November target for CDS central counterparty

Dealers have pledged to the Federal Reserve Bank of New York to begin using a central counterparty for clearing credit derivatives by the end of November.

In an October 31 letter to the New York Fed, the Operations Management Group (OMG) - a collective of 16 major dealers and several buy-side industry associations - committed to centrally clear index credit derivatives trades by November 30 and single name credit default swaps (CDSs) within the first quarter of 2009.

This is the OMG’s latest set of targets to improve over-the-counter (OTC) derivatives processing to reduce operational risk - goals have been reviewed every few months since September 2005, with the most recent previous commitments outlined in letter dated July 31.

“Although efforts by the New York Fed and other US and European regulators over the past three years have led market participants to significantly improve many operational elements of the OTC derivatives infrastructure, financial market events have demonstrated that broader action is warranted to address additional market design elements,” the New York Fed said in a statement on October 31.

Four competing groups have confirmed plans to establish a central clearing house for credit derivatives: Atlanta-based Intercontinental Exchange (Ice) and Chicago-based The Clearing Corp (which Ice is set to acquire), Frankfurt-based exchange Eurex; Chicago-based exchange operator CME Group and hedge fund Citadel, and NYSE Euronext.

In line with the industry’s progress developing the credit derivatives central counterparty, the OMG has stated it will increasingly use and develop central clearing and settlement systems for OTC equity, interest rate, foreign exchange and commodity derivatives. However, the deadline for implementing these are not as soon as for credit. For example, with equity derivatives there is a target of evaluating potential service provider systems by the end of 2009.

Other credit derivatives targets include continuing to compress portfolios of CDS through multilateral trade terminations (tear-ups). So far this process has resulted in an elimination of $24 trillion in notional CDS exposures, reducing the notional amount outstanding by a third.

The OMG will also start compression cycles for interest rate derivatives, the largest OTC derivatives asset class, in early 2009.

“Reducing notionals helps both front and back offices. Cancelling out economically offsetting transactions reduces the cost and operational workload of managing those transactions," said Robert Pickel, New York-based chief executive officer of the International Swaps and Derivatives Association.

The OMG and the New York Fed have raised derivatives electronic processing targets. Market participants aim to submit 85% of eligible CDS trades (including novations) on trade date by June 30, 2009, up from the previous target of submitting 92% on T+1.

The OMG plans to increase the portion of equity derivatives eligible for electronic matching to 60% from the current 40% by the end of 2009, and to raise the trade matching target to 85% by the end of September 2009 for all counterparties. This number is reflective of the relatively higher proportion of structured products, currently estimated at 25% of total volume, which will not be candidates for electronic processing.

Regulators will get tougher with firms that do not switch to electronic platforms to process CDS novations from the current system of emails. From the start of 2009, the names of buy-side firms continuing to request novations by email will be given to each dealer’s primary regulator. And from March 2009, major dealers will only accept novations submitted on electronic platforms. In addition to these new targets, steps are being taken in conjunction with the New York Fed to increase transparency for OTC derivatives.

In a response to regulatory demands for more publicly available information about these instruments, the Depository Trust & Clearing Corporation (DTCC), a New York-based company that processes credit derivatives trades, will publish aggregate market data from the central repository it maintains on credit derivatives.

Starting Tuesday, November 4 and continuing weekly, DTCC will release a set of aggregate stock and weekly trade data, including the levels of both gross and net notional CDS traded on the 1,000 largest CDS reference entities. The New York Fed said regulators will continue to work with market participants and service providers to make more market data publicly available.

See also: Ice picks off ClearCorp
Fed’s OTC processing targets expanded to interest rates and commodities
A creditable target?