Ice tees up CDS options launch for November 9

Fight for CDS market share heats up as Ice begins clearing options and LCH preps CDX offering

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Ice is set to launch clearing of credit default swap index options contracts on November 9 – a long-awaited move that pitches the central counterparty (CCP) into direct competition with LCH in a key market for hedgers.

From Monday, Ice Clear Credit will clear options on the CDX North American Investment Grade and High Yield indexes. Ice is aiming to add options on iTraxx Europe indexes in 2021.

The launch of CDS options clearing at Ice has been long touted and delayed, with the first quarter of 2018, 2019 and the second quarter of 2020 successively flagged as potential launch dates. The consultation process for Ice’s options clearing solution took five years, according to Stan Ivanov, president of Ice Clear Credit, as dealers wrangled over the valuation methodology of the options when constituents of CDS indexes defaulted.

Counterintuitively, says Ivanov, “in some senses, the Covid-19 situation helped with the approval of the options”, with the wild gyrations in credit markets seen in March focusing minds on “how much systemic risk can be crystallised from uncleared CDS option positions upon extreme market realisations”.

LCH’s CDSClear launched index options clearing in 2017, offering contracts on the iTraxx Main five-year benchmark, and the iTraxx Crossover five-year. The CCP has cleared €58 billion in credit index options in 2020 up to October 31. LCH is aiming to extend the offering to the United States CDX investment grade and high-yield indexes in the coming weeks.

LCH has so far failed to make inroads against Ice in US CDS clearing, but has picked up substantial volumes in European CDSs. LCH held €144.3 billion in open interest for European index CDSs as of November 2.

Members and clients will be able to net their cleared options positions with the rest of their products at Ice Clear Credit using the newly implemented Monte Carlo model, adds Ian Springle, head of corporate development at ICC.

“The dealers are interested in clearing options because they can net all their CDS instruments at the clearing house. But this is a very client-heavy business, and they have put a lot of pressure on the dealers to make these instruments cleared too.”

“There are a lot of end-users out there that use credit index options to complement their single-name CDS strategies or to protect against macroeconomic tail risk in a capital-efficient manner,” adds Ivanov.

Ice has built in a number of different backstop measures in a bid to minimise operational risk issues from affecting CDS exercises. The daily options exercise window will be between 9am and 11am eastern time, but the clearing house will facilitate preliminary exercises of options on the day before exercise from 6pm up until 9am on the day of exercise.

If operational issues do occur, the clearing house can reschedule the exercise window for a later period on the same day. Finally, Ice can automatically exercise in-the-money options at the end of the day, should a rescheduled window not be possible, based on an average of the underlying index during the day and day before exercise.

Ice is hoping for a fast start to steal a march on its rival. “We have about nine dealers that most actively trade options. Probably six will be ready in the first two weeks of options launch,” says Springle. “We expect the full gamut of nine dealers by the end of the year, with their affiliated futures commission merchants following in Q1.”

Ice is understood to be hopeful of offering clearing for different debt tranches and total return swaps sometime in the future.

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