04 Mar 2009, Peter Madigan, Risk magazine
In announcing its approval, the Fed reiterated that Ice Trust "is being organised to reduce the risk associated with the trading and settlement of CDS transactions". As previously confirmed by Ice, CDS clearing will initially be restricted to contracts based on CDX North American indexes, including investment-grade, investment-grade high-volatility sub-indexes and high-yield indexes.
Ice Trust will charge a fee for its CDS clearing services to participants on a per-transaction basis, and the clearing house will utilise both TCC's existing infrastructure for clearing operations and its risk-management services while Ice will provide internal audit functions for the new unit.
In assessing the capital adequacy of the proposed CCP, the Fed mandated that in addition to reserves covering start-up costs, projected operational losses, unanticipated losses and funds to allow for an orderly wind-down of positions if the CCP ceases operations, Ice Trust must also have sufficient "financial resources...to withstand a default in extreme but plausible market conditions by the participant to which it has the largest exposure".
Those resources will include margin collateral posted by users based on both the value and risk of their open positions and participants' contributions to the underlying guaranty fund. If a counterparty defaults, Ice Trust will draw on margin posted by that party, and if insufficient, look to the defaulting participant's guaranty fund contribution to make up any shortfall.
Should both these sources prove incapable of covering losses on defaulted obligations, Ice will be authorised to use other participants' guaranty fund contributions to satisfy any remaining obligations of the defaulting party. If the entire collective CCP guaranty fund fails to meet losses on defaulted obligations, Ice "would have the ability to assess additional guaranty fund contributions on non-defaulting participants", to meet its default commitments, according to the Fed statement.
Counterparties will be obliged to contribute a minimum of $20 million to the guaranty fund, with additional contributions based on the participant's expected level of position exposures.
Margin requirements will be two-fold, comprising both initial collateral pledged at the time of contract novation, as well as supplementary mark-to-market margin requirements to be calculated at the end of each day based on a counterparty's outstanding positions. To ensure liquidity, only cash or G7 government debt will be acceptable as collateral.
Membership of the Ice clearing house will be limited to financial institutions with a net worth in excess of $5 billion and a credit rating of A or higher, alongside a requirement for all participants to "demonstrate that it has systems, management, and risk management expertise with respect to CDS transactions".
Ice also plans to perform regular stress tests on its calculations of credit exposure and margin requirements to determine the sufficiency of the financial resources needed to withstand counterparty defaults under a range of plausible market scenarios.
Fed approval is conditional upon "receipt of required authorisations from certain other agencies" - namely the NYSBB, which has already granted authorisation, and the Securities and Exchange Commission, which has not yet given its blessing to the Ice initiative.
Ice is just one of four platforms vying for a slice of the potentially lucrative central CDS clearing business. Liffe, the derivatives arm of NYSE Euronext and fellow London-based clearing house LCH.Clearnet, partnered to become the first CCP platform to launch on December 22, clearing trades linked to series 8, 9 and 10 of the Markit iTraxx Europe, Hi-Vol and Crossover indexes.
In the US, the Chicago Mercantile Exchange Group is - like Ice Trust - still awaiting the regulatory green light from the SEC before it can get clearing underway, despite being ready to roll out its system and receiving the necessary approvals from both the Federal Reserve Bank of New York and the Commodity Futures Trading Commission by December 23.
The other European contender, Frankfurt-based derivatives exchange Eurex, plans to launch a CDS clearing service for trades linked to series 7, 8, 9, 10 and 11 of the iTraxx Europe, Hi-Vol and Crossover indexes, later on this month.