CME Shares Spike On Derivatives Plan

[scandal 951]

This is perhaps the best sign yet that we may be getting out of the worst-of-the-worst of the financial meltdown: Geithner & co. are actually able to look up from TARP & TALF & stimulus plans & auto bailouts & AIG bailouts for just long enough to actually focus on what's needed for the long term structural fixes needed to get derivatives trading under control.

It was well recognized even in the waning months of the Bush administration that the free for all of the OTC markets would have to be brought to heel by requiring central clearing on the exchanges. It's just that when the house is on fire nobody has any time to think of how to firm up the foundations. That mood persisted through the first 100 days of Obama's term with all the attention being on the TALF and stimulus plans. The fact that we are now seeing serious efforts underway on regulatory reform is a very good sign - not just for the health of the derivatives markets, but as a signal that Congress, Treasury and the SEC feel they can turn their eye away from just keeping the markets solvent long enough to fix the mess structurally.

The article mentions CME, ICE and NYSE/Euronext as the likeliest winners. Eurex is probably a player here too. It wouldn't surprise me to see cross-listed issuings on ICE and the Merc with a natural arbitrage market between them. Here in Chicago the inside bet is on the CME as having the most in-depth experience over decades of managing centralized clearing on any conceivable contract. It's not bad being in Chicago these days - The Merc is bubbling, the Black Hawks are gunning for the Stanley Cup, and the Cubs are only 1/2 game out.

http://www.thestreet.com/story/10501162/1/...tives-plan.html

CME Shares Spike On Derivatives Plan

05/14/09 - 11:53 AM EDT

CME(CME Quote) might well become the trading platform of choice for the complex derivatives the U.S. now wants to regulate. That's what investors were betting on Thursday, at least, sending shares of the big Chicago exchange operator up as much as 5%.

On Wednesday, the Obama administration released details of its plan to keep a tighter watch over the market for so-called over-the-counter derivatives -- those complex instruments that contributed to the near collapse of the financial system last year.

In a letter to Congressional members, Secretary Treasury Timothy Geithner sketched out the administration's plan, which calls for the use of a central electronic exchange where the instruments -- among them the notorious credit default swap -- can be cleared and traded. Since CME is arguably the world's leading exchange for more common derivatives such as futures and options, it would appear to be in a position to benefit from any fresh legislation.

CME's shares were trading Thursday at $288.49, up 5%, on heavy volume. JPMorgan analysts upgraded the stock to neutral from underweight with a price target of $274. CME rival Intercontinental Exchange(ICE Quote) saw its shares jump 6% to $102.34, while NYSE Euronext(NYX Quote) stock was up 2%. All three exchanges have already initiated credit default swap clearinghouses, though these mechanisms stop short of the kind of standardization and risk-management procedures that the administration's plan calls for.

The administration's plan also calls for increased capital requirements at the firms that issue and sell derivatives.

As it stands now, derivatives are traded privately in a market that is not only unregulated but also controlled by the handful of behemoth Wall Street firms that issue and sell the instruments. That being the case, those firms -- including all the usual suspects: Goldman Sachs(GS Quote), Morgan Stanley(MS Quote), JP Morgan(JPM Quote), Bank of America(BAC Quote) and Citigroup(C Quote) -- are expected to deploy a squadron of lobbyists in Washington to attempt to stave off the legislation.

Most infamously, AIG's financial products unit underwrote hundreds of billions of dollars in credit-default swaps, or CDOs, which caused a black hole to open in the financial system after the subprime mortgage collapse.

"As the AIG situation has made clear, massive risks in derivatives markets have gone undetected by both regulators and market participants," Geithner said in a press release. "But even if those risks had been better known, regulators lacked the proper authorities to mount an effective policy response."

[Hilarious Clinton 452]

I'll bump it.

[scandal 951]

Update........ I realize that very few on VJ know or care about the efforts to bring over the counter (OTC) trading of derivatives into the clearing rooms and exchanges. However I believe that this is absolutely fundamental to correcting much of the problems that led to the subprime bust.

For all the small-government types out there, note that this is a market solution, not a government imposed one. In the best traditions of capitalism we have not one but two exchanges vying to be first and best -- ICE and CME. This is important news and deserves attention, imho.

http://www.chicagotribune.com/business/chi...,4796025.column

Give ICE credit in swaps-clearinghouse race with CME

David Greising

June 12, 2009

From this austere room in a gleaming Midtown Manhattan office building, a group of four women on Friday will conduct an auction to set prices for General Motors Corp. bonds that went into default as GM plunged into bankruptcy.

Once the prices are set, billions of dollars worth of credit-default swaps tied to those GM bonds can be closed out by the buyers and sellers who, at this point, must surely regret they ever heard of such a thing.The GM auction is the largest since Lehman Brothers Holdings Inc. collapsed last fall. And it is happening in the offices of Creditex, a firm that specializes in processing trades in credit derivatives.

The words "credit-default swaps" still may send shivers up the spines of anyone who remembers the role that these arcane instruments, a form of insurance for investors in corporate debt, played in the economic meltdown.

The panic of 2008 has led to the mop-up of 2009. In places such as Creditex's auction room, the race is on to provide a solution to structural problems that surfaced last fall when the financial markets broke down.

The Creditex auction room is one redoubt of the effort by IntercontinentalExchange Inc., or ICE, to beat out Chicago-based CME Group Inc. in the effort to make the global financial system safe from the disasters that can arise when the market for credit-default swaps breaks down. We saw last fall how a handful of seemingly sophisticated firms can bring the financial markets to its knees when a failure by one major firm cascades to another, then another, then another.

Clearinghouses are designed to eliminate the cascading effect because they stand between buyer and seller. They assess the credit profile of both parties and charge each based on the risk they represent to the overall marketplace. They rely on member firms -- big banks and trading houses, mainly -- to provide the capital needed to prevent systemwide damage from any individual failure in the market.

Systemwide damage is a clear threat. The Lehman collapse proved that. And Treasury Secretary Timothy Geithner has called for more effective regulation and the establishment of clearinghouses and other mechanisms that can give regulators and market players better views into systemic risk.

CME Group, working with Chicago-based hedge-fund firm Citadel Investment Group, is building a clearinghouse aimed at credit-default-swap trading. The CME effort is quickly approaching a launch date.

But the ICE effort already is off the ground. ICE Trust, the exchange's clearinghouse for credit-default-swap contracts, since early March has cleared more than $600 billion of contracts for an index of credit-default swaps. ICE plans to roll out trading in individual credit-default-swap contracts soon. At present, there are $2 billion in open positions on the ICE market at any given time, a fair indicator of the market's viability.

Sunil Hirani, a graduate of Northwestern University's Kellogg School of Management who created Creditex and sold it to ICE two weeks before Lehman collapsed, said ICE is scrambling to establish leadership in the clearing of over-the-counter derivatives before any competition develops.

"When people say we aren't moving fast enough, we say we're moving faster than anybody else in the world has moved," Hirani said.

There are legitimate questions about ICE Trust. For starters, only big financial firms with $5 billion in capital can directly participate. Critics say this rule is in deference to the major investment houses that own controlling stakes in ICE.

And Craig Donohue, CME Group's chief executive, notes that ICE's head start means little. ICE Trust is clearing only a small percentage of the total trade.

"This is very early stages," Donohue told analysts earlier this year.

Still, there's an important if ungrammatical adage in financial markets: "The firstest with the mostest always wins."

ICE is first into the market with a way to clear credit-default contracts. It's too soon to say if its offering will be the most robust. But little things. even the stuffy little auction room, can lend a market presence and level of sophistication that could give ICE the edge. After all, some 400 major market players are expected to participate in the GM auction.

CME and Citadel have talked for some time about how their OTC clearinghouse will be a market beater. They'd better get to market soon, or else they'll get beat.

---------

dgreising@tribune.com

[scandal 951]

Another good read on this topic. I'm just gonna keep posting such articles in this thread as I run across them, to build up a running collection.

For any VJers who are interested in markets and trading and the big crash of 08 (I'm thinking perhaps mawilson, Matt, others of course welcome), would be happy to discuss the significance of all things CDS: central clearing, regulation, trading, the ICE vs. CME battle..... this isn't making the mainstream press but I believe it's amongst the most important fallouts of the entire subprime crisis and resulting liquidity crisis.

http://www.secuobs.com/revue/news/107495.shtml

CDS regulation battle looming

Par News

Le [2009-06-09] à 17:10:37

Présentation : To hear some people talk about them, credit default swaps are financial weapons of mass destruction. Others tend to see them as modern financial tools that can facilitate better risk management. No matter what your view, two things are clear: Derivatives such as these are here to stay and reform regulation is on the way. A huge battle now looms: In one corner, federal regulators who would like to create a market that would rival the stock markets in terms of transparency and regulate-ability. Wall Street on the other hand has profited enormously from trading CDSs and they are not about to give up their massive spreads and commissions without a fight. So in some ways, the situation reflects the stock markets before new order handling rules, decimalization and other changes made it much harder for traders to make money (the situation has reversed itself somewhat lately). In some sense, it also reflects the bond market before the end of fixed commissions. All of which is to say: We stand at the edge of a new era that threatens the profit of big Wall Street broker dealers. None of this is new. It's clear to all that Wall Street is digging in. In this environment, for PR purposes, it can't very well oppose reform attempts. But it can work to shape them to its liking. Wall Street's biggest broker dealers have thrown their weight behind a clearinghouse initiative spearheaded by the Intercontinental Exchange (ICE). They have all taken equity stakes and are supporting the clearinghouse with their volume. Since March, it has cleared $710 billion in CDSs. To the chagrin of competitors like the CME Group, who do not enjoy the backing of the dealers; it has yet to clear a single trade. So the dealers--who have banded together to form the CDS Dealers Consortium--enjoy the advantage of an existing solution. For the exchange movement to prevail, it will require some stand-up leadership. While the Treasury Department has not embraced an all-out move to an exchange, several bills have been proposed that would do just that. They have the benefit of recent memory. After all, these are the tools that caused the financial meltdown in the first place. Given their importance, shouldn't they be as tightly regulated and the market as closely monitored as stocks? Here's one area where they might make hay: Insider trading. The SEC charged recently a Deutsche Bank bond salesman with giving inside information about a bond issue to a portfolio manager who bought CDSs and realized an immediate profit of $1.2 million based on the information. That was the first-ever case of insider trading that involved the CDS market. Regulators have invested heavily in creating systems to prevent insider stock trading, but we've got nothing when it comes to CDSs. Would an exchange offer any more protection? In a different vein, Larry Tabb, of the Tabb Group, notes that one critical tool might be capital requirements. While the debate now centers on moving CDS trading to an actual exchange or instead requiring central clearing (a movement well underway), Tabb suggests that capital requirements could be deployed as a way to reduce risk across the market. "Regulators only need to implement a sliding capital scale depending on the product, clearing method or trading mechanics to change the way that products are developed, underwritten, traded and positioned. Naturally exchange-traded products would have the lowest capital requirements, centrally cleared products a bit higher and OTC self-cleared products would maintain the highest tariff," says Tabb. The nascent central-clearing movement, if I recall correctly, does require all parties facing the clearinghouse, which is to say all trading parties, are required to essentially post a bond. The idea is certainly not far fetched. We'll see how this plays out. - Jim

[mawilson 2,133]

Another good read on this topic. I'm just gonna keep posting such articles in this thread as I run across them, to build up a running collection.

For any VJers who are interested in markets and trading and the big crash of 08 (I'm thinking perhaps mawilson, Matt, others of course welcome), would be happy to discuss the significance of all things CDS: central clearing, regulation, trading, the ICE vs. CME battle..... this isn't making the mainstream press but I believe it's amongst the most important fallouts of the entire subprime crisis and resulting liquidity crisis.

To be honest, I don't care much about CDS - I mostly trade index and commodity futures - but I'm curious

to see how this "regulation battle" plays out.

[Peikko 1,575]

From what I heard, the problem is that any attempt to regulate will reduce to practically zero the performance of derivatives. Now, that could be propaganda from those selling them...I don't know. The theory is though, that they need to be ultimately tailorable. Anything 'off the shelf' (and therefore able to be regulated) is unsatisfactory.

[scandal 951]

From what I heard, the problem is that any attempt to regulate will reduce to practically zero the performance of derivatives. Now, that could be propaganda from those selling them...I don't know. The theory is though, that they need to be ultimately tailorable. Anything 'off the shelf' (and therefore able to be regulated) is unsatisfactory.

I'm sure Goldman, UBS and the rest of the investment banks would love for you to believe this. They're content with forming their own clearing house and let the regulators keep their mitts off the little gold mine of CDS trades. But given the explosion at AIG I don't think there's any possible way this can end without regulation.

And besides - this is not just about regulation. It's about centralized clearing and reducing counterparty risk and having sufficient capital reserves. Even the banks recognize they need those kinds of protections hence their backing of ICE.

To your point of "will reduce to zero the performance of derivatives" ...I don't see why a standardized CDS market should "reduce to zero the performance of derivatives".

Look at the options and futures markets. Before 1971 all options were traded OTC and "ultimately tailorable". Skeptics scoffed then at standardized options. Since the introduction of exchange traded options with standard contract sizes, strikes and expirations has been insanely successful for the buy side, sell side and exchanges. Volumes and open interest have skyrocketed and American capitalism benefited. I see no reason why the CDS market can't do the same thing.

Counterparty risk with CDS is huge ... when Lehman blew up that became evident. AIG instantly became largely insolvent due to holding piles of Lehman CDS. The trouble with unregulated CDS is you can doubly, triply, 4X, 5X, infinitely "insure" the same underlying default risk. So Lehman goes bankrupt once, but the multiplier effect is like a Tsunami with everybody short Lehman CDS has to pay up on the same bet. This was not a good thing, to put it mildly.

I think CDS were a very useful financial innovation. They really do help distribute risks to those best able to carry them. We should not throw out the baby with the bath water. There needs to be a way to keep the benefits of CDS while preventing the excesses that came incredibly close to tanking the entire system.

[Peikko 1,575]

You could be right. I did say I don't know, it was from my usual source though

I am not sure if I agree that the CDS's are useful, ultimately. Of course, again, this is probably down to my extremely limited knowledge of such things - but when it was explained with goats and airplanes, it just seemed like this was money for old rope

[scandal 951]

http://www.reuters.com/article/idUSN0310556220091203

CME to launch CDS clearing house, signs 8 big banks

Thu Dec 3, 2009 3:24pm EST

NEW YORK/CHICAGO, Dec 3 (Reuters) - CME Group Inc (CME.O), the world's largest derivatives exchange, said on Thursday it plans to launch a clearing house for the $26 trillion credit default swap market by Dec. 15 and has signed eight of the largest credit derivative dealers to the service.

Barclays Capital (BARC.L), Citigroup (C.N), Credit Suisse (CSGN.VX), Deutsche Bank (DBKGn.DE), Goldman Sachs (GS.N), JPMorgan Chase & Co (JPM.N), Morgan Stanley (MS.N) and UBS AG (UBSN.VX) are joining the CME platform as founding members, the CME said.

The launch comes as lawmakers globally move to bring the $450 trillion derivative markets under the purview of regulators and make central clearing more widespread as a means of reducing risks posed by the default of a major swaps dealer and the web of exposure the contracts create among large financial companies.

Insurer American International Group Inc (AIG.N) needed a government bailout in September of last year after it sold hundreds of billions of dollars of protection on risky assets using credit default swaps and did not have adequate capital to back up its commitments.

Credit default swaps are used to protect against a borrower defaulting on their debt or to speculate on their credit quality.

Dealer preferences to clear trades through ICE Trust, part of the IntercontinentalExchange (ICE.N), had created doubts that the CME would gain enough support to launch its platform.

ICE is the only clearinghouse in the United States to have cleared CDS trades.

The CME is, however, expected to benefit from strong support by fund managers, many of whom may be lured by the ability to cross margin CDSs contracts against their futures positions.

"The buy side seem to like the CME model more than ICE," said Kevin McPartland, senior analyst at TABB Group in New York. "There is a lot of buy-side volume that hasn't touched a clearinghouse yet, so everybody is essentially starting from zero."

ICE, which has a revenue sharing agreement with large dealers, has cleared about $4 trillion in notional CDS contract value since March when it launched its U.S. clearinghouse. The company started clearing European CDS in July.

The CME's decision to bring in buyside clients "was a Hail Mary pass to see if you could bring pressure on the brokers to break ranks and work with them. It appears to have worked," said Brad Hintz, an analyst at Sanford C. Bernstein and a former Wall Street executive.

"CME as a general rule is viewed by the Street as a competitor. ICE is viewed by the Street as a technology ally," he said.

CME shares rose 1.75 percent to $334.

The dealers join CME's buy-side founding members, AllianceBernstein, BlackRock Inc (BLK.N), BlueMountain Capital Management, the D.E. Shaw Group, Pacific Investment Management Co, and Citadel Investment Group. Citadel was CME's original joint venture partner for the offering.

The volume of trades cleared through the CME offering may initially be light due to the December holiday season, making it hard to judge the success of the offering until next year, said McPartland.

The CME will clear credit default swaps protecting the debt of a single issuer in addition to indexes, Craig Donohue, chief executive officer at the exchange, said in the release.

A group of fifteen of the largest derivatives dealers told regulators in June that they would offer buy-side market participants access to all viable clearing credit default swap solutions by Dec. 15. (Reporting by Karen Brettell and Jonathan Spicer in New York; Additional reporting by K.T. Arasu in Chicago; Editing by Kenneth Barry)