Monday, July 7, 2008
Liffe Joins Credit-Default Arena
CDS will be regulated. Congress is supporting a centeral clearing house. But many exchanges are trying to get a pie... Liffe, the derivatives arm of NYSE Euronext, announced plans to start clearing credit-default-swap trades later this year, potentially rivaling a similar effort by a Chicago company that has the support of large dealers. Starting in the fourth quarter, Liffe will offer to provide centralized clearing for dealers, money managers and others that trade European credit-default-swap indexes called the Markit iTraxx. Credit-default swaps are private contracts that pay off when bonds or loans default, providing their holders with protection against credit risk. They trade "over the counter," meaning they change hands directly between firms, as opposed to on an exchange. Liffe officials say they aren't trying to change the way CDS contracts are negotiated and traded. The exchange-owned business aims to process completed trades and provide clearing -- or timely, guaranteed payments between the counterparties in the contracts -- through a clearing company called LCH.Clearnet Ltd. Doing so could help insulate individual firms from losses if their trading counterparties run into serious problems and are unable to meet obligations under the trades. In Chicago, Clearing Corp. -- which counts many large dealers as shareholders -- also is trying to create a clearinghouse for CDS trades. That initiative is scheduled to go live in the third quarter and plans to start by clearing CDS-index trades between dealers and extend it to CDS on individual bonds later. "We think there's room for more than one solution in this market," John O'Neill, a senior analyst at Liffe, said in an interview. He added that Liffe's CDS platform can be used by money managers in addition to dealers, many of whom already are using it to clear their futures and options contracts. Officials from Clearing weren't available for comment. The move by Liffe represents the first effort by NYSE Euronext to get into the booming, but sometimes chaotic, credit-derivatives market. The area has represented a conundrum for exchanges. On one hand, investors and regulators have called for more transparency and stability in credit derivatives, something exchanges say they can do. On the other hand, dealers have been reluctant to turn trades on popular CDS indexes over to an exchange-traded futures contract, which could reduce their profits in buying and selling credit derivatives. Many say it is an unnecessary step and that they can improve the market without an exchange. It isn't clear how dealers will respond to Liffe's plans. Analysts say that having a financially stable exchange guaranteeing swaps will benefit the broader market. Brian Yelvington, an analyst at debt research firm CreditSights, says centralized CDS clearing needs to go beyond indexes to be fully effective. CME Group Inc.'s Chicago Mercantile Exchange, Europe's Eurex AG and the Chicago Board Options Exchange all have launched their own versions of exchange-traded credit derivatives, with limited success. Even the market turmoil recently has failed to give the products a kick-start, as many Wall Street credit desks are too busy with their own losses and problems to consider how the exchanges might redesign the contracts to be more useful. "We still believe in the index futures we've launched," said a spokesman for Eurex, which is run by German exchange group Deutsche Börse AG. The exchange continues to explore opportunities in the area, he added. NYSE Euronext had moved tentatively, wanting to portray itself as more dealer-friendly than competitors that launched contracts over the protests of big brokerage firms. In April, NYSE Chief Executive Duncan Niederauer said the company would move into credit derivatives only if it felt it had enough support for the initiative from potential customers.