IntercontinentalExchange Inc. (ICE) is working with regulators
and market participants to establish a "new market structure" that
will standardize over-the-counter credit derivatives and increase
price transparency to the $30 trillion market, the company's chief
executive said Tuesday.
As ICE prepares to launch ICE US Trust, a credit derivatives
clearinghouse developed with the bank-backed Clearing Corporation,
ICE Chief Executive Jeffrey Sprecher said the exchange is now
involved in a "broader CDS discussion" that will bring fundamental
changes to the functioning of a market laid low by the credit
crisis.
Over the last 30 days, Sprecher said, there is a growing
consensus among market participants that the credit derivatives
market in its current form is "broken," and that most of the trades
taking place are associated with participants' exiting the
sector.
Introducing clearing to bilaterally traded credit instruments is
just one step, according to Sprecher.
"It's really about repackaging the risk and making needed
changes in the product itself to support a growing and important
market," he said in a call discussing ICE's fourth-quarter
earnings.
ICE reported Tuesday that net income declined 24% in the fourth
quarter, following a $16 million write-down related to its stake in
the National Commodity and Derivatives Exchange of India, a deal
which has lost value in the wake of the global financial
crisis.
Fourth-quarter net income at ICE came in at $48.9 million, or 67
cents a share, down from $64.7 million, or 90 cents a share, a year
earlier; analysts surveyed by Thomson Reuters expected earnings,
excluding items, of 83 cents on revenue of $213 million.
Futures-related transaction revenue grew by 18% year-over-year,
while over-the-counter revenue grew 54%.
ICE shares were recently up 6.4% at $66.27.
Clearing Credit Derivatives Only the First Step
ICE, along with other exchanges including CME Group Inc. (CME),
NYSE Euronext (NYX) and Deutsche Boerse's (DB1.XE) derivatives unit
Eurex, has had a proposal to clear credit derivatives trades in the
works since last fall.
ICE US Trust will be structured as a Federal Reserve-regulated
New York trust bank. As part of the venture, ICE announced in
October that it would acquire The Clearing Corp., which had been
developing its own credit derivatives clearing solution.
That deal has yet to close and is being evaluated by the
Department of Justice. Meanwhile, ICE US Trust has secured approval
from the New York State Banking Department and the Commodity
Futures Trading Commission, though it still awaits approval from
the Federal Reserve and the Securities and Exchange Commission.
Moving preexisting credit derivatives trades into clearinghouse
is only the first step-then they must be marked to market, a much
more difficult proposition, according to Sprecher. The answer, he
said, increasingly appears to be an end-of-day auction process that
would improve price transparency in the historically opaque
market.
Sprecher said there is also a need to standardize default
procedures, based on anecdotal evidence from the two dozen or so
defaults in the fourth quarter of 2008. Work on ICE US Trust, he
said, has "served as a forum for these issues" for market
participants and regulators.
"We're positioning for what we think is going to be a very
different market going forward," he said.
Although the International Swaps and Derivatives Association,
which oversees swaps markets, is currently weighing the same
issues, Sprecher said credit market participants can't wait for
that process to play out.
That's because upon launch of ICE US Trust, Sprecher said the
nine banks that have signaled their support for the venture will
immediately migrate their existing CDS positions into the
clearinghouse.
"That means from the first day, we need transparency and price
discovery into these positions," he said. "Our clearinghouse will
only be as good as the marks we put in; it's important that from
the beginning, we get these right."
Sprecher said that because the banks supporting the ICE US Trust
initiative represent such a large amount of open interest in the
credit derivatives market, the mark-to-market and standardization
processes it incorporates will likely become the industry
standard.
Closing the TCC deal is tied to the final regulatory approvals
for ICE US Trust, Sprecher said. The exchange expects those
approvals sometime in the first quarter of this year.
Acquisition Opportunities May Arise From Chaos
Separately, Sprecher said that acquisition opportunities could
surface as the financial crisis has prompted private companies to
revisit their valuations.
While investors have badly bruised the market capitalization of
public companies - the exchange sector itself has shed
approximately 70% over the past year - it's taken a bit longer for
the climate to affect private companies, according to Sprecher.
"For a while, private companies that could have been acquired
had not reset their expectations" regarding valuation, he said.
"People are getting realistic now."
Sprecher added that in recent weeks, ICE has had discussions
with banks regarding borrowing capacities and the exchange's debt
positioning.
"We really do see an improvement in the debt markets right now,"
he said, "to an extent that we might want to tap them."
Besides the deal to acquire The Clearing Corporation as part of
its ICE US Trust effort, ICE last June purchased the credit
derivatives boutique Creditex in June.
-By Jacob Bunge, Dow Jones Newswires; (312) 750 4117;
jacob.bunge@dowjones.com
(Kerry E. Grace contributed to this report.)