This month should see the conclusion of the credit derivatives market’s moves to reinvent itself as a more stable and less risky industry by moving to centralized clearing in both the US and Europe. This has seen both markets adopt new CDS contracts: in the US the Standard North American Contract (SNAC) and in Europe the Standard European Contract or SEC (it’s a good job no-one had got to that acronym first). The US contract was introduced and began trading on April 8 this year – a process the market modestly dubbed “big bang” – and in Europe the SEC began trading on June 22, with the introduction of a central counterparty due on July 27 (“little bang”).
The CDS market is racing to put its house in order before any money-making incentive left in the business is regulated away. According to the Depository Trust & Clearing Corp there was at least $27.5 trillion in CDS contracts outstanding at the end of April this year. This is a fraction of the wider OTC derivatives market but the instruments continue to be the focus of regulators’ ire because of public outrage over the collapse of AIG and Lehman Brothers. In addition to streamlining contracts and introducing central clearing, Isda has standardized auctions to settle credit events and appointed five buy-side firms, including Pimco, to its settlement committee in an attempt to answer criticisms that its decision-making processes are dominated by dealer firms. Isda is working hard to paint the product as mainstream.
But it is hard to believe that even if, and it is a big if, central clearing is adopted smoothly in Europe at the end of this month it will appease critics who insist that the only way for the CDS market to be truly transparent is for it to be fully exchange-traded. All signs from the Obama administration are that in addition to bringing CDS under the control of a regulator – probably the SEC – there is sympathy for the exchange-traded argument. SEC chairwoman Mary Schapiro has confirmed that she will look “very closely” at imposing Trace-style transparency and reporting requirements for OTC derivatives. It now looks as if nothing short of full regulated exchange trading will be enough to placate the industry’s many critics on Capitol Hill. The CDS market has worked very hard to make central clearing a reality – in the hope that this would be sufficient to address the counterparty and systemic risk concerns that have been levelled at it.
But it seems that, ironically, a number of exchanges are thinking twice about taking on this business: citing – wait for it – systemic risk.
