Lots of movement toward a CDS clearinghouse

We noted recently that the respected research firm CreditSights suggested that buyers and sellers of credit defaults swaps would be best served if the market transitioned from an OTC system to an actual exchange. That would allow for more regulation of trades and a smoother clearing and settling process.  

CME and hedge fund firm Citadel have answered the call. They announced their intention last week to create an electronic marketplace with central counterparty clearing; they would like to launch the system within 30 days, which sounds aggressive. This effort would muscle in on the Clearing Corporation, a Chicago clearinghouse owned by big broker-dealers. Its effort has been delayed a bit recently, but the firm would still like to launch by the end of the year. Meanwhile, there has been speculation that the Intercontinental Exchange has designs on the market.  

The Fed has been aggressively proselytizing for such a move and will likely weigh in with some thoughts at some point. It will likely take an active role as these systems are set up. Already, Bloomberg reports that the Clearing Corporation's delay stemmed in part from a Fed push to persuade the firm "to obtain a banking license that would place it under the central bank's watch."  

The Fed may end up "blessing" a multiple venue approach. Clearly, automation and something close to STP is in the market's best interests. The CME-Citadel effort is interesting in that a well-regarded hedge fund aims to own the system; it has said it will sell ownership stakes to dealers. You've got to wonder how other hedge funds will view that. Some might argue that Citadel's ownership of the system is akin to Microsoft's ownership of the Windows OS. Some will always claim, even in the absence of evidence, that Citadel has some sort of advantage. This argument will be muted a bit if the CME and Citadel are successful in selling equity stakes to big Wall Street firms.   

The bottom line is that this is a huge financial opportunity. Perhaps competition is a good idea. - Jim