The trading of credit default swaps passed a key milestone on Monday as dealers started placing trades executed with their clients into ICE Trust, a central clearing house for over-the-counter (OTC) derivatives.
A rival clearing service from the CME Group is expected to start clearing the customer trades of dealers this week, possibly beginning as soon as Tuesday.
The clearing of trades between banks and their “buy-side” customers, such as hedge funds and institutional investors, comes after months of planning and a strong push from regulators to mitigate systemic risks – including the risk of failure of a leading dealer – associated with OTC derivatives, where two parties privately agree to a customised contract.
The massive growth of credit derivatives this decade has been blamed for exacerbating the financial crisis.
The lack of transparency in the OTC market has compelled regulators and lawmakers to demand that most derivative deals be centrally traded and cleared. Dave Olsen, head of OTC clearing at JPMorgan, which was the first bank to clear a client trade through ICE said: “We have pushed off from the dock and can now provide clients with the benefits of centralised clearing.”
He added: “This marks the beginning of institutionalising and scaling the capability of central CDS clearing for clients who wish to use it.”
One client involved with JPMorgan yesterday was Blue Crest Capital in London. Farid Amellal, portfolio manager at Blue Crest said it planned on clearing more trades from its multi-strategy credit master fund.
“Clearing removes the counterparty risk associated with trades,” he said.
Centralised clearing will reveal more information about trades but it will also impose margin requirements on traders, increasing their costs.
For now, the size and number of transactions being cleared are not materially large, as dealers and the buy-side become accustomed to using the service. Volumes are expected to pick up in the new year.
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