The Chicago Mercantile Exchange and Citadel Investment Group see an opening in the sprawling and unregulated credit-default-swap market, their interest fueled by a growing awareness of the enormity of the space. With this awakening, arguments against regulation have faded, and interest in some form of market standardization, at least, has risen.
“Two weeks ago, market participants and other folks were screaming about potential regulations,” says Robert Claassen, a New York–based partner with global law firm Paul, Hastings, Janofsky & Walker. “Now everybody gets that they have to have a platform and wants it, and that is where the market is headed.”
Enter the CME and Citadel, a $20 billion hedge fund firm, with their proposal for a central clearinghouse and electronic trading platform for the CDS market, whose size is almost too big to fathom (see “The Number”).
The idea is to offer complete “novation” in which the clearinghouse acts as buyer to the sellers and as seller to the buyers — as a guarantor, in other words, so that neither side is a direct credit risk to the other. The CME and Citadel have set aside for themselves part of the equity in the venture and have invited major players in the CDS market to become founding members (in return for market-maker privileges).
A hindrance thus far to the creation of a clearinghouse has been a lack of uniformity among CDSs. Unlike a stock or a bond, a CDS is often uniquely tailored to a particular contract. The CME/Citadel project would offer standardization around single-name products — say, swaps for a company’s bonds.
Although CME/Citadel are first out of the gate, there is already competition. After the announcement, Atlanta-based Intercontinental-Exchange said it would team up with Clearing Corp., based in Chicago, on a similar offering. The potential is gigantic.
“Irrespective of who wins, you’ll see a migration toward a platform,” Claassen says. “I think it will happen very quickly because lots of folks want to get in on this.”
