CME Group begins clearing credit derivatives

By Reuters Staff
December 15, 2009

By Jonathan Spicer

NEW YORK, Dec 15 (Reuters) – CME Group Inc began clearing U.S.-based credit derivatives on Tuesday, aiming to capitalize on a government push to safeguard a private market blamed for exacerbating the financial crisis.

The launch of CME’s clearinghouse for credit default swaps (CDS) coincides with the date large dealers promised to offer clearing to their clients. It comes more than a year after the venture was announced, and more than nine months after rival IntercontinentalExchange Inc began clearing CDS.

CME, the world’s largest derivatives exchange operator, has from the beginning promoted its clearinghouse as one friendly to buyside firms, six of which are founding members. Citadel Investment Group was CME’s original partner.

“We really had nice, broad participation from founding partners, and from the other clearing members,” Laurent Paulhac, managing director of CME’s over the counter products and services, said of activity on the first day.

The company did not reveal trading volume. A spokesman said open interest will be published on Wednesday.

Central clearing, in which a clearinghouse stands between the two parties to a trade and assumes the risk of a default, is seen by U.S. and European regulators and legislators as key to reducing risks of derivatives due to the maze of exposures the contracts create between firms.

CDS are used to protect against a borrower defaulting on debt, or to speculate on its credit quality.

The global CDS market is worth about $26 trillion and has been under scrutiny as governments push the wider $450 trillion derivatives market through central clearinghouses.

American International Group Inc needed a government bailout last year after the giant insurer sold hundreds of billions of dollars of protection on risky assets using credit default swaps and did not have adequate capital to back up its commitments.

This month, CME added eight dealers to its group of founding buyside members. Barclays Capital, one of those dealer members, said it cleared the first trade through the CME on Tuesday, a contract based on a benchmark CDS index.

“There’s definitely been an uptick of interest by buyside firms in the past two months as dealers get more active about marketing services and because of the general buzz in the CDS marketplace about the launch,” said Paul Hamill, a director in Credit Trading at Barclays Capital.

CME is expected to have support from fund managers who will be able to easily use margin for both CDS contracts and futures positions. But it is unclear how successful the CDS venture will be.

Chicago-based CME, which launched the venture after a long delay in a slow trading season, is taking on ICE, which has a revenue-sharing agreement with dealers and has cleared more than $4.3 trillion in notional value of CDS so far this year.

On Monday, Atlanta-based ICE began clearing U.S.-based CDS for buy-side traders, as well as European-based single-name CDS. ICE logged $13 million in CDS clearing fees last quarter.

Patrick O’Shaughnessy, analyst at Raymond James and Associates, wrote earlier this month that it was likely most CDS trades would continue to be cleared through ICE, and that the “financial impact on CME Group’s earnings will likely be minimal,” noting CME is much larger than ICE.

CME shares were down 0.5 percent to $331.37 in afternoon trade on the Nasdaq Stock Market. ICE was off 2.1 percent at $107.43 on the New York Stock Exchange. (Reporting by Jonathan Spicer; editing by John Wallace, Gary Hill)

((jonathan.spicer@thomsonreuters.com; +1-646-223-6253; Reuters Messaging: jonathan.spicer.reuters.com@reuters.net))

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