27 Jul 2009, Alastair Marsh, Risk magazine
The new CDS clearing service, Eurex Credit Clear, will be operational by July 27, with clearing expected to begin on June 30. Nine major dealers have promised the European Commission they will commence central clearing of European CDS trades by the end of July.
The Frankfurt-based exchange received the necessary regulatory approval from the US Securities and Exchange Commission on July 23, and from the UK Financial Services Authority on July 24.
It has 20 market participants currently testing the service and putting in place the necessary systems infrastructure. The nine dealers who signed the EC commitment – Barclays Capital, Citigroup Global Markets, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JP Morgan, Morgan Stanley and UBS – are all testing Eurex’s system.
Initially, Eurex Credit Clear will offer clearing for series 11 of the Markit iTraxx Europe, HiVol and Crossover indexes, with standard terms of three, five, seven and 10 years. It will also cover 17 single-name index constituents from the utility sector. The exchange hopes to expand its clearing capability for single names by the end of August, and to offer a clearing service for Markit’s North American CDX suite of indexes by the end of the year.
The exchange has established a new default fund for clearing CDS trades, separate from its futures and options business. An official at the exchange declined to give the initial size of the fund, but said the minimum contribution for clearing members will be €50 million.
To become a credit clearing member at Eurex, a firm must have a minimum equity capital of €1 billion, thus restricting direct participation to dealers and large buy-side firms. Eurex hopes smaller buy-side firms will be able to use the service through direct clearing members.
Atlanta-based IntercontinentalExchange (Ice) has similar ambitions. It hopes to launch a clearing service by October for US buy-side firms that do not meet its requirements for clearing membership – a credit rating of A or higher and a net worth in excess of $5 billion (€2.52 billion higher than Eurex’s criteria).
The service will use the existing Ice Trust infrastructure and default fund. A buy-side firm will be able to submit a CDS position to the clearing house by using an existing clearing member to act as its derivatives clearing member (DCM). Clearing members will be able to do this in two ways: either bilaterally as principal, or by acting as an intermediary, between its buy-side customer and the customer’s dealer counterparty.
DCMs will be required to collect a minimum amount of customer margin dependant on a firm’s portfolio. A customer’s margin payment will be segregated from its DCM’s margin in a customer omnibus account. If a customer’s clearing firm defaults, its own margin contributions will be protected and will not be used to offset the dealer’s default, Ice said. A customer may move its position to another clearing firm if it wishes.
In the case of a customer default, risk will be mutualised across a DCM’s customer book. In some cases, the DCM may use the defaulting customer’s omnibus margin to unwind the customer’s position.