UPDATE: Fed Approves ICE's Credit-Default Swaps Clearing Plan
March 04 2009 - 5:57PM
Dow Jones News
IntercontinentalExchange Inc. (ICE)'s proposal to clear
credit-default swap trades surpassed a major regulatory hurdle
Wednesday after the Federal Reserve Board approved the plan,
advancing the federal government's goal of establishing a
clearinghouse for these complex instruments.
The Fed's approval will allow ICE to form a limited purpose
bank, known as ICE US Trust, to serve as a clearinghouse for
credit-default swaps.
Until now, trading of credit-default swaps, or CDS, has been
over-the-counter and outside the oversight of regulators. Following
the financial crisis, however, some lawmakers have called for
centralized clearing of these products to avoid widespread risks to
the marketplace in the event of a major default. Clearinghouses
help contain defaults because they assume the risk between buyers
and sellers.
But who should regulate them and how they should be structured
continue to stir controversy among lawmakers.
Several plans for offering clearing services for credit-default
swaps have emerged, including a rival proposal from CME Group Inc.
(CME). Because they are structured differently, ICE's plan will be
regulated by the Fed while CME's will be overseen by the U.S.
Commodity Futures Trading Commission.
Both plans, however, still need approval from the Securities and
Exchange Commission before they can operate. Until then, the U.S.
still lacks a place where credit-default swap trades can be
cleared.
"The establishment of ICE Trust as a central counterparty for
credit-default swap contracts is expected to minimize the impact on
financial markets of the failure by a single participant," the Fed
said in its approval of ICE's plan.
"After carefully considering all the facts of record, the board
has concluded that ICE Trust's financial condition, capital
adequacy, future earnings prospects and other financial factors are
consistent with the approval of the proposal."
The Fed's approval of ICE's application comes just two days
after the antitrust division of the Department of Justice approved
a portion of its clearing plan by allowing for the merger of ICE
and the Clearing Corporation.
ICE said it plans to close the deal with the Clearing
Corporation within a week and launch ICE US Trust shortly
thereafter pending SEC approval.
The SEC isn't expected to announce any decisions on ICE's plan
Wednesday. In a recent interview, though, the SEC's trading and
markets director Erik Sirri said he hoped to sign off on both CME
and ICE's plans "in short order."
Meanwhile, even once the SEC does eventually approve the plans,
questions still remain about whether or not financial companies
will opt to use the clearinghouses.
In Europe, NYSE Euronext has struggled to build volume for its
credit-default swap clearinghouse.
ICE, however, has the support of big banks including Bank of
America, J.P. Morgan, Citigroup, Morgan Stanley and others, which
indicates that ICE is likely to see some volume.
To address that issue, regulators and lawmakers are currently
considering passing legislation to mandate clearing for
over-the-counter derivatives, including credit-default swaps.
The Fed's approval of ICE's plan comes as Wall Street
derivatives dealers prepare to start trading a new set of
credit-default swaps with more standardized features from March 20.
The new features include fixed coupons for swaps tied to individual
companies' bonds, and are meant to help facilitate central clearing
of the contracts.
On Wednesday, an index that measures counterparty risk in the
financial markets hit its highest level since the failure of Lehman
Brothers Holdings last fall. The index, created by Credit
Derivatives Research LLC, gets its value from the cost of credit
protection on 14 banks that are also sizable players in the
derivatives markets.
-By Sarah N. Lynch, Dow Jones Newswires; 202-862-6634;
sarah.lynch@dowjones.com
(Jacob Bunge from Dow Jones Newswires and Serena Ng from The
Wall Street Journal contributed to this report.)