Best innovation by a clearing house, Americas
ICE Trust
Best innovation by a clearing house, Europe, Middle East and Africa
ICE Clear Europe
Most innovative work by a law firm in the field of exchange-traded or centrally cleared derivatives
Shearman & Sterling’s work on setting up ICE Clear Europe and ICE Trust
IntercontinentalExchange’s scooping of both FOW’s clearing house awards (the Asia Pacific award was not given) will come as little surprise to derivatives professionals.
The most dramatic change during 2008-9 in the field of cleared derivatives was the shifting of a large over-the-counter market, credit default swaps, at least partly into the cleared world.
Regulatory goading played a big part, but the industry had to do the heavy pushing and pulling.
This transformation was played out in a competitive way, as several exchanges vied for a share of the CDS clearing action. Some well informed commentators backed ICE from the start, knowing that it had the support of leading investment banks, the most powerful players in the CDS market.
But few could have predicted quite how convincing ICE’s victory would be. On October 5 2009, it announced that its US and European CDS clearing houses had cleared a total of $3tr of CDS, since their respective openings in March and July.
Of its leading rivals, NYSE Euronext Liffe had retired from the field without clearing a single trade; CME was still trying but had also not cleared a trade; and Eurex had cleared a minute trickle of transactions.
Central to this achievement was the complex, innovative work of designing and building two new clearing houses. And key to the success of both projects was the work of ICE’s legal adviser, Shearman & Sterling.
After 129 years, a new clearing house
The genesis of ICE Clear Europe goes back further than the financial crisis, to when the market landscape looked very different.
As the first exchange to begin clearing OTC derivatives in 2002, ICE has always prided itself on being at the cutting edge in this area. In April 2007 it announced a new global clearing strategy, including plans for a new European central clearing house, based in London. Instead of using LCH.Clearnet, ICE Futures Europe’s clearing would come in-house.
The tech-heavy effort involved creating entirely new platforms for a dozen services, such as electronic banking, billing, reporting, risk management and physical delivery.
Then, Shearman & Sterling helped make a highly detailed application to the Financial Services Authority for regulatory recognition. In the nine month period, some 200 requirements had to be met, such as producing new rules and contracts with members and exchanges.
That was not all. Clearing members’ contracts with LCH.Clearnet had to be transferred, and then their positions and collateral. The transition arrangements were entirely new and had to be agreed by all the members.
Even the near-meltdown of the banking industry didn’t set the project back for long. ICE made the initial transfer of billions of dollars of collateral on September 13 – two days before Lehman Brothers collapsed.
When the rumours circulating about the scale of the bank’s losses became too loud to ignore, ICE swiftly rolled back the transfer the following day, without any disruption to services.
The eventual November transfer of 28.5m customer positions and $16.5bn of collateral to the new central counterparty marked the culmination of a two year effort, and the creation of London’s first new derivatives clearing house since 1880.
ICE Clear Europe was then in pole position for the race to clear CDS in Europe.
Uncharted territory
ICE and Shearman & Sterling’s achievement in the US was just as impressive, if not more so, because it was done exceptionally quickly, under the pressure of a fast-changing regulatory environment.
ICE entered the credit derivatives market only in August 2008, when it bought Creditex, the CDS trading platform.
Then in October 2008 it acquired The Clearing Corporation (TCC), which had already been working with leading CDS dealers for nearly two years on developing a clearing house.
TCC’s owners included these dealers, and that gave ICE a critical advantage. Why would the likes of Goldman Sachs and JP Morgan clear trades through CME Group when they could use what was basically their own clearing house, thanks to the TCC acquisition, which gives them 50% of its profits from 2010?
Over the next five months, ICE worked with TCC’s team to expedite its work. This involved continual communication with the New York State Banking Department, the Securities and Exchange Commission, and the UK FSA, all of which were themselves working out what they wanted from a CDS clearing house.
What they got was something completely new. ICE Trust uses a risk model developed specifically for CDS. The portfolio margining approach is based on advanced statistical techniques that model the dynamics of the asymmetric distribution of credit spreads and capture co-movements among CDS products.
As one judge put it: “Their work seems like a large step forward toward transparency in the CDS market. Additionally, the risk management framework may go a long way in helping to offset systemic risk possibilities.”