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ICE and CME Group Speak Out About Implications of CCPs for Derivatives Markets

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Following the concerns raised by Craig Donohue, chief executive of CME Group, last month about the dangers of forcing all derivatives to be cleared electronically, CME and rival IntercontinentalExchange (ICE) have this week released a 150 page report on the subject. The report details the legislative and regulatory action that may be needed in order to safeguard participants in a credit derivatives clearing central counterparty (CCP) against potential failures.

The two market players are themselves bidding for a slice of the derivatives clearing market: ICE launched its ICE Trust CCP earlier this year and the CME facility has already been approved for launch in the US market. However, Donohue in particular has been particularly vocal in recent months about the risks posed by the introduction of these facilities into the markets. “We have to be careful to manage the risk profile of what we clear and there will be a range of things that we would not be comfortable clearing,” he warned last month.

Donohue is therefore keen for the market to have some sway in deciding what is centrally cleared, rather than being forced to clear all standardised trades. “We want to be able to make the decision to clear what we feel comfortable with from a risk perspective,” he said.

This subject is dealt with in the report, as well as recommendations for regulatory protection to be introduced for market participants in the event of a bankruptcy. This could achieved through regulatory change, contends CME, by amending US bankruptcy rules to remove “uncertainties” that persist around buy side firms by extending existing rules for commodity contracts to the CDS sector.

ICE suggests that rules should be introduced for the segregation of collateral posted for CDS trades and for regulators to step in and assist in the timely return of customer collateral in the event of a clearing member’s bankruptcy.

The Federal Reserve Bank of New York has thus far indicated its support for the publication of this analysis and said it will look into the concerns raised. “Segregation and portability are key elements in building robust central counterparties. We requested the analysis because market participants were not making enough progress to analyse and address these buy side issues. This is a good first step and, as we move the OTC derivatives market to central clearing, we will work to strengthen the regulatory and legal environment for buy side clearing,” said William Dudley, president of the New York Fed earlier this week.

The Fed added that it expects market participants to continue to work with regulators and other authorities to strengthen the foundations for buy side clearing as they work to honour their commitment to start clearing customer trades by 15 December 2009.

The Asset Management Group (AMG) of the Securities Industry and Financial Markets Association (Sifma) has also pledged its support for the report, albeit in a general rather than detailed sense: “The Asset Management Group of Sifma encouraged this independent review of complex legal and operational issues that affect the segregation and portability of initial margin in CDS transactions. Protecting asset managers’ rights to recover the assets they have pledged in the event of counterparty default is an essential component of the enhanced processing changes that industry members have defined in recent discussions with regulators.”

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