UPDATE: Private-Equity Cos Seen Backing New Clearinghouse

Private-equity companies are backing the development of a new clearinghouse, according to people familiar with the matter, a move apparently designed to compete with similar trade-processing venues affiliated with major banks.

The identities of the private-equity backers behind the project, called "Baseclear," couldn't be learned, nor could its location or the types of contracts on which the new venture will focus on clearing.

Clearing is a process that involves a central counterparty standing between trading parties and guaranteeing their contractual obligations in case a member of the clearinghouse defaults. But bank ownership of clearinghouses has made regulators across the globe nervous as they look to see more financial instruments, including privately traded derivatives, processed centrally.

Regulators are leery of allowing the clearing industry--which they consider a key safety net for financial markets--to be controlled by big banks, which they often see as contributing to risks in the system.

Work on Baseclear is at a very early stage, but its current ownership structure would seem to set it apart from existing central clearing organizations that are partly owned by banks, possibly making it more attractive to regulators.

The 2010 Dodd-Frank U.S. financial-regulation overhaul law, which will require a large portion of the privately traded derivatives--or swaps--market to be cleared, specifically restricts dealer banks' control over derivatives clearinghouses and trading platforms. Regulators outside the U.S. are considering similar caps.

Restrictions on dealer banks' stakes in clearinghouses grow out of concern about having derivatives markets "too much under the control of one group," said Darrell Duffie, professor of finance at Stanford University and an expert in clearing. There also are concerns on "conflicts of interest in risk requirements," he added.

Duffie said a private-equity-owned clearinghouse would seem to "fit very well with the Dodd-Frank requirements on limits to bank ownership of clearinghouses."

The business of clearing is growing fast, with pending regulation helping it gain traction among users and interest growing from that penetration. A Citigroup report earlier this year estimated that two thirds of the $600 trillion swaps market will be cleared under proposed regulations.

"The business of clearing hasn't been touted as something that has very high margins," said Duffie, but he said regulations limiting banks' affiliations with central counterparties may make a compelling case to build a new, independent clearinghouse.

"Clearinghouses can be part of multipurpose financial businesses that involve data, execution and clearing," he said.

Exchanges around the world have seen a wave of merger-and-acquisitions activity in recent months, and even LCH.Clearnet, which owns the largest global clearinghouse for interest-rate swaps, has been recently been in play. This suggests market participants expect clearing to play a vital role in financial markets, lending weight to the notion of private-equity companies doing the initial legwork for a handsome payoff downstream.

Peter Burton, a managing director at trading platform consultancy Delta Markets Group and part of the founding group of a former venture capital-backed clearinghouse and exchange called onExchange, said one opportunity would be to offer a better clearinghouse model in terms of technology, or possibly a structure that better supports new trading firms brought about by proposed regulations.

"We've seen a number of new trading facilities launched for swaps as a direct result of new regulation, so perhaps this group sees an opportunity to launch a new clearinghouse along the same lines," said Burton.

"A new independent clearinghouse in Europe may be seen as warranted," he continued. "LCH.Clearnet successfully clears trades at multiple exchanges, and is independent. But maybe someone said there is room for another."

The world's largest clearinghouses include: Eurex Clearing, a joint venture between Deutsche Boerse AG (DB1.XE) and SIX Swiss Exchange, with institutional investors but no significant bank ownership; LCH.Clearnet, which is owned 17% by exchanges and 83% by its users, including banks and brokers; CME Group Inc. (CME), which is publicly traded; and IntercontinentalExchange Inc. (ICE), which has clearinghouses for futures and energy swaps, but also two credit-default-swap clearinghouses that share approximately 35% of CDS clearing profits with a group of 10 banks and other non-bank members.

Burton said a new independent clearinghouse may find it challenging to sign up members, however. "One of the things we faced when we were setting up onExchange was the last thing in the world any of the investment banks or futures commission merchants wanted was to join another clearinghouse," he said. "Members don't necessarily want to invest the time and infrastructure resources to back any new exchanges or new clearinghouses."

In the absence of clearing members, the private-equity companies would need a pot of money to back trades and create an alternative structure to collect collateral and margin, said Burton. That way, the investors could potentially back the transactions cleared through Baseclear, and eventually leverage off that to attract more trades into the clearinghouse.

-By Katy Burne, Dow Jones Newswires; 212-416-3084; katy.burne@dowjones.com

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