Buy-side CDS clearing 'not really happening'

Despite regulatory calls for buy-side clearing of credit derivatives, few client trades are being cleared.

In June 2009, major dealers made a commitment to the Federal Reserve Bank of New York to give dealer clients access to clearing for credit default swaps (CDS) in the US by December last year. The December 15 deadline was met by both the Chicago Mercantile Exchange (CME) Group and Ice Trust, the credit derivatives clearing arm of the Atlanta-based Intercontinental Exchange. Both firms are vying to clear CDSs in the US.

However, work to make central clearing an operational success is still far from complete, suggest market participants. "What was done in December for CDSs was manual and not something that could be operationally sustained on a day-to-day basis," says one source close to the matter.

Dealers say aspects of the services are not properly automated or scalable, and are not part of the day-to-day workflow of clients at the moment.

"Buy-side clearing of trades isn't really happening. You might have a couple of little outliers where they've done a few trades to say they did it, but it's definitely not pumping numbers through like on the dealer-to-dealer side," says one New York-based banker at a large prime broker.

Although dealer clients, particularly hedge funds, put pressure on the New York Fed to make buy-side clearing available, many of are now taking a wait-and-see approach, says Christian Erickson, New York-based global chief operating officer of prime brokerage at UBS. "In December last year, there was a handful of transactions cleared just to test the pipes and for clients to be able to say ‘yes, we can centrally clear over-the-counter derivatives'. The take-up since then has not picked up a lot of steam. I would say for most of our clients, it's primarily been a wait-and-see approach," he says.

What was done in December for CDS was manual and not something that could be operationally sustained on a day-to-day basis

CME Group and Ice Trust insist their services are automated and fully scalable, but admit clearing is at an early stage. CME Group had cleared $47 million in CDS notional across series 12 and 13 of the Markit CDX investment-grade indexes by April 15. The exchange declined to reveal how much of this volume consisted of dealer-to-client trades. On April 9, Ice Trust reported it had cleared $490 million in buy-side CDS notional.

"We had a pilot launch for CDSs, and we met the mandate and successfully cleared business for buy-side clients. That was the pilot launch and we are still working on a public launch," says Sunil Cutinho, Chicago-based director of clearing solutions at CME Group. The company does not yet have a date for the full launch, he adds.

"It's fair to say buy-side clearing is not currently a core part of anybody's day-to-day workflow," admits Peter Barsoom, chief development officer at Ice Trust in New York. Nonetheless, he suggests the reasons for the lack of volume are more straightforward. These include uncertainty over derivatives regulation, which looks likely to compel market participants to clear certain trades, as well as the narrow set of products offered by clearers. At the moment, Ice Trust only offers buy-side clearing for index CDSs, limiting the margin efficiencies that can be obtained by clearing trades. "With the launch of single-name CDSs for buy-side participants, expected in the coming months, we'll have the ability to provide more effective margin benefits across both indexes and single names," he says.

In a letter to the New York Fed on March 1, dealers committed to work with central counterparties to remove the remaining obstacles to buy-side clearing of credit derivatives. While the launch of central clearing represented a "significant milestone", it noted it was "preliminary and requires further substantial work to effectively implement".

Some dealers believe the ability to clear buy-side CDS trades on a day-to-day basis could be six months or a year away. "All of the central counterparties are optimistic about the timelines on which they can develop things like new products and services. And the history of this business is that it takes a lot longer to come to market with something than initially anticipated," says the source.