CDS clearing plans? Certainly too little. Possibly too late. Greg Newton looks for a cleansing bolt of sunlight and greater clarity
Into each life a little certainty must fall, even in the midst
of The Greatest Global Financial Calamity Since The Great
The certainty is that sometime in the reasonably foreseeable
future, one, or as many as all, the worlds leading
financial exchanges the CME Group (possibly in
association with hedge fund manager Ken Griffins Citadel
Investment Group), Eurex, Intercontinental Exchange and
NYSE-Euronext will offer a central counterparty clearing
solution for the controversial credit default swap market.
The concomitant uncertainties are legion.
Will CDS market participants use a CCP? With two of the
markets key players Lehman Brothers and AIG
having been carried off the field on their shields in recent
weeks, those left standing are more favourably disposed today
to the idea of CCPs.
But the businesss kudzu-like growth occurred in the
shadows because its participants liked it that way; their
determined refusal to support credit default index futures
contracts listed in Frankfurt and Chicago, even while issuance
rose and risks multiplied, spoke strongly to their preference
for keeping things pretty much on the quiet.
Even today, its leaders are dragging out the privately
negotiated contracts negotiated between sophisticated
investors message, conveniently looking past the
instruments unquestionable impact on public markets.
Its taken years of increasingly strident speechifying
and press releasing by regulators to get the process this far;
it will certainly take brute force, and probably legislation,
to get the horses actually slurping, however unhappily, from
So will a CCP solve the issues related to allegedly
providing the playground where assorted Evil Speculators And
Overpaid Executives have undermined civilization?
Properly implemented and actually used, it would take the
worst of the newly rediscovered counterparty risk question out
of the equation.
But it would not, by itself, bring urgently needed
transparency to the market, or address the so far
unsubstantiated suspicions that CDS have taken the place of the
stock and option markets as the preferred venue for such old
favourites as insider trading and various forms of market
And, as ridiculous as it sounds, will the CDS market be
worth saving by the time a CCP is up and running?
Some indication of how important regulators regard the
question is that even as G7 leaders gathered in Washington DC
to plot The Biggest Bailout Since Time Began over the weekend
of October 11-12, Federal Reserve Bank of New York president
Tim Geithner was also looking at the issue of clearing. He
hosted representatives of the four exchanges, along with
representatives of major dealers, buy side firms, other US
regulators and the European Central Bank for a quiet chat to
discuss industry progress for that read
virtually none on creation of a CCP for CDS.
The CDS market has shrunk this year. The ISDA says the
notional value of CDS increased 81%, to more than $66.2
trillion, during 2007 but dropped to $54.6 trillion at the end
Confirming that the trend is unquestionably down, GlobeOp, a
US-based but London Stock Exchange-listed hedge fund
administrator with $108 billion in client assets, said in
mid-October that clients reduced their total OTC exposure (a
number that includes much more than CDS) by more than 40%, from
$11.6 trillion to $6.6 trillion.
Not only that, it seems that the fog of all those
misunderstood, and ultimately inscrutable, trillions is
resolving into evidence that the worst fears may prove to have
been significantly overblown.
On October 10, CDS on the Lehmans so-called
credit event were unwound in an increasingly
familiar auction process that settled the companys debt,
which had been trading in the secondary market at 10-15 cents,
at 8.625 cents. At the entirely guesstimated, but widely
quoted, $400 billion of notional exposure, that implied the
croupier would be pushing $360 billion of sellers money
over the table to protection buyers.
Not exactly. According to DTCC, its central trade registry,
which it claims has registered the vast majority of CDS
trades at all of the major global CDS dealers, the
notional value of Lehman debt-related trades was $72
Adjusted for already-posted cash or collateral, and
offsetting positions, it estimated the net transfer in the $6
billion range. Even if they only knew the half of it,
thats still a 95% climb-down from the apocalypse.
Its still probably too early to know which exchange
will be the first to market with a workable CCP offering, and
much too early to know which will most quickly attract the
critical mass of business that will make it the winner.
To that venue, however, will probably go the ultimate prize
of providing an open trading venue that will provide what the
CDS market really needs for its own good: the cleansing blast
of a bolt of sunlight.
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