CDS clearers could face headwinds from industry group

The move to clear more CDS contracts could face some headwinds from a few brokers who claim the road to transparency starts with increased access to the more established clearinghouses themselves. If a newly formed broker group - dubbed the Swaps and Derivatives Market Association - gets its way, there will be fewer clearinghouse restrictions and increased counterparty diversity.

StormHarbour Partners, for one, confirms that it is a member of the Swaps and Derivatives Market Association, but an executive at the company had no further comment. It is, however, understood to be among about 20 firms in the association that include BTIG, Hexagon Securities, Jefferies and Miller Tabak Roberts Securities. Law firm Venable is representing the group in Washington.

But the main clearinghouses and those still attempting to get their clearing legs are also lobbying for their right to charge the membership fees and requirements they say are necessary for sufficient responsibilities in the case of defaults, regardless of whether the price of admittance may seem high, say CDS traders. To become a member of the biggest CDS clearinghouse, IntercontinentalExchange's ICE Trust, participants must have a minimum of US$5bn of tangible net worth - though the requirement may be met by a direct or indirect parent.

Another sore spot debated in the industry is whether a dealer has to be a clearer and a clearer has to be a dealer, which is the case at ICE, notes one trader. There are discussions, he says, taking place in Washington to separate the two roles.

Letting more participants into the clearinghouses will enable markets to operate better for the end-user, the trader says. "Bid/ask spreads will tighten due to the competition, there will be more transparency and it will be cheaper to the end-user," he notes.

"Markets work more efficiently and in a more continuous manner when there are more market participants and more liquidity providers, not fewer," adds James Cawley, ceo of inter-dealer broker IDX Capital.

ICE Trust, which began clearing CDS indices in March 2009, currently has 13 dealers as members. ICE Clear Europe began in July 2009. According to an ICE spokesperson, ICE Clear Europe will soon be launching clearing in Europe for buy-side participants (SCI passim).

But the move from a bilateral contract to a clearing model is still anathema to several participants in an industry that is not known for its openness, says Stephen Bruel, research director at research advisory firm TowerGroup. "It's not an overnight shift."

The smaller brokers do not have much alternative but to lobby against the larger clearinghouses' strict membership requirements, according to one hedge fund manager. Most, he says, do not favour divulging their clients in order to trade through the larger dealers, so they have to alter current methods.

"They are trying to convince Washington to make an exception for them. I don't think it makes sense," he says.

According to TowerGroup's Bruel, the largest dealers do have a concentration in terms of CDS trading volumes. But he notes that is not unique to this asset class or unique to OTC derivatives.

Still, CDS clearing in general has a long way to go. Regardless of the more than US$6.6trn in CDS that has been cleared on ICE Trust as of mid-March, traders and market-makers say a majority of the single name CDS trades and some of the index trades are still not cleared at all.

"It will take time to work itself out. We will not see the true evolution of this for another two to four years," notes Bruel. But he concedes: "A measured step is not necessarily a sign of failure. The goal of the buy-side is not to rush into this as fast as possible."

The larger dealers are also said to be behind some of the stalled initiatives for more clearing. More than actually fighting with smaller dealers over the clearing issue, one buy-side participant says the larger firms are keen to delay progress.

"The large dealers are the ones pushing back, but everyone else wants to see a more vigorous clearing environment," he concludes.

KFH