SEC forces Ice into single-name CDS clearing U-turn

Clearing house has been told its own rules prevent it from shelving buy-side clearing for single-name CDS contracts

Ice Clear Credit has been forced by the US Securities and Exchange Commission (SEC) to reverse a decision not to offer client clearing for single-name credit default swaps (CDSs). The central counterparty (CCP) announced that decision last month, blaming it on a new margin policy unveiled by the SEC, but the agency is understood to have told Ice that the company's own rules require it to accept the trades for clearing.

"The SEC has interpreted Ice's rules – in particular 309(g) – as requiring it to accept single-name trades for clearing, and said that if it insists on not clearing, then it would have to submit a rule change. So Ice is going to go ahead and clear all client-traded single names submitted starting April 15," says one clearing expert at a global bank.

Another clearing executive at a US bank says: "The SEC is effectively forcing Ice to launch single-name clearing for clients." A spokesperson for Ice in the US declined to comment.

The clearer's risk committee is understood to have agreed the move yesterday, ahead of a board vote scheduled for later in the day. Subject to that approval, Ice will allow buy-side firms to begin clearing single-name CDSs in less than a fortnight, but three futures commission merchants (FCMs) say the SEC's margin rules are so punitive that no client will use the service.

That was behind Ice's original decision. Speaking at the Futures Industry Association's annual conference in Boca Raton, Florida on March 14, Peter Barsoom, Ice's chief operating officer, said clients had rejected the SEC's margin terms.

The SEC is effectively forcing Ice to launch single-name clearing for clients

"Last Friday [March 8], the SEC issued a temporary approval requiring broker-dealer FCMs to charge two times the initial margin requirement of the CCPs. This was unfortunate, so we made a decision, based upon that unexpected development – news of which we received very late in the day on Friday – and based upon input from many clients, that it would be better not to offer single-name clearing under those conditions than to make single names available," Barsoom told attendees.

Dealers say the SEC has told Ice this decision is not consistent with the clearer's own rules, meaning the CCP is effectively being forced to back down.

Rule 309(g) states: "Ice Clear Credit shall accept for clearance all trades that are submitted in accordance with, and meet the requirements established by, these rules and the Ice Clear Credit procedures (including implementation of and compliance with applicable risk filters required by Ice Clear Credit) (each, a "conforming trade") in the time frames specified above; provided that Ice Clear Credit may decline to accept a submitted conforming trade if an eligible officer determines in good faith that, based on the exercise of prudent risk management standards, Ice Clear Credit should not accept the conforming trade."

However, some participants say they have a different interpretation of the rule. "My initial thought would be that 309(g) has another purpose, and that the SEC is stretching the rule almost beyond recognition. My interpretation of the rule is that, if Ice decides to clear a particular product, then it must accept trades in that product submitted by all eligible counterparties, unless doing so would violate prudent risk management standards. That is, 309(g) prevents Ice from picking and choosing the specific trades that it clears. It doesn't oblige it to clear a trade in any old contract somebody brings to it," says Craig Pirrong, a finance professor at the University of Houston.

Ice has long planned to let buy-side firms recognise offsets between cleared index and single-name CDSs, and the SEC approved this in December last year, with the stipulation that the regulator must vet the margin models used by each FCM first. With no models approved as the clock counted down towards the start of mandatory clearing for index CDSs on March 11, buy-side firms that were subject to this mandate faced the prospect of losing margin offsets available in the bilateral world – indexes would be forced into a clearing house, while single names could remain outside, meaning both would be margined separately. Even if the firm opted to clear the single-name trades, an FCM would be prevented from margining the trades on a net basis.

The SEC issued a temporary order on March 8 in an attempt to provide a workaround. FCMs would be able to cross-margin index and single-name CDSs, but only if it applied a multiplier of 150% to the margin required by Ice Clear Credit – for firms with "virtually no credit risk" – and 200% for all other clients. FCMs say the latter standard would apply almost universally, and claim clients have not expressed any interest in using the service as a result.

"The conditions under which FCMs are allowed by the SEC to offer client single-name clearing are very onerous – a two-times multiplier on the CCP margin requirement needs to be charged to clients. As such, we have heard no interest either from clients or other FCMs in clearing single names under these conditions. Hopefully that will encourage the SEC to adopt a more moderate approach," says the second clearing executive.

The first executive concurs. "No-one is expecting any client to submit a single-name trade for clearing under the SEC's current 200% margin requirement," he says.

The SEC declined to comment.