Buy side fuels boom in single-name CDS clearing

Ice single-name CDS volumes double year on year following switch to semi-annual rolls

buy side cds clearing
Upward trajectory: buy-side interest has fuelled the recent moves

Buy-side clearing of single-name credit default swaps (CDSs) is booming. Quarterly notional buy-side CDSs cleared by Ice Clear Credit have more than doubled, from $46.3 billion in the third quarter of 2016 to $108.4 billion in the first quarter of 2017.

Three banks say they have seen huge growth in clearing of the instruments among US clients.

“Last year, our client-facing single-name CDSs cleared versus our total percentage traded was just north of 40%. Year-to-date, we are at over 70%,” says a New York-based credit strategist at a large US dealer.

A second US bank reports its single-name CDS cleared volumes are up 52% year-on-year. The instruments now comprise 17% of this dealer’s total cleared credit derivatives portfolio year to date, up from 10% in 2016.

The credit strategist at the first dealer cites the recent March 20 roll date as the spur for a sudden surge in the first-quarter volumes.

“A lot of it was driven by the roll, and we saw a handful of meaningful clients who rolled into cleared,” she says.

Since December 2015, the roll to new on-the-run CDS contracts has taken place semi-annually, on March 20 and September 20, instead of quarterly, as was the previous practice. The change was introduced by the International Swaps and Derivatives Association to bring the roll frequency for single-name contracts into line with indexes, in a bid to improve market liquidity.

The New York-based head of credit trading at an international bank says: “Our internal figures confirm a large majority of new trades since the roll have been cleared. A few hedge fund clients have also mentioned the margin netting between single-name CDSs and indexes as a strong argument for clearing.” 

The shift to clearing across the buy side is also driving banks to offer so-called ‘differentiated pricing’. This is where the cost of a single-name CDS trade is altered depending on whether or not the client elects to clear at Ice. Credit Suisse is one bank that has implemented this practice.

Ice Clear Credit controls the lion’s share of buy-side single-name CDS clearing, though rival LCH’s Paris-based CDSClear onboarded its first buy-side clearing member, the French asset manager Amundi, in late March. The latter also stole a march on Ice by becoming the first CCP to clear single-name financial CDSs in June 2015.

As reported by Risk.net, Ice Clear Credit will also start clearing single-name CDS referencing bank entities as of April 10.

The buy-side surge is the latest chapter in the long and complicated history of CDS clearing, which has been stymied by an array of technical and regulatory obstacles. The US market is still waiting on the Securities and Exchange Commission (SEC) to produce capital, margin and segregation rules for security-based swaps – including CDSs – as well as regulation governing the mandatory clearing of the instruments.

Voluntary clearing

Frustrated by the hold-up, 25 investment firms announced they would voluntarily clear the instruments in late 2015. However, a number are yet to make good on this commitment, citing regulatory complexity and economic pressures among their reasons.

There are also questions about cross-margining. Firms that voluntarily clear single-name CDSs can only do so on the basis of an exemptive order issued by the SEC in December 2012, which allows clearing of single names alongside indexes. The Commodity Futures Trading Commission made clearing of CDS indexes mandatory in November 2012.

Though the order is narrow in scope, intended only to grant relief to buy-side firms that hedge CDS index positions with single names, the New York-based credit strategist says it has been used more broadly by firms, and that regulators haven’t communicated to buy-side firms nor futures commission merchants that the relief is limited.

“Mixed portfolios were explicitly approved by the SEC, and under that guidance there was no prohibition on clearing single-name CDSs unrelated to index trades,” she adds.

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