Liffe blames regulatory uncertainty for lack of CDS clearing

Despite being the only firm to launch a centralised clearing platform for credit default swap (CDS) index trades, London-based derivatives exchange NYSE Liffe has yet to clear any trades, a situation it blames on the uncertain regulatory landscape in Europe.

Liffe launched the service via its BClear facility on December 22, covering series 8,9 and 10 of the Markit iTraxx Europe investment grade, Crossover and Hi-Vol indexes.

But Ade Cordell, the exchange's director of over the counter (OTC) products and services, told Risk that potential users have so far refrained from doing the necessary technology work to hook up to BClear due to concerns that a UK-domiciled central counterparty (CCP) might be undermined by the European Commission's (EC) desire for a eurozone alternative.

"There has been a lack of clarity with regard to the European landscape, and the recommendation that the CCP would have to be in the eurozone hasn't helped," Cordell said. "I have spoken to a number of the large banks and they said: 'Until this is clarified, would you expect us to be part of your solution?' A firm would understandably be cautious in committing resources to signing up to a London-domiciled CCP if policy makers subsequently mandate that they need to sign up to a eurozone CCP".

Nonetheless, Cordell believes a resolution to the eurozone question has been brought closer by the commitment made on February 19 by nine major dealers to use a European Union-domiciled CCP for CDS clearing.

The development has opened the way for talks between the EC and the industry to resume: if the EC decides to permit clearing outside the eurozone, Cordell expects that firms will recommence technology work to sign up to BClear. Meanwhile, if the EC takes the hardline approach of compelling eurozone clearing, Liffe is prepared to work through its relationship with LCH.Clearnet to offer eurozone clearing services in Paris.

Even so, some participants have questioned the wisdom of Liffe's decision to launch its CDS clearing service early, given the continuing uncertainty about the EC's policy. "Sometimes there is a first mover advantage, but in this market, delaying launch for three months while having your ducks lined up and dealers backing you is better," said one US market participant.

Cordell explained the exchange wanted to honour the commitment it had made to the market for a Q4 launch, adding that systems work takes time and he had not expected user firms to be ready on the launch date.

"If we launched today, it could take up to six weeks for firms to connect to us, and you would still get people asking in a few weeks time why there haven't been any trades. With any new product, we make sure our software is ready and out in the market first and then market participants connect to us. It's not the case that we should be ready on day one," asserted Cordell.

The exchange is targeting buy-side firms such as hedge funds and asset managers to use the service. But typically, those firms are reliant on banks for clearing services, meaning their dealers would also need to sign up to the CCP. One investment director of equity derivatives and portfolio trading at a firm using BClear for equity derivatives said that Liffe informed him in January the CDS service had not been rolled out to the exchange's clearing members, and would therefore not be available to his firm.

However, Cordell said that the service has been operational and available upon request since December 22. "Most of the institutions that we are talking to have either already got the software or are busy trying to get it and then testing it", he said, adding that 31 firms have signed up to a revenue-sharing scheme, whereby Liffe will share 40% of its net revenues with these members.

See also: Breath of Liffe
Liffe prepares for CDS clearing launch in US
Portal combat
LCH.Clearnet to expand CDS clearing into eurozone
Banks agree to EU CCP for clearing CDS