2nd UPDATE:Fed Approves ICE Credit Derivatives Clearing Plan
March 04 2009 - 7:01PM
Dow Jones News
IntercontinentalExchange Inc.'s (ICE) proposal to clear
credit-default swap trades surpassed a major regulatory hurdle
Wednesday after the U.S. 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. In the
wake of 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 CDS 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.
Trans-Atlantic exchange operator NYSE Euronext (NYX) has
received approval from regulators to launch its own U.S. swaps
clearing platform, but that effort remains in development,
according to officials.
"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 U.S. Justice Department
approved a portion of its clearing plan by allowing for the merger
of ICE and the Clearing Corp.
ICE said it plans to close the deal with the Clearing Corp.
within a week and launch ICE US Trust shortly thereafter pending
SEC approval. ICE shares were up in after-hours trading, rising to
$59.23 from $57.37 at Wednesday's close. CME shares were little
changed from the close.
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's
and ICE's plans "in short order."
Once the SEC does approve the plans, however, the question will
remain whether financial companies will opt to use the
clearinghouses.
In Europe, NYSE Euronext in December launched a credit-default
swap clearinghouse in conjunction with LCH.Clearnet, but that
service has yet to see any volume, according to NYSE Euronext.
Exchange officials have cited connectivity and integration
issues for the slow start, but banks are seen as reluctant to
support a CDS clearing solution that isn't backed by the
dealers.
ICE, however, has secured support in the U.S. from nine major
banks including Bank of America Corp. (BAC), JP Morgan Chase &
Co. (JPM), Citigroup Inc. (C), Morgan Stanley (MS) and others,
which indicates that ICE US Trust is likely to see some volume.
To address the 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 beginning
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 autumn. 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.)