INTERVIEW – LCH.Clearnet wary of clearing some CDSs – chief executive

July 29, 2009

By Karen Brettell and Jonathan Spicer
NEW YORK, July 29 (Reuters) – LCH.Clearnet plans to offer clearing services for credit default swaps based on European indexes, but is wary about clearing contracts written on the debt of single issuers, Chief Executive Roger Liddell said in an interview on Wednesday.

London-based LCH.Clearnet, Europe’s largest independent clearinghouse, plans to offer clearing for credit default swaps based out of a Paris office by the end of the year, Liddell said.

The move is designed to benefit from an international regulatory push to move opaque, privately traded derivatives, including CDSs, to central clearinghouses in order to remove systemic risks posed by the contracts, which led to American International Group <AIG.N> needing a government bailout.

LCH.Clearnet is wary, however, of taking on risks associated with so-called single name credit default swaps, which are used to protect against the risk of a single issuer defaulting on their debt.

“We’ve got a lot of reservations about clearing single names, it’s a complicated product and it’s a very concentrated market,” Liddell said.

Regulators are pushing for the majority of the CDSs to be centrally cleared, though clearinghouses have expressed reticence to take on the risks associated with contracts that have illiquid prices.

Craig Donohue, chief executive at CME Group <CME.O>, told Reuters last month that the CME wants the freedom to reject clearing illiquid CDSs, including some single-name contracts.

Enforcing margin requirements on CDSs can be challenging as the value of the contracts can rapidly change if a borrower is suddenly deemed near default. In some cases defaults can occur before sufficient collateral payments can be made.

“If you’re going to clear those and you have to be able to mark them to market in advance of a clearing member defaulting, then you need a very good source of pricing data and there isn’t one that actually exists,” said Liddell.

In many cases there also may be only three or four dealers making markets in the contracts, “so if one of those dealers disappears you have to really worry about access to liquidity and your ability to dispose of a portfolio,” Liddell added.

LCH.Clearnet also plans to open its interest rate derivatives clearing service, SwapClear, to buyside market participants by year-end. SwapClear, which clears notional volumes of around $170 trillion in interest rate derivatives, presently only accepts trades made between banks.

Client access to central clearing has been a large concern of fund managers since some investors lost collateral backing their derivative trades when Lehman Brothers failed in September.

LCH.Clearnet will offer a model that is similar to
clearing in the futures market, whereby buyside participants can clear trades through members of the clearinghouse, Liddell said.

The company also plans to expand its services to new markets, including foreign exchange cash and derivative markets, Liddell said. The company will start by clearing foreign exchange forwards, before expanding to spot and option contracts, he said.

The company is also continuing talks with a 14-member consortium that includes inter-dealer broker ICAP Plc <IAP.L> over a potential takeover, Liddell said.

The consortium, which also includes Deutsche Bank, Morgan Stanley and UBS AG, in May offered 813 million euros ($1.14 billion) for LCH.Clearnet.

“We are still in talks with the consortium. They’ve gone on a long time now, so you would probably conclude that they’re not that rapid,” Liddell said. “We’re still trying to find an appropriate way, and an executable way, of having our ownership structure better reflect our business concentration.” (Editing by Kenneth Barry)

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