ICE Emerges as Credit-Default Swap Clearinghouse Frontrunner
Thursday, January 15th, 2009
ICE Emerges as Credit-Default Swap Clearinghouse Frontrunner
By Matthew Leising and Shannon D. Harrington
Jan. 15 (Bloomberg) — Intercontinental Exchange Inc., the second-largest U.S. futures market, is emerging as the leading candidate to run a clearinghouse for the $29 trillion market for credit-default swaps.
Analysts at Morgan Stanley and CreditSights Inc. said this week that Atlanta-based Intercontinental, also known as ICE, will likely be the industry choice to back the contracts because of its partnership with Goldman Sachs Group Inc.,JPMorgan Chase & Co. and seven other banks that account for over 80 percent of the trading. A clearinghouse may earn as much as $400 million in annual revenue, according to Keefe Bruyette & Woods Inc.
An ICE victory would mean the securities firms that control a market responsible for billions of dollars of losses will continue to shape the way the contracts are traded. ICE is competing against CME Group Inc., the world’s largest futures market, NYSE Euronext, the owner of the New York Stock Exchange, and Eurex AG.
“People have some concerns over the banks’ influence, but no matter what entity this goes to, you’re going to have a lot of dealer influence,” said Brian Yelvington, a New York-based strategist at fixed-income research firm CreditSights. “I don’t see how you get away from that.”
Regulators in the U.S. and Europe are pushing the banks to form a clearinghouse to curb risks in the market, where trades are typically negotiated privately between banks and investors such as hedge funds.
Regulators’ Hopes
The New York Fed said in October that it was “hopeful” one or more credit-default swap clearinghouses would begin guaranteeing trades by the end of 2009.
Dealers in the market probably lost hundreds of millions of dollars on trades with Lehman Brothers Holdings Inc. after the collapse of the securities firm, Moody’s Investors Service analysts estimate. American International Group Inc. ceded control to the U.S. government in exchange for a bailout loan after it couldn’t come up with collateral on more than $440 billion in contracts linked to mortgages and other debt.
A clearinghouse, capitalized by its members, spreads the risk of default and aims to keep markets stable by acting as the buyer to every seller and seller to every buyer.
The move to clearing over-the-counter contracts such as credit-default swaps is also part of derivatives exchanges’ efforts to earn new revenue after futures trading slowed last year.
Banks’ Backing
ICE Chief Executive Officer Jeffrey Sprecher built his company with the backing of investment banks Goldman Sachs and Morgan Stanley. Now he’s planning to purchase Clearing Corp., the former clearinghouse for the Chicago Board of Trade, which is owned by New York-based Goldman Sachs, Morgan Stanley, JPMorgan, Citigroup Inc., Merrill Lynch & Co., Bank of America Corp. in Charlotte, North Carolina, Deutsche Bank AG in Frankfurt and Credit Suisse Group AG and UBS of Zurich.
The nine banks that own Clearing Corp. agreed to move their credit-default swap trading to the ICE U.S. Trust clearinghouse, Sprecher, 53, said on Dec. 10 at a Goldman Sachs investor forum in New York.
“If we were trading broccoli, we’d affiliate ourselves with agribusiness,” Sprecher said in an interview last month.
ICE declined 28 percent this year after falling $2.84, or 4.6 percent, to $58.99 yesterday in New York Stock Exchange composite trading. The Standard & Poor’s 500 index dropped 29 percent this year.
Investor Protection
Credit-default swaps were conceived to protect bondholders against default and are now 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.
CME Group, which traces its roots to 1848, says it’s premature to declare a winner in credit-default swaps clearing.
“This is way too soon to make any pronouncements about what will happen competitively in the market,” CEO Craig Donohue, 47, said last month in an interview. “You have two very different proposals out there. Many of the dealers we’re talking to very much want to keep their options open to participate on more than one platform.”
As much as 40 percent of the profit at Goldman Sachs and Morgan Stanley stemmed from private over-the-counter transactions, according to CreditSights.
‘Antagonistic Relationship’
“The CME has a very good brand and is very well- capitalized, but they’re in the futures space and they’ve had an antagonistic relationship with the banks,” said Craig Pirrong, a finance professor at the University of Houston. “It was a very slick move for Sprecher to move in and fold Clearing Corp. into the ICE operation. He’s always had a good relationship with banks.”
Between $100 million and $400 million a year in revenue is up for grabs for a clearinghouse owner through fees from clearing credit-default swap trades, according to estimates by Wachovia Capital Markets and Keefe Bruyette.
About 84 percent of the gross credit-default swap trades outstanding are between dealers, according to Depository Trust & Clearing Corp. data as of Jan. 9. About 16 percent are between dealers and clients such as hedge funds, while 0.1 percent are trades between two parties that aren’t dealers.
CME Group has said it will process existing bi-lateral credit-default swap trades with its clearinghouse only if both parties to the trade agree.
Hedge Fund Combination
The company joined with Chicago-based hedge fund Citadel Investment Group LLC, in part to attract derivatives traders at hedge funds. The Chicago exchange also offered as much as 30 percent of the equity in its credit-default swap venture to potential partners.
Donohue said negotiations about those stakes are showing “very good interest.” He declined to name any funds or banks that have invested.
CME Group’s clearing plan must still be approved by the U.S. Securities and Exchange Commission. ICE U.S. Trust is awaiting SEC and Federal Reserve approval.
ICE’s acquisition of New York-based credit-default swaps broker Creditex Group Inc. last year and an agreement with London-based index owner Markit Group Ltd. also gave the company access to the two firms that administer auctions used to determine the price on which most of the contracts are settled after an underlying company defaults.
“Markit and Creditex — that really gives them people who understand how that product is marketed, how it’s traded and how they’re valued,” said John Jay, a senior analyst at financial services consulting firm Aite Group LLC in Boston. “That’s a very key thing.”
To contact the reporter on this story: Matthew Leising in New York at mleising@bloomberg.netShannon D. Harrington in New York at sharrington6@bloomberg.net;
Last Updated: January 15, 2009 00:01 EST
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Regulators looked the other way while credit default swaps grew into a $60 trillion threat to the world’s financial system. Now the CDS market is getting plenty of attention, and brawling has broken out over how to regulate it and who should oversee the job.






