the winner just because they're the first mover.”

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