LCH to clear single-name CDSs for US clients

Paris-based CDSClear is already in discussions to onboard its first US FCM

LCH: in discussions with futures commission merchants

The US Securities and Exchange Commission (SEC) has approved an application by LCH's CDSClear unit for registration as a clearing agency. The authorisation, granted on December 29, 2016, allows LCH to begin clearing single-name credit default swap (CDS) contracts for US clients.

The move is expected to boost competition in a business currently dominated by Ice Clear Credit, which launched client clearing for single-name CDSs in June 2013. CME Group registered with the SEC to clear single-name CDSs in 2012, only to deregister at the end of 2015 after deciding to concentrate on clearing index trades.

LCH is in discussions with futures commission merchants (FCMs), which provide client access to central counterparties (CCPs). Those arrangements could take some time to conclude, however. "Despite being registered as a DCO [derivatives clearing organisation] with the CFTC, it was not optimal for US FCMs to onboard CDSClear while we were waiting for our SEC clearing agency licence," says Frank Soussan, Paris-based global head of CDSClear.

Those negotiations have started with at least one large FCM, and now that CDSClear's SEC registration has been approved, Soussan says clearing services for US clients will be made available "as soon as possible in 2017".

LCH's push to clear single-name CDS for US clients could also be slowed by the impending phase-in of the European Union's clearing obligations, which take effect for dealers on February 9. So-called Category 2 firms, consisting of financial counterparties with non-cleared derivatives notionals of more than €8 billion ($8.5 billion), will follow suit on August 9.

If a client trades a CDS on Deutsche Bank, for example, we are the only CCP that can clear this trade
Frank Soussan, CDSClear

"We are in the middle of onboarding European clients. At the same time, we are developing a commercial approach for US clients who have expressed interest in CDSClear – particularly in light of our very wide and broad product coverage," says Soussan.

To further complicate matters, on January 2, Euronext made a €510 million offer to purchase LCH.Clearnet SA – the Paris-based clearing unit that houses CDSClear – from London Stock Exchange Group, which is seeking to sell its French clearing operations to address regulatory concerns around its own acquisition by Deutsche Boerse.

Once CDSClear is up and running in the US, LCH claims it will allow clients to clear a wider range of single names than rival Ice Clear Credit, which currently clears 431 corporate single names. The universe of clearing eligible contracts at Ice includes all constituents of the on-the-run CDX North America Investment Grade index – the CDX.NA.IG.27 – but covers only 44% of the names in the iTraxx Europe Crossover index, and 68% of the constituents of the iTraxx Europe Senior Financials index.

By comparison, contracts referencing roughly 480 individual reference entities are eligible for clearing at CDSClear, including all constituents of the iTraxx Europe indexes – Main, HiVol, Crossover and Senior Financials – as well as 124 of the 125 names in the CDX.NA.IG.27.

Soussan says LCH's ability to clear CDSs referencing banks sets it apart from the competition. "That's quite a unique feature," he says. "If a client trades a CDS on Deutsche Bank, for example, we are the only CCP that can clear this trade."

LCH's ability to clear a wider range of index constituents could also result in lower margin requirements for clients that trade skew packages, which seek to arbitrage mispricings across an index and the underlying single names.

After a slow start, client clearing of single-name CDSs began to take off in the US last year. Ice cleared $190 billion of single-name CDSs for buy-side clients in 2016, compared with $33 billion the previous year. However, that still accounts for only a tiny fraction of the overall market for single-name CDSs – derivatives users traded more than $3 trillion of these contracts in the first half of 2016, according to the Bank for International Settlements.

Demand for Ice's services has been hampered by the SEC's failure to mandate clearing of single-name CDS contracts. However, 25 large asset managers committed to begin voluntarily clearing their single-name CDS trades in late 2015 – a development that helped boost clearing volumes at Ice in 2016.

Risk.net will publish an in-depth article on single-name CDS clearing in the US later this month.