US Exchanges Request Regulatory Changes For CDS Clearing
July 13 2009 - 4:24PM
Dow Jones News
U.S. federal bankruptcy laws may need to change to protect hedge
funds and other institutions trading credit default swaps,
derivatives exchanges warned Monday in a report to the New York
Federal Reserve.
In the 150-page document, IntercontinentalExchange Inc. (ICE)
and CME Group Inc. (CME) said that legislative and regulatory
action may be necessary to guard buy-side firms against potential
failures of clearing member banks involved in exchange-backed
facilities set up to handle credit derivatives trades.
With ICE's credit default swap clearinghouse up and running and
a competing facility from CME approved for launch, regulators and
market participants have pushed for broader protection of hedge
funds, pension funds and other non-bank traders of credit default
swaps, over-the-counter instruments that pay off in the event of a
bankruptcy.
Credit derivatives figured into the downfall of insurer American
International Group Inc. (AIG) last fall, and banks' bilateral
positions in the often-complex instruments prompted calls from
Washington to reduce counterparty risk in the market, currently
estimated to be around $27 trillion.
Derivatives exchange operators like CME, ICE and Deutsche
Boerse's (DB1.XE) derivatives arm Eurex have moved to develop
clearing services for the swaps, structuring the facilities to
incentivize the dealer banks that account for most of the activity
in the market.
Executives of ICE and CME pledged that their clearinghouses
would also protect buy-side participants in the event that a
clearing member bank defaults, but details have remained hazy as
exchanges focused on getting the facilities operational.
In the report to the New York Fed, CME proposed amending the
U.S. bankruptcy code to help resolve persistent "uncertainties"
around protecting buy-side firms.
The Chicago-based exchange operator said that market
participants looking to clear credit default swap trades through a
U.S. futures commission merchant may need to be covered by existing
rules for commodity contracts in the event of an FCM
bankruptcy.
ICE suggested its own amendments to statutes covering its
clearing framework, requesting rules for the segregation of
collateral posted for credit default swap trades, and asking that
the Federal Depository Insurance Corp. transfer cleared credit
derivatives positions separately from non-cleared positions in the
event of a clearing member firm's failure.
Atlanta-based ICE also wants regulators to assist in the timely
return of customer collateral in the event of a clearing member's
bankruptcy, and to allow the clearinghouse to shift customers'
credit default swap positions to other clearing members if need
be.
ICE's credit derivatives clearinghouse, supported by major Wall
Street banks, has processed more than $1.3 trillion in credit
default swap trades since its launch in mid-March.
CME's rival platform, a joint venture with Chicago-based hedge
fund firm Citadel Investment Group, has yet to open for business as
the companies work to secure support from dealers.
-By Jacob Bunge, Dow Jones Newswires; (312) 750 4117;
jacob.bunge@dowjones.com